If you’re leaving extra retirement cash to your family members, grant them some of the tax breaks as well.

By Ginger Applegarth

One Piece of the Estate Planning Maze

Here’s an estate-planning technique that allows you to lower the tax sting for your heirs, and reduces your retirement income in case you don’t think you will need all of your Individual Retirement Account funds in retirement.

Stretch IRA

It’s called a “Stretch IRA”, and it does just what it says—it stretches out the time that money can stay in an IRA.
The concept is gaining favor with professional financial planners because it’s a simple technique that can save your heirs thousand of dollars or more in estate taxes. It’s also gaining popularity because of the increasing numbers of relatively affluent retirees who realize that they have enough money to sustain them through their lives without using up all of their IRA assets.

Financial help for your children, grandchildren

How does it work? Think of your estate plan as involving three generations. You (and your spouse, if you are married) are the first generation; your children, or other heirs, are the second generation; and their beneficiaries are the third generation. The stretch would occur in the second and third generations.

Here’s how it works:
If you are married, usually the best option is to leave money to your spouse, who then rolls the money into his or her own name, names a younger beneficiary (such as a child) and takes distributions (starting at age 70 1/2) based on their combined life expectancy  When your spouse dies, payments go to the younger beneficiary. The stretch occurs at your child’s death; your child names a beneficiary, so that if your child dies before all distributions are made, remaining distributions continue on the same schedule, instead of in a lump sum.
If you are not married, your beneficiary has two options:

1. Take the entire amount out of the IRA by the end of the fifth calendar year after your death.
2. Take distributions over a period of time

If your death occurs before you start taking distributions, the period of time is based on the beneficiary’s life expectancy. If your death occurs after you start taking distributions, the time period varies according to what distribution method you were using (whether you were recalculating or not recalculating your life expectancy each year.) If you weren’t recalculating, distributions continue on the same schedule they were on before your death. If you were recalculating, the distributions are based on your beneficiary’s life expectancy (with some adjustments).
Obviously, the lifetime distribution, with deferred taxes and tax-deferred growth, stretches that person’s income. The real stretch occurs at the beneficiary’s death, if that person dies before all payments are made and another beneficiary has been named. That next beneficiary receives the rest of the annual IRA distributions and does not have to take the money in a lump sum.

For those who don’t need it all.

Generally, stretch IRAs are only recommended if you do not plan on using up the assets from your IRAs (except for the minimum withdrawals required by law after age 70 1/2) during your lifetime. Stretch IRAs allow your beneficiary to name his or her own beneficiary upon your death, with the longest allowable period of tax-deferral before all the assets in the IRA must be distributed.
There are a couple of tax regulations to keep in mind.

1. The names of the account holder and the beneficiary must appear on the stretch account
2. The IRA payout must begin no later than December 31 after the death of the account holder