How Does A Stretch-Out IRA Work?

A stretch out IRA is a new type of individual retirement account. Specific IRA rules, the stretch IRA rules, apply to stretch out IRA accounts. Some of the stretch IRA rules are discussed here.

Stretch IRA rules on IRA distributions

Upon the death of the IRA owner, the designated beneficiary* must choose an IRA distribution option.

One option for the designated beneficiary could include taking minimum distributions over his or her life expectancy, rather than distributing the IRA individual retirement account in a lump sum. If a designated beneficiary, age 49, chooses to take annual minimum distributions over his or her life expectancy of 35.1 years, the tax-deferred status of the inherited assets remaining in the IRA could continue for 35.1 years after the IRA owner's death.

If the designated beneficiary started taking IRA distributions over his or her life expectancy, but were to pass away before the distribution term were completed, the remaining portion of the IRA would go to the designated beneficiary's estate. The estate could continue minimum distributions over the remaining life expectancy of the designated beneficiary. However, most executors want to close estates, not hold them open for 10, 20 or more years. Therefore, executors tend to accelerate the IRA payments and distribute the IRA all at once.

Rather than the inherited IRA going to the designated beneficiary's estate, the designated beneficiary could name a "remainder beneficiary" who could continue to receive the annual minimum distributions, established by the designated beneficiary, until the end of the original payout term.

Using the example from above, if the designated beneficiary were to pass away after only completing 20 years of the 35.1-year distribution term, the remainder beneficiary could continue the remaining 15 years of annual payments. Instead of distributing the IRA in a lump-sum and paying income taxes on the distribution all at once, the remainder beneficiary could spread the income tax liability from the IRA over the next 15 years.

The remainder beneficiary cannot increase the number of years over which the IRA could be paid. Instead, annual minimum distributions are only re-directed to the remainder beneficiary.

*Designated beneficiaries include living individuals and qualifying, pass-through trusts, but do not include an estate, charities, or certain non-qualifying trusts.