CFP®, RFC, CSA
Senior Financial Advisor
IRAs have been in existence for the last 34 years, and Americans have managed to pile up about nine trillion dollars in them…yes trillion! We are beginning to see the first generation of IRA owners passing these tax-deferred accounts to their beneficiaries.
Thanks to the Pension Protection Act of 2006, we have a much greater ability to stretch out the tax deferral of these accounts to the next generation. Unfortunately most beneficiaries have no clue of the requirements, and the majority of advisors seem to be misinformed.
The primary advantage of stretching inherited IRAs is the ability to continue the tax-deferred growth over the longest period possible. For example, let's assume you have a 40 year old son or daughter that inherits a $500,000 IRA. A 40 year old would have the option of stretching distributions over a 42 year period. Assuming that they earn only 6% during those 42 years, the total withdrawals will equal over $2.5 million. On the flip side, if your son or daughter accepts the IRA as cash and does not elect to Stretch the distributions, all $500,000 will be recognized as income and taxed accordingly…likely at a much higher tax bracket then they would normally pay. Generally speaking, stretching an IRA means less tax paid and more money in beneficiaries' pockets.
There are unscrupulous "advisors" who use this idea of stretching an IRA to sell specific products, insinuating that only certain products will allow beneficiaries the benefit of stretching. The fact of the matter is that all IRAs have the benefit of being stretched regardless of the investment(s). Where these distributions can become difficult to navigate is in identifying the most appropriate tool to pass IRA assets to your beneficiaries.
When I use the word "tool" I am referring to the legal documents that allow you as an IRA owner the ability select a beneficiary. The important thing to consider is whether the tool you use considers the beneficiary as "designated." In order to be considered "designated" the beneficiary must be a living, breathing natural person or group of natural persons or a qualifying trust for the benefit of an identifiable natural person. When IRAs are left to beneficiaries that are considered "non-designated," the stretch options are greatly reduced or non-existent. A common mistake that I see is individuals that name their trust as the beneficiary of their IRA. Often times individual trusts will not have appropriate language in them and therefore are considered "non-designated" beneficiaries.
If you would like a second opinion of your IRA to determine the tax ramifications for your beneficiaries please feel free to call me, 760-705-3517 or e-mail, firstname.lastname@example.org.