Where Can I Buy A Stretch IRA?—Nowhere

15192780_sI find the financial industry to be riddled with terminology designed to confuse the general population. With acronyms that no one can explain, multiple terms all meaning the same thing, and names that appear to be pulled from thin air, it can seem like the financial world is speaking a totally different language.
Last week a gentleman came to my office having heard the term “Stretch IRA.” He was interested in incorporating one into his retirement plan. After a discussion with him to further understand his situation, I said that I absolutely agreed, using a Stretch IRA would be incredibly advantageous for him. And then he said, “Okay, but I was at the bank and they said they don’t have any Stretch IRAs. How can I get one?”
Hmm. The convolution of financial terminology strikes again.
There is no Stretch IRA store. A Stretch IRA is not a product. It is a marketing term, referring to the concept of extending the life of a tax-deferred account over multiple generations.
A Stretch IRA is a valuable strategy for anyone expecting to have assets remaining in his or her IRA at the time of his or her death. The strategy involves transferring an IRA from an account owner to a beneficiary at the time of the account owner’s death. Distributions from an inherited IRA are generally determined using the beneficiary’s life expectancy, and the younger a beneficiary, the longer the life expectancy he or she will be able to use to “stretch” the life of the IRA by having smaller required minimum distributions each year. (Distributions that a beneficiary must take from an IRA are referred to as Life Expectancy Payments, LEPs).
Yes, beneficiaries must take RMDs each year but think of the ratio of withdrawal rates to growth rates. Even if the beneficiary must begin taking distributions at age 40, using the IRS Single Life Expectancy Table, the RMD will be only 2.29 percent of the account. (Compared to an 80-year-old IRA owner, whose distribution must equal 5.35 percent of the account.) If we assume an 8 percent growth rate, that’s more than a 5 percent advantage in the beneficiary’s favor, and all that growth is tax-deferred. The value of the inherited IRA wouldn’t begin to decrease until the withdrawal exceeds the growth, in this example 8 percent.
Folks, in my private practice we educate our clients on legacy planning strategies. A Stretch IRA is a very good way to create a legacy for generations to come.
So how do you stretch your IRA? Well this is one of those times when the IRS guidelines actually work in your favor. All you need to do to ensure your IRA is eligible to be stretched is to name a designated beneficiary. (You should also confirm that your IRA custodian will allow beneficiaries to take distributions over a life expectancy period; not all will.)
The key word to note is “designated.” Your beneficiary is not able to take advantage of the stretch if he or she is not a designated beneficiary. It may seem inconsequential, but that one word can make a world of difference. Generally speaking, in the financial world, a beneficiary usually refers to anyone who is eligible to receive distributions from a trust, will or life insurance policy, either because they are named or because they have met stipulations that make them eligible for such distributions. A designated beneficiary, on the other hand, is an individual specifically named on an account as the person to whom such an account will transfer upon the original owner’s death. The difference is important because if there is no designated beneficiary, the IRA will often be transferred into the owner’s estate, to be distributed pursuant to the terms of a will (or state intestacy laws in the absence of a will). The problem that arises when an IRA is transferred to an estate is that an estate is not considered an individual, and therefore, pursuant to federal tax laws, the entire IRA must generally be distributed much faster than if there was a designated beneficiary. Good for Uncle Sam since he gets his taxes sooner; not so great for the recipient.
Now you may be asking, what if you have multiple beneficiaries on a single IRA account, as is often common for parents with multiple children? Can there only be one designated beneficiary on a retirement account?
Well, it’s time for you to finally declare which kid has always been your favorite. Just kidding. As a general rule, the LEPs will be calculated based on the oldest beneficiary. This can be pretty inconsequential if all the beneficiaries are around the same age, but what if one beneficiary is your 77-year-old sister, and the other is your 16-year old grandchild? That 16-year old is treated (for Life Expectancy Payment purposes) as if she is 77 and loses out on the stretch opportunity of a 16-year-old. That doesn’t make sense, does it? Of course not.
The solution is relatively simply. The original IRA can be split into several different IRAs and each beneficiary becomes the sole owner of his or her account. That way your 77-year-old sister and 16-year-old granddaughter each has her own IRA that will have Life Expectancy Payments calculated based on her respective age.
To get back to the original issue of semantics and financial terminology, try to remember the value of a Stretch IRA by understanding this—you want to stretch your wealth.
Be vigilant and stay alert, because you deserve more.