What Is A Stretch IRA?

While many of today’s investors are putting money away to secure their near future, several are starting to realize the value of the stretch IRA. An individual retirement account, commonly called an IRA, is one of the most popular ways to ensure financial stability upon retirement. The tax-deferred money protected by an IRA is what makes this account so appealing to investors. However, by choosing a stretch IRA over the regular type, this tax-deferred money can be sheltered and will grow for multiple generations.

What Is A Stretch IRA?

This account has been available for quite awhile, and the benefits it has to offer are enormous. Typically with Traditional IRA’s there are minimum distributions required every year after the account owner reaches age 70 1/2 up until the owner dies. A life expectancy table has been set up by the IRS which helps determine the amount of this deduction. Due to new rules governing all IRA accounts, the minimum distribution amount can be based on the joint age of the owner and a beneficiary who is at least ten years younger than the owner. This means that naming a grandchild or great-grandchild as a beneficiary on a stretch IRA would lower the required minimum distribution amount, thereby increasing the amount of tax-deferred money left in the account.

Thus, the primary purpose of a stretch IRA is to maximize the tax-deferral.  Suppose you name your spouse as the beneficiary of your IRA (as most people do).  When you die, your spouse may be forced to take much larger distributions than he or she would otherwise need to pay for everyday living expenses, dramatically reducing the size of your heir’s inheritance in the process.  For account-owners with substantial financial resources, it makes sense to name a much younger beneficiary, thereby “stretching” the value of the tax deferral.

By having to take less money out of the IRA account, and by letting it grow and gain interest over multiple generations, financial security can be almost guaranteed for the heirs of the IRA owner. For example, if a man starts an IRA at the age of 29 which has a rate of return of seven percent, by contributing two thousand dollars per year and choosing a grandchild or great-grandchild seventy years younger than him as a beneficiary, the heir can amass over two million dollars of tax-deferred money by the time he or she retires. If larger contributions come to be allowed, or if distribution laws change again, the amount earned by the grandchild could be even bigger. The possibility for growth is potentially limitless, giving peace of mind to the original owner, knowing that future generations will be well cared for thanks to decisions made by him years before the heirs will inherit the money.

Though based on several assumptions including unchanging tax laws, a stretch IRA can be a profitable little trick for your future heirs.