Clients and prospects often ask about “stretch IRAs” as if they were a specific sort of IRA, like a traditional or Roth IRA. However, a stretch IRA is not a type of IRA at all. It is a planning strategy for IRAs designed to benefit from deferred taxation by taking death distributions from an IRA over an extended (stretched) period of time.
When an IRA owner dies, the IRA assets are payable to the beneficiary or beneficiaries. The minimum amount that must be distributed to the beneficiary is dependent upon two factors: (1) whether the IRA owner died before, on, or after his or her required beginning date (RBD1); and (2) whether the IRA beneficiary is an individual.
Death Before RBD
If the IRA owner died before his or her RBD, the beneficiary may choose to take the IRA funds using the five-year rule (payments over five years) or the life-expectancy rule (payment over his or her life expectancy). A Roth IRA owner is not required to take distributions while living. Accordingly, Roth IRA beneficiaries may choose the five-year rule or the life-expectancy rule regardless of the Roth IRA owner’s age at death. The five-year rule doesn’t s-t-r-e-t-c-h the IRA very far, because the beneficiary must generally close the IRA by the end of the fifth year following the year the owner died. However, using the life-expectancy rule allows the beneficiary to “stretch” the IRA distributions over his or her single life expectancy.
Death On or After RBD
If the traditional IRA owner died on or after his or her RBD, the beneficiary does not need to make a payment selection. There is a minimum required death distribution – based on the longer of (a) the single life expectancy of the beneficiary, or (b) the remaining single life expectancy of the deceased IRA owner. If the beneficiary does not have a life ex¬pectancy, the IRA owner’s remaining single life expectancy must be used.
S-t-r-e-t-c-h-i-n-g the IRA
The ability to stretch the payments over the beneficiary’s life expectancy is what gives this strategy its name. However, the strategy is generally available only when the beneficiary has a life expectancy. Therefore, the primary strategy that allows for a stretch IRA is for the IRA owner to name a living person (or persons) as beneficiary. If the beneficiary is not an individual, generally, the only option is the five-year rule or, if the traditional IRA owner died on or after his or her RBD, the deceased IRA owner’s remaining life expectancy. However, there is an exception to the general rule whereby a stretch IRA may be available even if the beneficiary is not an individual. If the beneficiary is a “look-through” trust, the stretch option may still be available. Generally, a trust is a look-through trust if it is valid under state law, it was an irrevocable trust or it became irrevocable at the grantor’s death, all beneficiaries of the trust are identifiable, and the trustee of the trust provides proper, timely documentation to the IRA spon¬sor. If these requirements are met, the IRA distributions may be paid over the single life expectancy of the trust beneficiary. If the trust has multiple beneficiaries, the life expectancy of the beneficiary with the shortest life expectancy must be used. The general rules regarding stretch IRAs have been set forth here to provide producers with useful information. Each case should, of course, be examined individually.
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1Required Minimum Distributions for the first calendar year (i.e., the age 70 ½ year) must be paid by April 1 of the year after the first distribution calendar year, even if the IRA owner is still working. This date is the RBD.