IRAs are meant to be used for retirement saving. However, if you don’t need to tap into your IRA for income during your retirement, you can preserve the assets as part of your estate, above and beyond what you’ve already set aside for your spouse and children. This “stretch IRA” strategy can be beneficial for both spousal and nonspousal beneficiaries.
Rules for RMDs
Tax laws encourage individuals to save for retirement in a variety of ways, but they don’t allow you to keep funds in a traditional IRA indefinitely. (Note, however, that a Roth IRA doesn’t have a required minimum distribution during the life of the account owner.) Under the rules for required minimum distributions (RMDs), you must begin taking traditional IRA distributions no later than April 1 of the year after the year in which you turn age 70½. You must then continue taking RMDs in each subsequent tax year.
For instance, if you turn age 70 on June 1, 2017, you must take an RMD for the 2017 tax year by April 1, 2018, and then another for the 2018 tax year by December 31, 2018. To avoid receiving two taxable RMDs in the same year — in this case, 2018 — you might arrange to take the first RMD in the year you turn age 70½.
The amount of each RMD is determined by the dollar balance in your IRA on the last day of the prior year and IRS-approved life expectancy tables based on the age of your beneficiary. For each subsequent year, the beneficiary should use the original life expectancy factor minus 1.
Rules for spousal beneficiaries
If a surviving spouse is the beneficiary of an IRA, he or she has greater flexibility than nonspousal beneficiaries. Notably, the surviving spouse can roll over the assets of the deceased spouse’s IRA into an IRA in the survivor’s name, continuing to benefit from tax deferral, subject to RMD rules. In this instance, the surviving spouse can postpone RMDs until he or she reaches age 70½, even if the deceased spouse was older.
Be aware that a surviving spouse under age 59½ can take money from an inherited IRA without paying the usual 10% tax penalty. However, the distributions from a traditional IRA are still subject to regular income tax.
Rules for nonspousal beneficiaries
The rules for nonspousal beneficiaries depend on whether the IRA owner dies before or after the required beginning date for RMDs. If he or she dies before the required beginning date, assets must be distributed either by the end of the fifth year following the death of the account owner or over the beneficiary’s life expectancy. Choosing the life expectancy method will nearly always allow you to stretch the IRA out longer. Conversely, if the owner was already taking RMDs, a nonspousal beneficiary may receive distributions over the longer of the remaining life expectancy of the deceased IRA owner or his or her own life expectancy.
One technique that may be used to stretch IRAs even further is to name grandchildren as beneficiaries instead of children. Because they have longer life expectancies, the annual RMDs for these beneficiaries are smaller than they would be for their parents.
As with spousal beneficiaries, a nonspousal beneficiary doesn’t have to pay the 10% early withdrawal penalty on pre–age 59½ distributions from an inherited IRA. Other complications may arise if there are multiple beneficiaries named or the IRA owner designates a trust or charitable organization as the beneficiary.
Based on recent tax proposals by Congress, the benefits of stretch IRAs could be diminished by requiring beneficiaries to empty out accounts faster. Contact your estate planning advisor to make arrangements now to maximize the benefits under current law. He or she can also keep you updated on any tax law changes that affect estate planning.