If you're looking for ways to pass on retirement savings to next generation beneficiaries, consider a stretch IRA. Simply put, a stretch IRA isn’t another type of IRA but a provision that can be added onto an existing plan whether a Traditional, Roth, SEP or SIMPLE IRA (S
an for E
mployees). With the stretch IRA provision, your funds can continue to grow tax-deferred. So that money can be passed from one generation to the next.
How a stretch IRA works
Just as the name implies, a stretch IRA is a wealth transfer method that enables you to stretch your IRA over future generations of beneficiaries. To create a stretch IRA, your IRA needs to have a designated beneficiary and allow that beneficiary to select second and third generation beneficiaries. To avoid penalties, your primary beneficiary needs to withdraw a minimum amount each year based on their life expectancy. Distributions would continue to stretch and pass on from each named beneficiary. For life expectancy charts and minimum distribution requirements, visit the IRS site.
The benefits of a stretch IRA
- Keeps assets in the hands of family and loved ones rather than an estate trustee
- Beneficiaries can potentially inherit large sums the longer the IRA has to grow
- Good way to pass on money if you're not depending on your IRA for retirement
Things to consider
- Not all IRAs allow the naming of second and third generation beneficiaries.
- Distributions from Traditional IRAs are taxed as ordinary income. Additionally, distributions prior to age 59½ are subject to a 10% federal income tax penalty. This rule does not, however, apply to IRA beneficiaries, who must begin taking minimum distributions no later than December 31 of the year following the original IRA owner’s death.
- Beneficiaries have the flexibility to liquidate the account at any time after inheriting the IRA assets; this would discontinue the stretch strategy.
- The strategies discussed are based on current tax law. If these laws change in the future, there is no guarantee that estimated distributions would occur as expected.
- Distributions over a long period of time expose an investor or heirs to potentially significant market risk.