Ending the Stretch IRA


Tucked away inside proposed legislation funding the national highway infrastructure was a provision that would limit the use of stretch IRAs. The Senate Majority leader removed the provision from the final version of the bill, but the sponsor, Max Baucus (D.-Mont) promises it will be made into law, on the grounds that IRAs should be used during the owner's retirement, and not be passed on to beneficiaries.  The huge current deficient and seeming inability of Congress to deal with it makes it seem likely that Baucus will have his wish come true. 


"Stretch IRA" refers to an estate planning technique that allows a beneficiary to inherit a traditional IRA and draw out required distributions over his or her own life expectancy. The longer the life expectancy, the smaller each payout must be, and only the actual payouts are subject to income tax. Stretching out the IRA gives the funds extra years to compound tax-deferred.    


The beneficiary designation on file with the custodian of the IRA dictates who inherits the account and its ability to be stretched out. If the beneficiary is the surviving spouse, the surviving spouse's life expectancy is used to calculate the required distributions. If the beneficiary is someone other than the spouse, distributions must begin by December 31 of the year after the IRA owner's death, but the withdrawals can be taken over the beneficiary's life expectancy, potentially enjoying decades of income-tax-deferred growth. If there are multiple beneficiaries, the life expectancy of the oldest is used to calculate the withdrawals. A properly drafted IRA trust can create individual sub-trusts, resulting in multiple beneficiaries being able to use their own life expectancies as the stretch-out period.


If an estate is named as beneficiary, the IRA cannot be stretched out. If the original owner was already 70 ½, the beneficiary of the estate can take distributions based on the life expectancy of the original owner. If the owner was not yet 70 ½, all funds must be withdrawn within five years. This is known as the "Five Year Rule".


Under the proposed legislation, effective for IRA account owners who die after December 31, 2012, the Five Year Rule would apply to most non-spouse inheritors, and they would need to withdraw the entire amount from the IRA within five years. The proposed legislation makes exceptions for a beneficiary who is either disabled, chronically ill, no more than ten years younger than the original owner of the IRA or a minor child. Those beneficiaries would still be able to take distributions over their life spans. However the Five Year Rule would apply to anyone who inherits the IRA from one of the excepted beneficiaries.



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