What is a Stretch IRA?

What is a Stretch IRA?

A stretch IRA is an estate planning strategy to transfer wealth to a non-spouse beneficiary. It allows your non-spouse heirs to stretch IRA distributions and benefits out over a period of time.

When you retire and start having to take minimum distributions from your IRA accounts, the stretch IRA’s goal is to take out the smallest amounts possible. You can then pass the remaining amounts on to your heirs.

In turn, your heirs can take out minimum distributions throughout their lifetime (according to an IRS table). It’s a great tool to use to minimize tax liability when passing assets on to heirs.

Benefits of the Stretch IRA

So, what are the benefits? Here’s an example. Let’s say your mom has a million dollars in an IRA. You are the sole beneficiary. If your mom passes away tomorrow, you can take that million dollars and stretch it out over the course of your lifetime.

For example, let’s assume the IRS tables say you need to take out three percent annually (thirty thousand dollars). The actual amount will be more or less. Chances are you’ll be in a lower tax bracket than if you liquidated the entire amount at one time.

Why? Because your taxable income would be whatever your annual earnings are plus one million dollars, putting you in the highest marginal tax bracket possible in that year. A better strategy is to stretch the money out over the course of your lifetime to minimize the tax burden.

Proposed Legislation

Unfortunately, there’s bipartisan support for doing away with the Stretch IRA or minimizing it to a specified period of time. If the latter happens, non-spouse heirs won’t be able to spread out the distributions over the course of their life. But the question remains how this change would be implemented.

People who already have inherited IRAs could be grandfathered in and may be able to continue under the Stretch IRA’s current rules. Those who haven’t inherited anything yet will fall under the new guidelines once the law goes into effect.

It’s just speculation now, as no one knows exactly how it will play out. However, we do know it would be a good inheritance planning tool taken away from financial planners. But there are other effective tax mitigation strategies available that we can discuss.

Taking IRA Distributions

There’s another potential change to discuss as part of the proposed legislation. Currently, the law states at 70 and a half you need to begin taking out IRA distributions. The age could be increasing up to 73. You may wonder if it’s ever beneficial to take out money earlier.

The answer is yes. For example, say you have 1.5 million dollars in your 401K plan. You’re 60 years old and you decide to retire. Since you have no other earned income, it might make sense to take money out and keep yourself in a lower tax bracket. You could even take the money and convert it to a Roth IRA. The Roth IRA doesn’t require minimum distributions and offers tax free growth.

If you don’t take the money out earlier and you hit the required age to take distributions, those distributions could likely put you in a much higher tax bracket. By maximizing the lesser tax rate earlier, it will go a long way in helping minimize your overall tax liability throughout the course of your life.

But before making this and other financial decisions, it’s always important to consult with an expert or run the numbers yourself.

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