Individual retirement accounts encourage people to save for retirement by offering certain tax breaks. When the owner of an IRA dies, the beneficiaries inherit the account's assets -- money, investments and property. Beneficiaries can simply receive the assets and pay the taxes on the proceeds from an inherited traditional IRA. Alternatively, individual beneficiaries can shelter the inheritance in their own IRAs and delay the taxes for five years or longer. A stretch IRA is so named because it allows individual beneficiaries to s-t-r-e-t-c-h out the distributions from an inherited IRA over an extended period.
Required Minimum Distributions
Required minimum distributions, or RMDs, play a central role in determining how far you can stretch an inherited IRA. The owner of a traditional IRA must take annual RMDs based on his life expectancy upon reaching age 70 1/2. The required beginning date for taking RMDs is no later than April 1 in the year following the attainment of age 70 1/2. When the owner dies, the stretch period for beneficiaries depends in part on whether death occurred before the required beginning date. The period also depends on whether a beneficiary is a surviving spouse, a non-spouse individual or an entity -- a charity, foundation or other non-individual. A third component of the stretch rules deals with the designated beneficiary when the IRA is inherited by more than one beneficiary.
The custodian of the deceased's IRA determines the designated beneficiary, who must be a beneficiary on both the day of the owner's death and Sept. 30 of the following year. This means that a beneficiary who dies or disclaims the IRA before Sept. 30 cannot be the designated beneficiary. Generally, if there is more than one beneficiary, the designated beneficiary is the oldest one. The significance of the designated beneficiary is that her life expectancy is used to determine the stretch period for distributions to all of the beneficiaries. For example if the designated beneficiary is 60 years old and another beneficiary is 40, the younger person will have a stretch period based on the life expectancy of the older person.
A surviving spouse can take ownership of her spouse's inherited IRA if she is the sole beneficiary. If she isn't the only beneficiary, she can transfer her portion to her own IRA. In either event, the spouse can stretch out payments. The stretch period depends on several factors, including:
- Whether the surviving spouse takes ownership of the inherited IRA or transfers it to her own IRA
- Whether the deceased IRA owned died before his required beginning date
- The age of surviving spouse
The rules are complicated, but generally the stretch period is the life expectancy of the surviving spouse or of the deceased IRA owner as of his year of death, whichever is longer. The required beginning date for the the distributions is that of the deceased or of the surviving spouse, depending on the circumstances. The surviving spouse may also choose to take her distributions according to the five-year rule, which states that all distributions must be completed by Dec. 31 of the fifth anniversary of the year in which the deceased died.
Non-spouse beneficiaries can't take ownership of an inherited IRA, but may transfer the inheritance to a beneficiary IRA -- another IRA registered in the deceased's name for the benefit of the beneficiary. A non-spouse beneficiary has a stretch period based upon the same factors as those for a spouse beneficiary, but the period depends on the age of the designated beneficiary relative to the final age of the deceased. If any of the beneficiaries on the Sept. 30 date is not an individual, the IRA must be distributed to all beneficiaries according to the five-year rule.