What is a Stretch IRA?
A Stretch IRA is a way to take an IRA and stretch the deferred earnings over the course of many years. Many times it is used to “stretch” that term over the course of generations. When the original owner of an IRA dies, and they have established a stretch IRA, the beneficiaries are allowed to keep that money in the IRA instead of having to take a lump sum right away and pay all the taxes up front. The beneficiaries will have to take required distributions that are defined by the plan so beneficiaries of such a plan should be informed prior to receiving the IRA from an estate so they can be prepared.
Do you need a Stretch IRA?
Before you decide to get a Stretch IRA you need to take into account your goals and decide if it is the right option for you. Most people that would use this type of IRA are those that are going to have more money than they can spend while they are alive. If there are no plans in place, the beneficiary would have a major tax payment due when they inherit a traditional IRA in the year they receive it. They would get a lump sum payment and is would be part of their income! A Stretch IRA allows your beneficiaries to spread that tax burden over a course of years so that the tax hit is minimized. This also allows the money to keep accumulating tax free while it is still in the plan. As always, you will want to discuss the situation with your financial adviser so that you have looked into all the possible options for your personal situation.
Setting up a Stretch IRA
1. Review your personal situation. You must make sure that you have all your bases covered before committing to such a plan. Make sure that your insurance for a long-term health stay is in place, any possible medical expenses would be taken care of, and that any emergency is looked at and reviewed just in case.
2. You must first look at your beneficiaries and what their needs may be. It may actually be more beneficial to them that you give them the lump sum payment as you want to help them pay off a large debt that they wouldn’t be able to do if they were forced to stretch that payment over a number of years. Though it may make sense to lower the current tax burden for your beneficiaries, it may not be in their best interest to do so due to them having a need for the money right away. Many of those that want to leave money after their death do not discuss their intentions with the beneficiaries. In some cases this may be important as you don’t want them to know, don’t want to deal with family squabbles while alive, or it just isn’t all that important. If your beneficiaries are more level-headed and you want them to get the best benefit possible, it should be a priority to discuss your intentions with them while you are still alive.
3. Talk to your financial advisor. Your advisor will need to put together the appropriate documents should the two of you decide this is your best option. Your advisor just may be able to recommend a better solution as well, or at the very least be able to set this up the best way possible. If you have several beneficiaries you may need to set up more than one account for them so that you can mark what percentage each is entitled to.
Possible Negatives for a Stretch IRA
1. If you think you may actually need this money during your life there is no benefit to a Stretch IRA. As I mentioned int he last section, it is very important to review your own situation before committing to any such plan.
2. Tax law changes. It is important to understand that tax laws change over the course of our lives. Although most situations are correctable when a law changes this is something to consider.
3. This point is so important that I will mention it again. If you think there is going to be any need during your life-time for this money then you do not want a Stretch IRA.