When you’re thinking about your retirement savings, you may have wondered how you could pass your
money on to second- and even third-generation beneficiaries. A stretch IRA might be the solution you
A stretch IRA isn’t an entirely different type of IRA. Instead, it’s a provision you can add to your current
IRA whether it’s a traditional IRA, Roth, SEP, or SIMPLE IRA. A stretch IRA allows your IRA to continue
to grow tax-deferred indefinitely because it can be passed from generation to generation.
How to Make a Stretch IRA
To be a stretch IRA, the IRA needs to have two provisions. First, the IRA should allow you to designate a
beneficiary who can elect to receive distributions based on a life-expectancy period. Second, the IRA
should allow the beneficiary to select a second- or third-generation beneficiary. This is the provision that
essentially makes it a stretch IRA.
To avoid an excess accumulation penalty, the primary beneficiary must withdraw a minimum amount
each year based on the beneficiary’s life expectancy. The life expectancy of a 48-year-old beneficiary is
36 years, so there would be a $5,000 minimum required distribution on an $180,000 IRA. If that
beneficiary passes away prematurely, the second-named beneficiary would continue receiving
distributions based on the previous 36-year life expectancy.
The distributions could be stretched out even further if the original IRA owner named a second- or third-
generation beneficiary from the start. For example, a 20-year-old beneficiary has a life expectancy of 63
and would receive a minimum $2,857 distribution for 63 years instead of the 36 years in the previous
Benefits of a Stretch IRA
Without the stretch IRA provision of making minimum
distributions based on life expectancy, beneficiaries will
have to receive distributions over a five-year period. In
five years, all the IRA savings must be distributed.
(This rule applies when the IRA owner dies before his
required minimum distribution date, which is April 1 the
year after he turned 70 1/2.)
This five-year IRA rule can present problems. The
beneficiary may not need all the extra income from the
IRA right away. Additionally, accepting higher
distributions could increase the beneficiary’s taxable
income and push him into a higher tax bracket. When
that happens a large percentage – up to 40% in some
cases – of the IRA could be lost to federal and state income taxes.
A stretch IRA keeps your assets in the hands of your family and loved ones rather than your estate
trustee who will likely pay out the IRA immediately, eliminating the possibility for future tax-deferred
You can make your beneficiary a millionaire. Assuming a 6% rate of return, a $150,000 IRA can pay out
more than $1 million over 55 years. The younger the beneficiary, the greater the life expectancy, and the
longer the IRA has to grow.
A stretch IRA might be good for you if you won’t need the money in your IRA even after you retire. You
must take the lowest amount possible (your required minimum distribution) at the latest age possible
(when you turn 70 ½.)
Stretch IRA Watchouts
Unfortunately, tax laws aren’t guaranteed for the next 60 years, so benefits of a stretch IRA are subject to
changes in the tax law. At any point in the future, the IRS could change the rules regarding named IRA
beneficiaries and minimum required distribution levels.
Your average rate of return should remain fairly constant to receive the highest earnings on your IRA. A
fluctuating rate of return will decrease IRA earnings, which means your beneficiaries may not become
millionaires, but they still get the advantages of tax-deferred growth from your IRA contributions.
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What is a Stretch IRA?
Most individuals utilize Individual Retirement Accounts
for retirement income, but there are alternative methods
of use. Here's how a stretch IRA can be passed from
generation to generation.