You may have heard from someone say or read somewhere mention of a, Stretch IRA, Multi Generational IRA or Inherited IRA. The Stretch IRA can be easy to set up and then your beneficiaries and mess their inherited IRA up.
To give a little history first… Prior to 2002 if you happened to leave behind an IRA, 401k or other type of retirement plan to anyone other than a spouse the only distribution option available for the beneficiary was to take a lump sum. Could you imagine if you had a household income of let’s say $100,000 and you inherited a $100,000, $200,000 or more IRA and you had claim that amount as income in one year? What would happen to your tax bracket? It would shoot to the top and 40% (federal and state) would go to Uncle Sam and you did not even write his name on the beneficiary form. Fortunately, the provision came about in 2002 that if you did everything right and your beneficiary did everything right, the majority of the IRA could continue to defer taxes. That can makes a huge difference. There are few, very BIG things to know in order for this to work though.
1. Check the “custodial” document to see if it permits the, IRA stretch provision.
2. Check the beneficiary form to see if allows the IRA stretch provision
3. Make sure a “living” person is named the beneficiary (you can’t name a revocable living trust).
4. When the beneficiary inherits the IRA, the account must be re-titled properly (ex. John Jones, deceased (date of death), IRA FBO Sam Jones)
5. A non-spouse beneficiary cannot roll the account assets into their own account or make contributions to the account.
6. If multiple beneficiaries inherit the IRA and each one wants to use their own life expectancy, the account must be split by 12/31 of the year after the account owner’s death.
7. Is there a need to force the beneficiaries to stretch the account? (ex. spendthrift beneficiary)
8. Make sure beneficiaries know how to implement the stretch. (unfortunately, most do not)
9. The Stretch IRA is not about the type of investment. It is making sure your beneficiary form is filled out correctly and your custodian will administor the Stretch IRA.
10. Most Beneficiaries do not Stretch their IRA. The main reason is, they simply do not know how. Make sure you have an IRA Estate Planner to guide the beneficiaries.
The goods news! It does not cost you anything to simply setup a stretch IRA. The bad news, a majority of beneficiaries don’t use the “stretch” provision. The main reason for this is, they simply do not know about it.