If you’ve ever wondered how far your self-directed IRA can stretch, the answer is probably further than you think. The answer is also probably different than you’re expecting. IRAs can be passed from one generation to the next enjoying tax-deferred status and accruing value the entire time.
This strategy, known as an IRA stretch, allows generation after generation to accumulate capital using an IRA established by the previous generation.
What is a Stretch IRA?
A stretch IRA does not refer to any specific kind of IRA. Rather it’s a strategy that allows an IRA to enjoy its tax-deferred status longer than it normally would. By stretching out the life of the IRA, the funds attached to the account are given decades to accumulate wealth. By contrast, a traditional IRA requires that the holder of the account take the required minimum distribution (RMD) by the time they turn 70 ½.
The RMD is determined by dividing the total value of the account by the number of years left in the average person’s life expectancy. So if there is an account worth $100,000, and an individual’s anticipated life expectancy is 85, the RMD would be 100,000 ➗ 15 at 70 years old.
The IRS provides a “Uniform Lifetime Table” to come up with the life expectancy number. Those who inherit the IRA would be expected to do the same thing, although the rules differ depending on whether or not the heir is a spouse.
How Do You Implement a Stretch IRA?
There is a simple and brilliant solution to making the most out of an IRA. As we said before, the IRS comes up with a table to determine the yearly payout for an IRA based on the life expectancy of the beneficiary. The younger the beneficiary, the smaller the yearly payout. While this number is recalculated each year, it will remain considerably lower for a younger beneficiary. In many cases, the annual tax-deferred gains on the IRA will exceed the yearly benefit.
Stretch IRAs and Other Considerations
Not every IRA plan will allow the holder to stretch out the IRA in this manner. It’s best to check with a financial advisor before implementing the stretch. If you want this idea in your back pocket, you’ll need to set up an IRA that allows the stretch strategy. The best choice for some in this situation is a Roth IRA because distributions are themselves tax-free. Other IRA distributions are considered as ordinary income and thus subject to taxes.
Future legislation may pose a threat to stretch IRAs. There has already been legislation proposed that would do away with the “loophole” that allows IRAs to grow tax-deferred from generation to generation. On the same token, the Supreme Court ruled that inherited IRAs did not constitute “retirement funds”, but general income.
So whether or not the stretch strategy will be there in the coming years remains uncertain.
But for the time being, those that are in a good spot for their own retirement have the option of naming the youngest member of their family the beneficiary of their IRA to allow it to grow tax-deferred for another generation.