A Stretch IRA is a strategy that allows you to help your loved ones by offering a tax-deferred solution for their long-term income in retirement. It is a type of inherited IRA plan that helps with long-term retirement goals. Knowing this strategy will help limit tax responsibilities on your loved ones in the future.
What You Need To Know About Stretch IRA
What is a Stretch IRA?
A Stretch IRA, or other inherited IRAs, help with long-term financial goals. This means you pass on the IRA plan to a loved one after your death. It allows your loved one to take out funds on a tax-deferred basis, but only when it applies to their situation. They may choose to take the money out on a different timeline or to roll the investment over into another account.
This plan is an IRA strategy that focuses on limiting the tax bill on your heirs. It means they will have fewer responsibilities up-front, which allows them to focus on long-term plans. It also helps your loved ones maintain an IRA account for their future retirement.
Types of IRAs
There are different types of IRAs that you may use for a Stretch IRA. It usually falls into two primary categories: a Traditional IRA and a Roth IRA. The Traditional IRA is a tax-deferred account as long as your income level qualifies for the individual retirement account. A Roth IRA is not tax-deferred but does allow your investments to grow tax free, and you do not pay any taxes once you start taking distributions from the account.
For a Traditional IRA, you can put up to $5,500 per year from the time you start working, and even more as you get closer to retirement age. Once you reach 70 and 1/2 years old, you can no longer make contributions and must instead take out required distributions.
As you reach retirement age, your IRA assets may reach a high level. Depending on your investments, you may have several hundred thousand dollars or more in your accounts. You want to divide the amount by your life expectancy to determine the IRA distributions required by law.
For a Stretch Roth IRA, you pass down your IRA at the time of your death. Since you may die when you still have funds in the account, it goes to a surviving spouse or the named beneficiary on the account. Your beneficiary must take out the required distributions in the year following the IRA holder’s death.
Setting up an IRA Beneficiary
After you set up an IRA strategy, you want to clarify your beneficiary. A beneficiary is an individual who will inherit your account. In many cases, a surviving spouse is an automatic beneficiary of your account. They receive the account at the time of your death. It is not considered a Stretch IRA when passed down to a spouse.
If you choose to pass down the account to a secondary beneficiary, then you must name them on your account. Clarify the individual and make sure they are mentioned in your estate. You can work with your estate planner or you can work with a financial professional to arrange for an inherited IRA.
When a child or other family member inherits your IRA assets, they have three options for the funds. They can take all of the money out of the account and use it. They can also start taking the required minimum distributions either at 70 and 1/2 years old if they are within one year of that age range for a Traditional IRA or in the year following the death of the original IRA holder for a Roth IRA. The final choice is to take out the money over a five year period. In the case of taking the money over five years, a beneficiary can take as much or as little in a single year. The IRS requires that they empty the account within the five-year time limit.
Using the Required Minimum Distributions
The final aspect of a Stretch IRA is the required minimum distributions. You are not required to wait until a certain age to start taking out money from an IRA account. You are subject to different requirements however depending on when you decide to pull from your IRA, so be sure to look into the fine print. The minimum amount you must take out depends on your funds and age at the time you start taking out distributions.
Deferred Taxes For Beneficiaries
The Stretch IRA strategy aims to increase the duration of time in a tax-deferred account. It prevents high taxes when a loved one inherits your account, but it also impacts their use of the funds.
Using the funds in the account depends on the individual’s preferences. The Traditional IRA is tax-deferred, so a loved one only pays taxes on the amount they remove from the account each year. A Roth IRA differs because it is not a tax-deferred account. That means you paid taxes before putting money into the account, so you do not pay capital gains on the funds when withdrawing the amount. A loved one must take the money out of the account when it passes down to them. They are not required to pay a tax on the money when taking it out of a Roth IRA account.
A Stretch IRA is a useful way to pass down wealth without a high tax rate. It helps in estate planning by limiting the amount your children or grandchildren pay in taxes. The key is setting up the account and ensuring that a loved one understands his or her options before you pass away. It will reduce the risk of high taxes and help your loved ones stay on track toward their own financial goals.
Do you still need more information about Stretch IRA? Post your questions in the comment section below.