Key Points
Whether you've amassed 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 it will be necessary to use
all of that money to support yourself during retirement.
If the answer is "no" (or even "maybe not") then you'll need to
determine the most efficient way of leaving the account balance to
your heirs while simultaneously safeguarding your accumulated
wealth for as long as possible.
Stretch Strategy
For many Americans, transferring wealth with a multigenerational
"stretch" IRA is an ideal solution.
A stretch IRA is a traditional IRA that passes from the account
owner to a younger beneficiary at the time of the account owner's
death. Since the younger beneficiary has a longer life expectancy
than the original IRA owner, he or she will be able to "stretch"
the life of the IRA by receiving smaller required minimum
distributions (RMDs) each year over his or her life span. More
money can then remain in the IRA with the potential for continued
tax-deferred growth.
Creating a stretch IRA has no effect on the account owner's
minimum distribution requirements, which continue to be based on
his or her life expectancy. Once the account owner dies, however,
beneficiaries begin taking RMDs based on their own life
expectancies. Whereas the owner of a stretch IRA must begin
receiving RMDs after reaching age 70½, beneficiaries of a
stretch IRA begin receiving RMDs after the account owner's death.
In either scenario, distributions are taxable to the payee at
then-current income tax rates.
It's worth noting that beneficiaries also have the right to
receive the full value of their inherited IRA assets by the end of
the fifth year following the year of the account owner's death.
However, by opting to take only the required minimum amount
instead, a beneficiary can theoretically stretch the IRA - and
tax-deferred growth - throughout his or her lifetime.
If you do not currently have any IRA beneficiaries, employing the
stretch technique by naming a beneficiary could provide
significantly more long-term benefits than simply allowing the
account balance to be paid out to your estate as a taxable lump-sum
distribution - particularly if the value of the IRA causes the
overall value of your estate to exceed the lifetime estate tax
exclusion, currently $5 million. Note that this exclusion is
currently scheduled to be reduced to $1 million in 2013 unless
extended by Congress. Any amount in excess of the exclusion would
be taxable at estate tax rates, which top out at 35% in 2011 and
2012.
So if you're unlikely to deplete your IRA assets during
retirement, consider creating a multigenerational stretch IRA. By
doing so, you could minimize your own estate's tax burden while
also helping to build long-term financial security for a loved
one.
Added Perspectives
Your enhanced ability to stretch IRA assets is a direct result
of an IRS decision to simplify the rules regarding RMDs from IRAs.
The new rules allow beneficiaries to be named after the account
owner's RMDs have begun, and beneficiary designations can be
changed after the account owner's death (although no new
beneficiaries may be named at that point.) Also, the amount of a
beneficiary's RMD is based on his or her own life expectancy, even
if the original account owner's RMDs had already begun.
Consider the Implications
- The ability to name new beneficiaries after RMDs have begun
means that you can include a child in your stretch IRA strategy
regardless of when the child was born.
- 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 so that more assets pass
to another beneficiary. For example, if an account owner names his
son as the primary beneficiary and his grandson as the secondary
beneficiary, the son could remove himself as a beneficiary and
allow the entire IRA to pass to the grandson. RMDs would then be
based on the grandson's life expectancy, not on the son's life
expectancy, as would have been the case if the son remained a
beneficiary. (When there is more than one beneficiary, RMDs are
calculated using the life expectancy of the oldest
beneficiary.)
- The ability of beneficiaries to base RMDs on their own life
expectancy 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. (See example.)
Keep in mind that this information is presented for educational
purposes only and does not represent tax or financial advice. While
it's true that recent regulatory changes have indeed made it much
easier to incorporate a stretch IRA into your multigenerational
financial planning initiatives, it's always a good idea to speak
with a tax professional before implementing any new tax
strategy.
| Case in Point: 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 an 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 have been
withdrawn from the account during the 50-year time period.* |
| *For illustrative purposes only. Not indicative of any
particular investment. |
Points to Remember
- A multigenerational "stretch" IRA makes it possible for
individuals who do not expect to deplete IRA assets during
retirement to maintain the account's tax-deferred status and reduce
the amount of required minimum distributions (RMDs).
- This is accomplished by naming a younger individual as the
primary beneficiary. Because that individual has a longer life
expectancy, RMDs will be smaller and more money can remain in the
account with the potential to earn additional tax-deferred
investment returns for younger loved ones.
- Current IRS rules allow increased flexibility regarding the
timing of and changes to beneficiary designations.
- A primary beneficiary can extend the life of a stretch IRA even
longer, by disclaiming his or her beneficiary status and allowing
the entire account balance to pass along to an even younger
secondary beneficiary.
- Consult a tax professional before implementing your stretch IRA
strategy.
© 2011 McGraw-Hill Financial Communications. All rights
reserved.
