An IRA in and of itself provides for the significant benefit of tax-deferred growth during the owner's lifetime. The funds in the IRA are only taxed when they are removed. They can be removed and used without penalty beginning the year the owner turns 59½. Later on, during the year that the owner turns 70½, the IRS requires withdrawal of a Required Minimum Distribution. For most participants, this first distribution is equal to 3.65% of the IRA’s value, with the percentage distribution required to be distributed by the IRS rising as they age.
What many individuals don’t realize is that the benefits of tax-deferred growth can extend to an individuals’ heirs through a Stretch IRA (more formally called an Inherited IRA). The IRA can become a Stretch IRA without significant effort on your part; it’s part of the tax law. Upon death, the specifically named heirs will inherit the IRA as an Inherited IRA and take distributions over their lifetime based on their age. They also may pass the IRA on a third time, to their heirs who must take distributions based on the second owner’s remaining life expectancy.
As mentioned, significant planning does not have to take place to accomplish this, but one important step must take place, the naming of a beneficiary. So that old 401k, that might or might not have a beneficiary, must be reviewed to ensure that one is in place. Many people choose to consolidate these plans over time, to make things easier to keep track of and in order to simplify their affairs for the benefit of their heirs. IRAs with entities, such as trusts set up as beneficiaries, must be reviewed by a qualified attorney to ensure that the specific trust can inherit an IRA.
For certain individuals a Stretch IRA does not have as much benefit. For example, if your heirs are in a high tax bracket and you are not, you might benefit from taking larger distributions or converting your IRA to a Roth IRA during your lifetime, and passing on the after-tax dollars to your heirs.
As a planning focused firm, we welcome the opportunity to work through these important decisions based on your individual situation with you, your heirs, and your attorney. We are uniquely qualified to help you make these decisions based on our experience and being part of a regional accounting firm, Dixon Hughes Goodman LLP.
Please review the attached article from the AICPA that details some of the specific rules surrounding stretching your IRA.