One of the primary benefits of an Individual Retirement Account (IRA) is the ability to defer taxes. The longer the deferral the faster the IRA will grow. The idea of “stretching” your IRA is c concept that has been talked about and utilized for many years. The “Stretch” Concept is a wealth transfer technique that may allow the benefits of an IRA to stretch across several generations.
The IRA is the governments way of allowing us to save for retirement. But, the IRS still wants its fair share. As we know, they require us to start taking distributions at age 70 1/2. Because all distributions are taxed and may cause the IRA owner to go into a higher tax bracket, most IRA owners take the least amount out of their IRA when forced to take distributions. This is called the Required Minimum Distribution (RMD).
When we refer to the “Stretch”, we mean only the RMD is taken each year by the account owner and their designated beneficiaries thereby extending the period for maximum deferral. When someone is only taking RMD’s, it is most often a situation when the person has other sources for current income so they do not need the RMD’s for living expenses.
Here is how it works- each situation is different and should reflect variables such as marital status, age of spouse, number of children and financial status. But in general the IRA owner should:
- Name the spouse as primary beneficiary
- Name children/ grandchildren as contingent beneficiaries
- Ultimately divide the account into separate accounts before the IRA reaches the contingent beneficiaries.
If the IRA is divided into separate accounts for each beneficiary by December 31 of the year after the IRA owner’s death, each beneficiary can use his life expectancy to compute the new RMD’s. Using the younger ages of the beneficiaries means smaller distributions and a “stretching” of the asset for a much longer time.
A “stretch” IRA can provide many benefits for a beneficiary. It may provide lifetime income to the beneficiaries. By withdrawing smaller amounts over a longer period of time, there is a great potential to pay lower taxes. In addition, the continued tax dereffed growth of the account can increase the wealth passed to heirs.