Hyers & Associates

Stretch IRA Planning

In January of 2002 the I.R.S. made significant changes to the tax treatment of Individual Retirement Accounts in order to simplify the distribution and inheritance process. While the new rules are not entirely simple, they do include many benefits to those who defer income using IRAs and similar tax deferred vehicles for retirement.

Lower Your Taxable Income

When used properly, these new techniques can save families tens of thousands of dollars in taxable income and can also provide income to future generations. Also referred to as a beneficial or multi generational IRA, the “Stretch IRA” is a tax favored vehicle that can continue to provide income for a spouse, one’s heirs or even a favorite charity after the owner has passed away.

Unfortunately, many consumers and advisors do not understand the intricacies of this new retirement plan. While there are different factors that will adjust the distribution of an IRA at passing, it is important to touch upon the most common beneficial plans. Upon their death, most investors simply want to leave their tax-deferred accounts to a spouse and then their children with all possible income tax benefits.

Spousal Options

The owner’s spouse will have the most options with IRA dollars. A surviving spouse can roll the funds over into his or her own name and combine these funds with an existing IRA. If the spouse has not attained the age of 70½ then no distributions are required. A spouse with no need of the IRA dollars might disclaim these funds, opting to pass them on to the children. If the children are minors, it may be wise to consult an estate planning attorney to protect against an early lump sum payment.

On the other hand, if the spouse has not reached the age of 59½ and is in need of income, then he or she might choose to become a beneficiary of the IRA account instead of its owner. At this point the IRA begins to “stretch.” As a beneficiary, the spouse will be required to take a minimum distribution based on his or her life expectancy. This is advantageous because income is provided, but the spouse is not required to cash in the IRA and pay income taxes on the entire amount. Thus, a large taxable event will be avoided.

Children as Beneficiaries

In the event that children are the beneficiaries of the owner’s IRA, the rules change slightly. While children cannot combine the inherited funds with their own retirement plans, they can choose to stretch the payments based on their own life expectancies. Children named as beneficiaries have until September 30th of the year following the owner’s passing to divide the account as stated by the plan. For instance four siblings named as equal beneficiaries of their mother’s IRA would divide the account into four equal beneficial IRA accounts. At that time, they will take a distribution based on their own life expectancy and thus continue to defer the majority of the taxable income.

This may be the most valuable aspect of the new rules, especially if your deferred plan is of significant value and your children are wage earners. By stretching the IRA, the children have avoided losing a larger portion of the IRA to income taxes. When the children only take out their required minimum distribution, (the younger you are, the smaller the distribution) they have avoided entering higher tax brackets on all earned income for that year. (See Table 3)

IRS Regulations

There are uniform tables used to calculate distributions for IRA owners and their beneficiaries. If your spouse is no more than ten years younger than you, a single table is used to calculate your required minimum distribution. (See Table 1) A second table is used if your spouse is more than ten years your junior. These tables will determine your required minimum distribution at age 70½ based on your life expectancy. As life expectancy grows, the I.R.S adjusts these divisors from time to time in order to reflect the fact that people are living longer.

With proper planning and advice, the “Stretch IRA” can be an extremely valuable and essential part of your estate plan. It is important to work with knowledgeable advisors in order to protect IRA dollars from income taxes as well as other market risks. This way, the owner, spouse and any beneficiary can benefit substantially from deferred plans without creating a taxable windfall to the Internal Revenue Service.

Contact us today for assistance with beneficial IRA accounts.