The Magic of the "Stretch IRA".

By: Ed Slott

Ed Slott, a CPA in Rockville Centre, N.Y., is one of America's top IRA experts. *

One of the single benefits in the tax code is the extended tax deferral of the inherited IRA, commonly known as the “Stretch IRA.” The stretch IRA is based on the concept of a designated beneficiary. The extended payout to an IRA beneficiary (the stretch IRA) is only available to a “designated beneficiary.” Under the IRS Regulations, a designated beneficiary is not a person or entity that you designate as your beneficiary by waving your magic wand or by naming them in your will. A designated beneficiary can only be a person (a human being) or people who are named as beneficiaries on the IRA beneficiary form. In some cases they can also be beneficiaries of certain qualifying trusts. This means that an entity like an estate, charity or non-qualifying trust (none of which are people) can never be a designated beneficiary. Even if a person eventually inherits through one of these entities, they can still never be a designated beneficiary so they cannot use their own life expectancy to extend required distributions and maximize the tax deferral on their inherited IRAs. They will be stuck following the required minimum distribution (RMD) rules that apply when there is no designated beneficiary. No designated beneficiary means no stretch IRA.

The only sure fire way to build wealth is to eliminate the government as a partner. The more you have to fork over in taxes, the less money you will have. The less you have to pay in taxes now, or the longer you can keep the taxman waiting for his money, the more time it will grow for you and your family and build a family fortune.

The stretch IRA is such an incredible way to build wealth that I wrote an entire book about it titled “Parlay Your IRA Into a Family Fortune” (Penguin 2005). I call the stretch IRA the great parlay of wealth allowed under the tax code.

Even though the benefit of the stretch IRA is totally for your beneficiaries, it has to be set up for them by you during your lifetime by naming them as your IRA beneficiary on the IRA beneficiary form and making sure the IRA custodial form from your financial institution allows the inherited IRA to be stretched over your beneficiary’s lifetime. You must set it up for them. They cannot get it on their own after you die if you have not set it up for them properly now.

The world won’t end if you don’t, but the IRS will likely get their mitts on your money very soon after you die with less building for your beneficiaries. The tax shelter of your IRA will end much more quickly than if your inherited IRA could continue to grow tax deferred (or even tax free with a stretch Roth IRA) over several more decades.

If your heirs are not designated beneficiaries and do not get to stretch your IRA over their lifetimes, they will be stuck with the rules that apply if you do not have a designated beneficiary. Those rules depend on whether you die before or after your required beginning date. Your required beginning date (RBD) on an IRA and most plans is April 1st of the year following the year you turn 70 ½ years old.

If you die before your RBD your beneficiaries must withdraw all of the funds in your IRA under what is known as the “5 year rule”.  This means that the entire inherited IRA must be distributed by the end of the 5th year following the year of your death and the tax deferral is gone forever. If you die on or after your RBD, then the payout to your beneficiaries (if they are not designated beneficiaries by being named on the IRA beneficiary form) will be your remaining life expectancy based on the IRS Single Life Table. Since the inherited IRA funds will be forced out much earlier than if they were stretched, the taxes your beneficiaries will pay will be higher and they will be paid sooner, building a savings account for Uncle Sam rather than your family.

The stretch IRA is mainly to benefit younger beneficiaries such as children and grandchildren. The younger they are, the longer their life expectancies and the greater the value the stretch IRA tax deferral will be on the inherited IRA.

Ed Slott, a CPA in Rockville Centre, N.Y., is a nationally recognized IRA distribution expert, professional speaker and author of several IRA books including the newly released Your Complete Retirement Planning Road Map (Random House; 2007) and Ed Slott’s IRA Advisor, a monthly IRA newsletter. Ed Slott has also created The IRA Leadership Program™ and Ed Slott’s Elite IRA Advisor Group™ developed specifically to help financial advisors, financial advisor firms and insurance companies become recognized leaders in the IRA marketplace. Visit his website at www.irahelp.com.