|
Submitted by: Jeremy E. Portnoff
Jeremy Portnoff is an independent fee-only financial advisor who specializes in retirement plans and retirement income distribution planning.
Perhaps you have heard of the "Stretch IRA." You might wonder, "where might I open one of these retirement accounts? Well, the answer is nowhere, because they don’t exist. There is no IRA officially named as a "Stretch IRA." The "Stretch IRA" refers to the ability to stretch inherited IRA funds over a beneficiary's own life expectancy. In fact, every IRA can be a Stretch IRA.
The concept for a stretch IRA is simple. It is a rule in the tax code that allows a named beneficiary to spread out required post-death distributions over the beneficiary’s own life expectancy according to the IRS Single Life Expectancy Table. For example, a $100,000 IRA inherited by a 1-year old could have cumulative lifetime distributions in the amount of $8,167,545 assuming a reasonable 8% annual investment return. Click here to see the full example. The reason the account grows so much is simple. Let’s consider another example. According to the IRS Single Life Expectancy table, the remaining life expectancy of a 33-year old is 50 years. This means the first required minimum distribution would be 1/50th of the account, or 2%. If the account earns 8%, then the additional 6% is re-invested and the account continues to grow. This is an incredible way to parlay your life savings into significant wealth for your beneficiaries.
Sounds great, however many IRA owners and beneficiaries make simple yet easily correctable errors that prevent them from taking advantage of this wonderful part of the tax code. So what do I need to do to get this “Stretch” IRA you might be wondering? Under the new IRS rules, it is very easy to get the stretch. The primary action that guarantees the stretch is simply to name a person (or qualifying trust) as a beneficiary. This is why I said that every IRA can be a Stretch IRA. Sounds simple right? Not so fast.
The sad truth is that even though the IRA rules now state that any IRA can be a stretch IRA, most IRA’s will never live to be Stretch IRA’s. There are several important points that can be easily overlooked. For example, the most common mistake is the IRA owner doesn’t designate a beneficiary. A Designated Beneficiary is any human person with birthday that can fog a mirror. It’s that simple. Most people ignore this or think someone else took care of it or it’s covered in the estate plan or the will or somewhere. For most people it isn’t.
Common beneficiary form mistakes can include: not naming a beneficiary; naming the estate as the beneficiary assuming it will pass according to the will; mixing non-human charitable beneficiaries with human beneficiaries; naming non-qualifying trusts; not receiving confirmation from the custodian of receipt of the beneficiary form and finding out when it’s too late that they don’t have it on file or it’s blank; not updating the beneficiary form for life changes such as marriage, birth, death, divorce, etc.; not having the form and assuming the bank or custodian has it; and many others.
Properly titling the IRA for the stretch and doing proper transfers is a big area for uncorrectable mistakes as well. Upon death, the IRA needs to be re-titled as an Inherited IRA. Many errors happen at this stage. The key point is that if the money is withdrawn from the IRA in any way other than a “Direct Transfer” or “Trustee-to-Trustee Transfer” then the IRA is blown, the Stretch is lost, and there is no going back. This is the worst outcome because not only is the tax deferral of the IRA lost, but also the entire IRA becomes immediately taxable as ordinary income to the beneficiary in that single year. It’s a great way to see years of savings evaporate in an instant, if that is what you want with your life savings that is.
This happens frequently when an advisor or custodian mistakenly transfers the funds into a brokerage account or the beneficiary’s own IRA. The reason there is no going back is that a non-spouse cannot do a rollover. In order to preserve the stretch, the money needs to be in a properly titled inherited IRA and the beneficiary must never take constructive receipt of the funds. A properly titled IRA would be something similar to the following: “John Doe IRA (deceased) FBO John Doe, JR., beneficiary.”
Finally, everything may be in order to take advantage of the Stretch, but what if the custodian doesn’t allow it? This is a critical area as well. An IRA custodial document is like the rule book for the IRA and will dictate how a beneficiary can inherit. Simply put, the custodial document could render beneficiary instructions useless if the IRA does not allow the stretch. As unbelievable as it might sound, there are still some that don’t. For example, it is possible that the IRA could force a distribution to the beneficiary if they don’t allow beneficiaries to do a “Trustee-to-Trustee” transfer, or the IRA could require the account to be distributed according to the five-year rule. We will explore the IRA Custodial Document at a later date.
The “Stretch IRA” is such a powerful way to preserve family wealth. Unfortunately, this benefit in the tax code is often not taken advantage of because either the IRA owner doesn’t know about it, or common mistakes shut the door on the Stretch. Don’t let this happen to you and your family!
For information on The Complete IRA Care Solution™ and a 14-point IRA Beneficiary Form Review, call my office to schedule an appointment.
> Return to IRAs |
Authored by the
founder of the
PaladinRegistry