Many times, people do not outlive their retirement accounts. This means that there are funds still left in the accounts when the owner passes away. Of course, this means their retirement accounts did their job in providing the funds necessary for the owner to live on during retirement. But it also leaves some questions for the beneficiaries.
Fortunately, there are ways to make sure your IRA funds can provide income to your heirs in the event that you pass away before you deplete your assets during your golden years. One of the best ways to do that is to transfer your funds using a multi-generational stretch IRA to one or more of your heirs.
What is a Stretch IRA?
When you establish a stretch IRA, you are basically naming someone younger than you as the beneficiary to take advantage of the IRS rule that says a beneficiary can take out minimum distributions from an inherited IRA over his or her anticipated life expectancy instead of being required to take out all of the funds within a specific time frame, usually five years after the death of the account holder.
With a stretch IRA, you can:
- Name beneficiaries after you begin taking the required minimum distributions (RMDs) from your own account.
- Change beneficiary designation following the account owner’s death
- Receive RMDs as a beneficiary that are based on that person’s life expectancy rather than the account owner’s life expectancy.
The key to making this kind of IRA work for your heirs is to designate a beneficiary that is significantly younger than you are. This way, your account balance can be stretched out for as many years as possible, creating an income stream for your beneficiaries that can last for a significant amount of time. In addition, the money that remains in the account minus the RMDs will continue to build tax-deferred growth, meaning that even more money can be stretched out over the years.
How Does Stretching Your IRA Affect You?
As the account holder, you can choose to stretch your IRA without any impact on your RMDs. You will continue to receive your minimum distributions that are calculated on your life expectancy, as you are required to begin taking distributions once you turn 70 ½ years old. However, if you die, your beneficiary will begin taking his or her RMDs that have been calculated on his or her life expectance. Your beneficiary does not have to wait until he or she turns 70 ½ to begin taking distributions.
You should know that your beneficiary does not have to abide by the stretch IRA rules if he or she does not want to. He or she has the option to receive the full value of the inherited IRA by the end of the fifth year following your death. However, having the option to stretch your funds can give him or her peace of mind in knowing there will always be an income source available to him or her if it is needed.
Benefits of Stretching an IRA:
Other than providing a steady income source for your heirs, there are other benefits to stretching your IRA as well. These include:
- Being able to include a child as a beneficiary no matter when the child was born.
- Being able to change the beneficiary after the account owner’s death means that your beneficiary can choose to pass on your assets to another beneficiary. For instance, if you name your daughter as the primary beneficiary of your account and your granddaughter as a secondary beneficiary, your daughter can choose to allow your funds to transfer directly to your granddaughter. This means the RMDs would then be calculated on your granddaughter’s life expectancy instead of your daughter’s life expectancy, thereby providing an income stream for a longer period of time.
- Being able to calculate RMDs on the beneficiary’s life expectancy. This means that your IRA funds could potentially be a source of income for many generations to come.
Example of the Stretch IRA Strategy:
Here’s how stretching your IRA could provide an income for not only your heirs, but for beneficiaries down through the years.
You have an IRA worth $100,000. You leave that account to your five-year-old grandson who has an estimated life expectancy of 77 years based on the IRS life expectancy tables. If the account grows by an average of 8 percent each year, your grandson could have an account worth $1.67 million by the time he reaches the age of 55.
That’s not all, though. By the time he turns 55, he will have received approximately $790,000 in RMDs over that time frame. Of course, this is only an example. Your particular situation will depend on a variety of factors including the amount of money you have in your account, the age of the person you leave it to, and the rate of return of your account.
If you do not anticipate using all of your IRA funds for retirement, stretching out the RMDs by leaving your account to a younger heir can protect your loved ones for many years after you have passed on. Your beneficiaries will be grateful and you can have the peace of mind in knowing they will be financially taken care of for decades to come.
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