Stretch IRA

What is the stretch IRA?

Stretch IRA is a strategy to “stretch” the distributions from an IRA over an extended period, in order to minimize the tax payments. The stretch IRA technique is regularly employed by families of affluent retirees in order to reduce the mandatory distributions that are taken from an IRA, thereby reducing the tax bite and making the funds last much longer.

How does the stretch IRA work?

Under current law, an IRA owner is typically required to start taking distributions from the IRA at age 70 ½. Those who don’t might be subject to an income tax equal to 50% of the distribution that should have been taken.

If the IRA owner passes away with a remaining balance in the IRA, the IRA is transferred to the IRA’s beneficiary, typically the owner’s spouse. The beneficiary can roll the funds into his or her own IRA.

The beneficiary must begin taking distributions from the IRA starting December 31 of the year they inherited the IRA, even if they are under age 70 ½. These distributions are taxable as income. The required minimum distribution (RMD) is calculated by dividing the remaining balance by the beneficiary’s remaining life expectancy, as determined by the IRS’s uniform life table.

This is where the stretch technique comes in. If the beneficiary doesn’t currently need the income, they can just take the RMD each year and leave the rest in the IRA to continue to grow, tax-deferred.

When the beneficiary passes away, the IRA is left to a second beneficiary, such as a child. The child can roll over the funds to their own IRA and continue taking RMDs. Since the child is younger, initially their RMD amount is lower, so the IRA funds are not depleted as fast.

As an example, suppose John Jones has an IRA with $400,000. At age 70 ½, John begins taking the RMD from the IRA, and continues until he passes away 15 years later. At that point, his wife Jane inherits the IRA and takes the RMD each year based on her life expectancy. She takes RMDs until she passes away at age 90. Then the couple’s 60-year-old son Jack inherits the remaining balance, and takes RMDs until the balance is depleted.

By using the stretch technique, the family has enabled the IRA to last beyond the lifetime of the original owner, John. By leaving the bulk of the funds in the IRA to grow, they have also enabled the IRA to provide payments longer than it would have if John had simply taken the funds out.

Because the stretch IRA often lasts for generations, it is sometimes called the multigenerational IRA. The stretch technique is often used by wealthy families for estate planning. It is particularly popular when used with Roth IRAs, since the IRA balance grows not tax-deferred, but tax-free, for generations.

In recent years, there has been a political push to raise tax revenue by ending the stretch technique. Under proposed new rules, non-spouse beneficiaries must take out the entire IRA balance within five years of the original owner’s death. Congress estimates ending the stretch IRA would generate $4.6 billion in tax revenue over 10 years. If the rule change goes into effect, many families would have to rework their retirement account strategies. This article has some tips for preparing.

In any case, you should consult a tax or financial advisor if you are considering setting up a stretch IRA, and ensure your beneficiaries are also aware of the strategy and their roles.

For more information

For more information about IRA distributions, including for beneficiaries, see the IRS’s required minimum distribution page.

To help determine RMDs for your beneficiaries, see this stretch IRA calculator.