“Stretch” IRA’s

When it comes to retirement planning, many people must decide whether to leave their assets in their employer’s plan or rollover them into an IRA. One of the benefits to an IRA includes a provision known as the Stretch IRA.

What is a "stretch" IRA?

The term "stretch IRA" has become a popular way to refer to an IRA that has provisions that make it easier to "stretch out" the time that funds can stay in the IRA after the death of the owner. A stretch IRA is not a special type of IRA under the Internal Revenue Code. It's just a traditional IRA or Roth IRA that has language giving a beneficiary the option to take distributions from an inherited IRA over their life expectancy. This language also allows a successor beneficiary to be named, facilitating the continued tax-deferred growth of the IRA over (possibly) more than one generation.

There's nothing dramatic about this "stretch" language, because any IRA provider can include it. The fact is, though, many do not. Absent the "stretch" language, IRA funds might have to be distributed on a more aggressive basis upon the death of the IRA owner or the original beneficiary.

Why is "stretching out" IRA distributions important?

Earnings in an IRA grow tax deferred. Over time, this tax-deferred growth can help individuals accumulate significant funds within their IRAs. For individuals fortunate enough to have adequate funds to support themselves in retirement without the need to tap into their IRAs, continuing this tax-deferred growth for as long as possible may be a priority. These individuals may want their heirs to benefit to the greatest extent possible from this tax-deferred growth as well.

Example(s): John, age 60, has $500,000 in an IRA. John has non-IRA funds that are adequate to provide for a comfortable retirement, and doesn't want to take any funds from his IRA unless he is required to do so. John names his spouse, Jenny, age 50, as beneficiary. Together they agree should John die, Jenny will not take any distributions from the IRA unless required, leaving the IRA to their grandchildren. John dies 10 years later. His IRA is worth $895,424 at that time (it has grown 6 percent per year). Jenny rolls over the funds to a new IRA in her name, and does not take a distribution until she is required to at age 70 1/2. By then, the IRA has grown to $1,603,568 (again, growing at 6 percent per year).

You can only stretch so far

How long funds can stay in a tax-deferred IRA, is limited by the required minimum distribution rules.

Required distributions during the IRA owner's lifetime

Lifetime required minimum distributions, RMDs or minimum required distributions, are amounts the federal government requires you to withdraw annually from a traditional IRA after age 70 1/2. You can always withdraw more than the annual minimum amount from your IRA, but if you withdraw less than the required minimum in any year, you will be subject to a federal penalty. These RMDs are calculated to dispose of your entire interest in the IRA over a specified period of time. The purpose of the RMD rules is to ensure that people use their retirement accounts to fund their retirement and not simply as a vehicle of wealth transfer and accumulation. This is true for all traditional IRAs, whether or not they have "stretch" provisions.

In fact, lifetime required minimum distributions can be spread over a significant period of time. Depending upon the performance of the investments within the IRA, it is possible for an IRA to continue to grow in overall value for a number of years, despite required distributions.

Bryant R. Filter is President of Filter & Associates located at 153 Perry Hwy. Suite 101 Pgh., Pa. 15229. They can be reached at 412-459-0203 or www.filterandassociates.com