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Can You Stretch Your IRA? |
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Imagine two sisters, Joan and Mary, who are nearly identical in all respects. Both are widows and each has a substantial IRA having approximately the same value. Each has children and grandchildren who are similar in age. Yet, the value of the stream of distributions which Joan’s family will receive from her IRA will probably exceed the value of the distributions to Mary’s family many times over. Why the difference? Joan had the benefit of an effective IRA distribution plan which gave each member of her family the opportunity to “stretch” his or her share of Joan’s IRA as permitted under the minimum distribution rules.
The key to stretching a share of an inherited IRA lies in the owner of the IRA creating, prior to his or her death, a beneficiary designation which meets the requirements of the IRS minimum distribution rules. Joan had an effective “designated beneficiary” under the rules; Mary did not. Since Mary’s retirement account designation documents did not qualify as a “designated beneficiary” under the rules, her children and grandchildren will each have to cash in their shares of her IRA and pay the resulting income taxes over a much shorter period of time than will be the case for Joan’s family members, some of whom may be able to stretch their shares 30, 40 or 50 years.
Individuals who inherit a share of an IRA must take required minimum distributions. If a designated beneficiary exists by the deadline following your death which complies with the rules, the individuals who inherit your IRA will draw annual required minimum distributions based upon their individual life expectancies.
For example, the initial annual required minimum distribution for your beneficiary who has a 40 year life expectancy is 2.5 percent, an amount substantially less than the potential annual investment return for the IRA. While your beneficiary’s annual required minimum distribution will increase slightly each year, the investment return of the IRA should substantially exceed the required minimum distributions for decades. As a result, the total value of the stream of annual minimum distributions to your beneficiary should substantially exceed the initial value of the IRA which your beneficiary inherits from you.
Joan is concerned that her grandchildren might “cash in” their inherited shares of her IRA prematurely and thus defeat her plan to give them a more financially secure retirement. Accordingly, Joan’s beneficiary designation directs her grandchildrens’ shares to trusts having provisions which will qualify for the “stretch.”
This article is intended to acquaint the reader with some general principles which govern the creation of beneficiary designation documents which will permit individuals who inherit shares of an IRA or retirement account to use the full stretch opportunities permitted under the required minimum distribution rules. Specific planning opportunities which employ these techniques require detailed legal analysis and drafting and the reader is therefore encouraged to call one of the following attorneys who practice in the Trusts and Estates group at Quinlivan & Hughes, P.A. 320-251-1414.
Kevin A. Spellacy
John H. Wenker
Robert P. Cunningham
W. Benjamin Winger
Bradley W. Hanson
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