Inherited IRA: Stretching the power of an IRA
Most people are aware of the value of IRA’s as a retirement asset. Traditional IRA accounts accumulate interest and income on a tax-deferred basis while Roth IRA’s compound tax-free. Each help to build retirement wealth. For those that may not use their IRA for retirement, it can be a great estate planning tool. You can use the tax-advantages to benefit your children or other beneficiaries. Essentially, you “stretch” the power of your IRA.
How does the “Stretch” work?
Whether you stretch your IRA out or not is dependent upon who is named as the beneficiary. Generally, you name a beneficiary younger than you, for example, your children or grandchildren.
Often times, people name their spouse as beneficiary. This approach allow him or her to make elections upon your death such as electing to roll the funds into their own IRA account. This allows the funds to continue to grow on a deferred or tax-free basis until needed or your spouse is required to take required minimum distributions (“RMD”). (Note that RMDs don’t apply to Roth IRAs while the participant is alive.)
If you name someone other than your spouse as beneficiary, he or she generally will have several options:
- Take a lump-sum distribution of the IRA’s balance.
- Withdraw the funds by the end of the year of the fifth anniversary of your death (if you die before beginning to take RMDs).
- Withdraw the funds over your “remaining” life expectancy, calculated under the applicable IRS table as of the year of death (if you die after beginning to take RMDs).
- Hold the funds in an “inherited IRA,” which allows the beneficiary to spread RMDs over his or her own life expectancy.
Usually the inherited IRA is the best choice because it maximizes the benefits of tax-deferred or tax-free growth.
Naming a trust as beneficiary
If you have any concerns about the financial acumen of a potential beneficiary, naming such person may not be the best idea. As a named beneficiary, they will generally be able to take the lump sum option noted above, which eliminates the potential benefits of a stretch IRA.
A trust may be something for you to consider in this situation. It is named as the beneficiary of your IRA, while directed to provide funds to your beneficiary. Because the trust is the beneficiary, not the individual, you are able to control how funds are used and distributed. In order for a trust to qualify for stretch treatment, it will need to meet certain requirements, such as distributing RMDs received from the IRA to the trust beneficiaries.
Estate Planning Kansas City is an estate planning attorney in Overland Park providing wills and trusts to those in Leawood, Lenexa, Olathe, Prairie Village, Roeland Park and Shawnee and now serving Parkville, Riverside and North Kansas City from our Briarcliff Office. Each situation is different and this article is intended for informational purposes only and should not be taken as legal advice. The choice of a lawyer is an important decision and should not be placed solely upon the base of this post.