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Stretching an IRA

A traditional IRA may be one of your more important estate assets. Your IRA will pass to whomever you have named as its beneficiary.

When it’s a substantial sum, there is an opportunity for continued tax deferral and use as income through IRA “stretching.”

The first step in the process is to limit what you take from your IRA to the required minimum every year; withdrawals are required after you reach age 70-and-a-half. After your death, the stretch options depend upon whom you have chosen as your beneficiary and what your beneficiary decides to do.

When your spouse is your beneficiary

Your spouse has several choices when he or she inherits your IRA. If he or she withdraws, regular income tax is paid on the amount. Taking everything ends any further “stretch.”

Other choices will extend the life of the IRA:

• Transferring the assets to the spouse’s IRA (or a new one). If otherwise eligible, your spouse can make contributions to this IRA, boosting the balance even higher for future beneficiaries. He or she needn’t make annual withdrawals until after age 70-and-a-half, and the withdrawals will be based on his or her life expectancy.

• Remaining a beneficiary. Your spouse’s name is added to yours as the owner of the account. Although contributions are not permitted, there’s an advantage when your spouse is younger than age 59-and-a-half. Should he or she need IRA funds before then, there’s no 10 percent early withdrawal penalty. The distribution rules are more complicated, however. If you die before reaching age 70-and-a-half, your spouse must start distributions when you would have turned age 70-and-a-half, and they must be based upon his or her life expectancy. If you had started making the required distributions before your death, your spouse can continue to receive them over your life expectancy or your spouse’s, whichever results in larger distributions.

• Disclaiming (refusing) the IRA. If your spouse has sufficient assets of his or her own, he or she may disclaim your IRA within nine months of your death. The IRA then will pass to an alternate beneficiary whom you have named, without paying gift tax.

Other beneficiaries or

multiple beneficiaries

If anyone other than your spouse is the beneficiary of your IRA, he or she cannot treat the IRA as his or her own. If your beneficiary wants to withdraw all the money from the IRA, it must be done by December 31 of the fifth year after your death.

If your beneficiary doesn’t withdraw the funds soon after your death, distributions must begin no later than December 31 of the year after your death. The best scenario is when a beneficiary is young because he or she is entitled to stretch out distributions over his or her lifetime. If the required distributions is less than the investment return of the account, the IRA grows. If you already had begun receiving distributions, the beneficiary can receive them, calculated over the life expectancy that yields the larger annual distribution.

If you plan to leave your IRA to more than one person, the annual distributions must be calculated over the life expectancy of the oldest beneficiary. This yields the largest distributions and the fastest exhaustion of the IRA. Avoid this by dividing the assets into separate IRAs for each


Distributions will then be based upon the life expectancy of each beneficiary

A trust as your beneficiary

Naming a trust as the beneficiary of your IRA may provide an extra layer of protection and degree of control over the assets in your IRA.

The trust’s beneficiary is considered the beneficiary of your IRA, and the required distributions must be calculated over his or her life expectancy; if more than one beneficiary, over the life expectancy of the oldest beneficiary. When the IRA beneficiary dies, assets pass as you have directed in the trust agreement.

• The trustee is given the authority to pay only the required distributions to an IRA beneficiary, maximizing the IRA’s life.

• You, not your IRA beneficiary, control to whom your IRA passes at your beneficiary’s death.

• Because your IRA is in a trust, its assets are less likely to be lost to a beneficiary’s poor investment management skills, divorce or creditors’ claims.

An IRA trust must be set up following a specific set of requirements established by the IRS.

The Roth IRA alternative

Amounts that you contribute to a Roth IRA aren’t tax deductible. However, presuming that the requirements are met, distributions will be completely tax-free. In addition, minimum distributions are not required for the account owner (though they are required for a surviving beneficiary).

Currently, converting a traditional IRA to a Roth IRA is possible only in a year that your adjusted gross income doesn’t exceed $100,000. You must be willing to pay ordinary income tax on the amount that is transferred.

Beneficiaries who inherit your Roth IRA won’t pay tax on the distributions and escape penalties as well. Distribution rules remain the same.

Jeff Francis is vice president and senior investment officer for First Tennessee Brokerage. For more information about this and other personal finance issues, call 865-971-2321.


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