| You
may have heard the term “stretch IRA” being used in the financial
services industry along with “multi-generational IRA” and
“perpetual IRA.” What is a stretch IRA? Does it last forever?
Can any financial organization offer stretch IRAs? Is a special IRA agreement
necessary to establish a stretch IRA?
What
is a Stretch IRA?
A stretch IRA is
not a special type of IRA created by Congress. There are no special IRA
agreements that establish stretch IRAs but a financial organization may
want to add language to its current IRA agreements to enable stretching.
The term “stretch”
here refers to a method for extending the duration of traditional and
Roth IRA beneficiary distributions to certain successor beneficiaries,
beyond the death of an original designated beneficiary—a method
especially valuable to a nonspouse beneficiary.
After an IRA owner’s
death, a spouse beneficiary can treat an IRA as his/her own if he/she
is the only beneficiary. If there are multiple beneficiaries, a spouse
beneficiary can always take a distribution of his/her share in an IRA
and roll it over to a personal IRA. Once the assets are in his/her own
IRA, he/she can name his/her own death beneficiaries.
After an IRA owner’s
death, a nonspouse IRA beneficiary, under the final required minimum distribution
(RMD) rules, generally takes RMDs based on his/her single life expectancy.
An original beneficiary’s death generally requires distribution
of any remaining IRA assets in a single sum to his/her estate. With stretching,
the duration of death distributions can continue to a series of successor
beneficiaries beyond the death of an IRA’s original beneficiary
but not forever.
How
Long Can Death Distributions Last?
The regulations prohibit
a death distribution period from extending beyond an original nonspouse
beneficiary’s single life expectancy even though RMDs continue to
successor beneficiaries. All beneficiaries base their RMD calculations
on the original beneficiary’s life expectancy, not on any life expectancy
of any successor beneficiary. This calculation guarantees the depletion
of an IRA’s assets because the original beneficiary’s life
expectancy factor decreases each year, eventually reaching 1.0 or less,
requiring a full distribution that year.
Example
As the sole designated
beneficiary of her mother’s IRA, Rhonda chose to take distributions
based on her single life expectancy. Rhonda named her son, Tyler, as the
successor beneficiary of her mother’s IRA.
At age 54 in the year
after her mother’s death, Rhonda’s single life expectancy
is 30.5 for the first year of her RMD calculation. As a nonspouse beneficiary,
she will reduce this factor by one for each subsequent year’s RMD
calculation.
If Rhonda passes away
after taking RMDs from her mother’s IRA for ten years, Tyler can
continue distributions based on Rhonda’s reduced life expectancy
factor of 20.5 at this point. Tyler can also name a successor beneficiary
who, at Tyler’s death, can continue the RMDs but based on Rhonda’s
reduced life expectancy factor at the time of Tyler’s death.
Eventually the continued
reduction of Rhonda’s life expectancy factor will reach .5, requiring
a full distribution that year of the IRA’s remaining balance. The
duration of the death distribution period to all beneficiaries does not
exceed Rhonda’s life expectancy factor the year after her mother’s
death of 30.5 years.
Had Rhonda not named
a successor beneficiary, the remaining assets in her mother’s IRA
would have passed to Rhonda’s estate after Rhonda died in a single
sum distribution subject to income taxes if Rhonda’s mother had
a traditional IRA.
Can a Beneficiary Always Name a Successor Beneficiary?
The final RMD regulations
imply the possibility and the model IRA agreements (IRS Forms 5305 and
5305A) do not deny the possibility of a beneficiary naming a successor
beneficiary. However, for compliance comfort an IRA agreement or a financial
organization’s policy and procedures should contain specific language
regarding successor beneficiaries.
A financial organization
can adopt its own successor beneficiary policy in accordance with state
law, its internal compliance requirements, and within the limitations
of its IRA administration system. Professional legal guidance may be necessary
to draft a policy and to ensure compliance with this attractive and convenient
but potentially complex feature.
This policy could
also require a unique or customized beneficiary designation form. In most
cases, a beneficiary naming a beneficiary should not use a standard beneficiary
designation form—one normally designed for use only by an IRA owner.
To help financial organizations document a designation of a successor
beneficiary, Bankers Systems Inc. has created the IRA Successor Beneficiary
Form (Form IRA-SUC-BEN). For more information regarding this form, call
1-800-552-9410.
Why Stretch Distributions?
A nonspouse IRA beneficiary
may want to name a successor beneficiary for the same reasons as an IRA
owner—to pass distribution rights to a specific person allowing
an IRA to accumulate additional tax deferred or tax-free income, and perhaps
save tax dollars by avoiding single sum distributions when a beneficiary
dies. A beneficiary should first determine if a deceased IRA owner’s
agreement permits the naming of a successor beneficiary and, before naming
a successor beneficiary, seek the advice of his/her tax or legal professional
to determine if this would be the best course of action for his/her personal
financial plan.
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