Advice from Labib: Stretch IRA
Advice from Labib
You may have heard the term "stretch IRA" being used in the financial services industry along with "multi-generational IRA" and "perpetual IRA." What is a stretch IRA? Does it last forever? Can any financial organization offer stretch IRAs? Is a special IRA agreement necessary to establish a stretch IRA?
What is a Stretch IRA?
A stretch IRA is not a special type of IRA created by Congress. There are no special IRA agreements that establish stretch IRAs but a financial organization may want to add language to its current IRA agreements to enable stretching.
The term "stretch" here refers to a method for extending the duration of traditional and Roth IRA beneficiary distributions to certain successor beneficiaries, beyond the death of an original designated beneficiary-a method especially valuable to a non-spouse beneficiary.
After an IRA owner's death, a spouse beneficiary can treat an IRA as his/her own if he/she is the only beneficiary. If there are multiple beneficiaries, a spouse beneficiary can always take a distribution of his/her share in an IRA and roll it over to a personal IRA. Once the assets are in his/her own IRA, he/she can name his/her own death beneficiaries.
After an IRA owner's death, a non-spouse IRA beneficiary, under the final required minimum distribution (RMD) rules, generally takes RMDs based on his/her single life expectancy. An original beneficiary's death generally requires distribution of any remaining IRA assets in a single sum to his/her estate. With stretching, the duration of death distributions can continue to a series of successor beneficiaries beyond the death of an IRA's original beneficiary but not forever.
How Long Can Death Distributions Last?
The regulations prohibit a death distribution period from extending beyond an original non-spouse beneficiary's single life expectancy even though RMDs continue to successor beneficiaries. All beneficiaries base their RMD calculations on the original beneficiary's life expectancy, not on any life expectancy of any successor beneficiary. This calculation guarantees the depletion of an IRA's assets because the original beneficiary's life expectancy factor decreases each year, eventually reaching 1.0 or less, requiring a full distribution that year.
As the sole designated beneficiary of her mother's IRA, Rhonda chose to take distributions based on her single life expectancy. Rhonda named her son, Tyler, as the successor beneficiary of her mother's IRA.
At age 54 in the year after her mother's death, Rhonda's single life expectancy is 30.5 for the first year of her RMD calculation. As a non-spouse beneficiary, she will reduce this factor by one for each subsequent year's RMD calculation.
If Rhonda passes away after taking RMDs from her mother's IRA for ten years, Tyler can continue distributions based on Rhonda's reduced life expectancy factor of 20.5 at this point. Tyler can also name a successor beneficiary who, at Tyler's death, can continue the RMDs but based on Rhonda's reduced life expectancy factor at the time of Tyler's death.
Eventually the continued reduction of Rhonda's life expectancy factor will reach .5, requiring a full distribution that year of the IRA's remaining balance. The duration of the death distribution period to all beneficiaries does not exceed Rhonda's life expectancy factor the year after her mother's death of 30.5 years.
Had Rhonda not named a successor beneficiary, the remaining assets in her mother's IRA would have passed to Rhonda's estate after Rhonda died in a single sum distribution subject to income taxes if Rhonda's mother had a traditional IRA.
Can a Beneficiary Always Name a Successor Beneficiary?
The final RMD regulations imply the possibility and the model IRA agreements (IRS Forms 5305 and 5305A) do not deny the possibility of a beneficiary naming a successor beneficiary. However, for compliance comfort an IRA agreement or a financial organization's policy and procedures should contain specific language regarding successor beneficiaries.
A financial organization can adopt its own successor beneficiary policy in accordance with state law, its internal compliance requirements, and within the limitations of its IRA administration system. Professional legal guidance may be necessary to draft a policy and to ensure compliance with this attractive and convenient but potentially complex feature.
This policy could also require a unique or customized beneficiary designation form. In most cases, a beneficiary naming a beneficiary should not use a standard beneficiary designation form-one normally designed for use only by an IRA owner. To help financial organizations document a designation of a successor beneficiary, Bankers Systems Inc. has created the IRA Successor Beneficiary Form (Form IRA-SUC-BEN). For more information regarding this form, call 1-800-552-9410.
Why Stretch Distributions?
A non-spouse IRA beneficiary may want to name a successor beneficiary for the same reasons as an IRA owner-to pass distribution rights to a specific person allowing an IRA to accumulate additional tax deferred or tax-free income, and perhaps save tax dollars by avoiding single sum distributions when a beneficiary dies. A beneficiary should first determine if a deceased IRA owner's agreement permits the naming of a successor beneficiary and, before naming a successor beneficiary, seek the advice of his/her tax or legal professional to determine if this would be the best course of action for his/her personal financial plan. Call our office with any questions or if we can be of service.
Alfred Labib is an Independent Financial Advisor. "Our Goal Is To Help Investors Grow And Preserve Their Wealth Through Discipline And Process." 301-824-4523, www.labibfinancial.com.