The stretch IRA, when implemented properly, can be a great vehicle for transferring wealth to your heirs. Using this method, you pass along the tax-deferred status of the account until it is withdrawn, which may be much later. The problem is that there are some very specific rules that must be followed in order to achieve the stretch IRA – and if you screw it up, there’s definitely not a do over in most of these cases.
First, let’s run through the specifics that make up a stretch IRA. When an IRA account owner dies, the beneficiary(s) are eligible to re-title (or transfer) the account(s) as inherited IRAs in the name of the deceased owner. At that point the beneficiary(s) must begin taking Required Minimum Distributions based upon the beneficiary’s age. This is much better (tax-wise) than having to take the entire sum all at once and pay tax on it, or the onerous five-year distribution rule that can come into effect if things aren’t done properly. (more on the specifics of the Stretch IRA can be found in this article.)
Keep in mind that these stretch IRA rules apply to both Traditional and Roth IRAs – because, even though Roth IRA owners are not subject to RMD, their beneficiaries are.
Here are some of the common mistakes that can be made when attempting to stretch an IRA:
Obviously this isn’t an exhaustive list, but rather a sampling of the more common errors that folks make when attempting to set up a stretch IRA. Done properly, this arrangement can turn an IRA of a sizeable amount in your lifetime into a very significant legacy to your heirs. Proper setup is very important – get a professional to help you with it if you are confused by how this works!
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