The “stretch” IRA: A simple yet powerful estate planning tool
The IRA’s value as a retirement planning tool is well known: IRA assets compound on a tax-deferred (or, in the case of a Roth IRA, tax-free) basis, which can help build a more substantial nest egg. But if you won’t need an IRA to fund your retirement, you can use it as an estate planning tool to benefit your children or other beneficiaries on a tax-advantaged basis by turning it into a “stretch” IRA.
Stretching the benefits
Turning an IRA into a “stretch” IRA is simply a matter of designating a beneficiary who is significantly younger than you. This could be, for example, your spouse (if there’s a substantial age difference between the two of you), a child or a grandchild.
If you name your spouse as beneficiary, he or she can elect to “roll over” the funds into his or her own IRA after you die, enabling the funds to continue growing tax-deferred or tax-free until your spouse begins withdrawing the funds in retirement, or must take required minimum distributions (RMDs) starting after age 70½. (Note that RMDs don’t apply to Roth IRAs while the participant is alive.)
A non-spouse beneficiary cannot use a spousal rollover, but s/he still has several options:
- Take a lump-sum distribution of the IRA’s balance.
- Withdraw the funds by the end of the year of the fifth anniversary of your death (if you die before beginning to take RMDs).
- Withdraw the funds over your “remaining” life expectancy, calculated under the applicable IRS table as of the year of death (if you die after beginning to take RMDs).
- Hold the funds in an “inherited IRA,” which allows the beneficiary to spread RMDs over his or her own life expectancy.
If the beneficiary does not need the funds immediately, the inherited IRA is often the best choice because it maximizes the benefits of tax-deferred or tax-free growth.
Naming a trust as beneficiary
A disadvantage of naming your child or grandchild as beneficiary of your IRA is that there’s nothing to prevent him or her from taking a lump-sum distribution, erasing any potential stretch IRA benefits.
To ensure that this doesn’t happen, you can name a trust as beneficiary. In order for a trust to qualify for preferable “stretch” treatment, it will need to meet certain requirements, such as distributing RMDs received from the IRA to the trust beneficiaries.
It’s important to remember that your IRA will pass directly to your designated beneficiaries. These funds are covered by the terms in your trust only if you have named your Trust as an IRA beneficiary.
Will the “stretch” IRA be included in tax reform?
Limiting the “stretch” IRA tax advantage was targeted in a 2016 tax reform proposal. It remains to be seen how this beneficial tool may be modified as part of this year’s tax reform legislation.
Contact our office for additional details about IRA beneficiary planning.