Taking Stock with George Shaw (6/10)

Whether you’ve accumulated assets in an individual retirement account (IRA) by making regular contributions through the years or by “rolling over” a lump-sum distribution from a workplace retirement plan, you may want to consider whether you’ll actually use all of that money to support yourself during retirement.

If the answer is “no,” then you’ll need to determine the most efficient way of leaving the money to your heirs. For many Americans, transferring wealth with a “stretch” IRA is an ideal solution.

What Is a stretch IRA?
A stretch IRA is not a specialized product, but rather a traditional IRA or Roth IRA that has language written into its documentation allowing for continued tax-deferred growth and distribution of IRA assets to primary and perhaps even secondary beneficiaries over a longer period of time. Without the presence of “stretch” language, assets remaining in an IRA may have to be distributed on a more aggressive basis upon the death of the IRA owner. The stretch IRA concept can be especially valuable to non-spousal beneficiaries who do not have the same ownership rights to IRA assets as do spousal beneficiaries.

Although the phrase “stretch IRA” has caught on, financial institutions offer IRAs with similar provisions under a variety of names including legacy IRAs, multi- generational IRAs, and perpetual IRAs. Keep in mind that even when different financial institutions use the same terminology, they can mean slightly different things, so you need to look closely at the fine print.

Using a stretch IRA strategy has no effect on the account owner’s minimum distribution requirements (RMDs), which continue to be based on his or her life expectancy. Once the account owner dies, however, the primary non-spousal beneficiary—say a child or grandchild—may begin taking RMDs based on his or her own life expectancy. The ability of beneficiaries to extend the life of the IRA in this fashion means that the money you accumulate in your IRA and leave to heirs has the potential to last longer and produce more wealth for younger generations.

Consider the Implications: A Stretch IRA in Action
Assume that you leave a $100,000 IRA to a five-year-old beneficiary who has an estimated life expectancy of 77.7 years, according to current IRS life expectancy tables. If the account earned a hypothetical 8% average annual rate of return, its value could grow to $1.67 million by his or her 55th birthday. And that amount is on top of the nearly $790,000 in taxable RMDs that would be withdrawn from the account during the 50-year time period. This example is for illustrative purposes only and is not indicative of any particular investment. Past performance is no guarantee of future results. The efficiency of the stretch IRA assumes that you take the smallest amount of money at the latest time allowed, that tax laws do not change, and that there is no inflation and returns do not vary.

A More Flexible Stretch

The IRS also has relaxed provisions around when beneficiaries can be named and/or changed. For instance, the ability to name new beneficiaries after RMDs have begun means that you could include a child in your stretch IRA strategy, regardless of when he or she was born. Similarly, the ability to change beneficiary designations after the account owner’s death means that one beneficiary may choose to “disclaim” his or her own beneficiary status in order to allow assets to pass to a secondary beneficiary, such as a child or grandchild.

There is also more flexibility for multiple beneficiaries. If more than one beneficiary inherits an IRA, distributions can be based on the life expectancy of the oldest beneficiary, or the IRA can be divided into separate accounts, allowing each beneficiary to use his or her own life expectancy for the purpose of taking distributions. While it’s true that regulatory changes have made it much easier to incorporate a stretch IRA into your financial planning initiatives, it’s always a good idea to speak with a financial professional before implementing any new strategy.