What is Stretch IRA?

A stretch IRA is a means to limit the distributions necessary for an older IRA, by avoiding the considerable collection of taxes in this process. Instead of designating the spouse as the beneficiary of the IRA, the account holder can designate children, grandchildren, or great-grandchildren. This extends the useful life of the IRA by continuing the deferred tax increase for years or decades over the life of the original owner. Let us explain:

How Stretch IRA works

Suppose you have been saving for retirement for decades. Maybe your IRA has reached six digits. You have a good job! If you don't expect to spend all of your IRA in retirement, you may be wondering how to make money last for your family. One of the strategies is to stretch the IRA.

The rules for inherited IRAs are distinctive for spouses and non-conjugal beneficiaries. As a couple who inherits an IRA, you can transfer funds to your IRA, or you can expect to make the minimum required distributions (RMD) until the deceased spouse reaches 70.5. If you have other income, you can expect to receive RMD so that the tax bill will be lower.

But what about beneficiaries who are not spouses? The IRS has stricter rules for non-marital heirs. These beneficiaries have three options:

• Take the money and run means clearing out all IRAs and paying taxes on that amount all at once. If you need money, this may be the best choice. However, be prepared for a substantial bill.
• Take RMD only

IRS requires that non-marital IRA beneficiaries of people over 70.5 years of age begin receiving RMD within one year of the IRA inheritance. These RMDs are based on the life expectancy of the recipients. 

• Cash in and empty your account for five years

There is no need to maintain a minimum of RMD or receive all IRA money at the same time. You can expect and receive the desired amount, but as soon as you start receiving distributions beyond the RMD, you must finish clearing the account within five years.

Why Consider Stretch IRA

The IRA function benefits from the fact that young beneficiaries have a lower RMD. With a stretch IRA, account owners name their grandchildren as beneficiaries. Wealthy people who know their husbands have enough money to survive can maintain and extend the wealth of their families by naming children, grandchildren, and great-grandchildren as beneficiaries of the IRA. These young parents take RMD, which is small enough to generate minimal taxes. The rest of the legacy account can continue to grow with deferred taxes and increase their value. It is a form of intergenerational asset transfer with serious tax advantages. Not all IRAs can stretch though; therefore, if you are considering this strategy, consult your IRA provider, or a financial expert.

If you feel uncomfortable bypassing your spouse as an IRA beneficiary, you can ask your spouse to stretch for you. With this strategy, name your spouse as the beneficiary of the IRA. Transform your IRA into an inherited IRA from your name to your spouse name, and start receiving RMD at 70.5 years of age. Your spouse appoints a member of the younger generation as the beneficiary of the IRA. When the spouse dies, the young beneficiary begins to enjoy the RMD described above.

Pros of Stretch IRAs

• A potential stretch ARI has provided lifetime income to a young beneficiary.
• The total tax paid may be lower due to smaller distributions over a more stretch period than a lump sum.
• The stretch gives the activities more time to develop without taxes, which increased the amount received by the beneficiaries.

Cons of Stretch IRAs

• A beneficiary may not have an average life expectancy.
• Changes to laws or regulations can have adverse effects on the owner or beneficiaries, as happened with the approval and signing of the SECURE Act on December 20, 2019.
• If a beneficiary is a minor, it may be necessary to create a deposit account.

Baseline

When considering your estate planning needs and strategies, consider this rule: the more you have, the more you should plan to limit your family's tax obligations. Many families feel lucky if they can retire. More and more people are still struggling with student debt in their heyday. If you are fortunate enough to retire with a lot of money, you are living the dream.

To better your chances of realizing a comfortable retirement dream, consider working with a financial advisor. Industry experts say that people who work with a financial advisor are twice as likely to reach their retirement goals.