Taking care to name a beneficiary on your IRA is an important aspect of estate planning. Naming your children or grandchildren as your beneficiary allows them to take money out of the IRA over their lifetimes. When you inherit an IRA, you will be required to take minimum distributions each year from the IRA account based on your life expectancy figure – regardless of your age. Taking the money out over time avoids the immediate taxation of the account and allows the balance to grow tax deferred. The technique is called a “stretch IRA.”
The immediate benefit of the stretch provision is that it allows the beneficiaries to defer paying taxes on the account balance rather than having the tax due all at once. Receiving a large taxable distribution could put the beneficiary in the highest tax bracket. Being able to stretch the payments allows for planning to minimize taxes while the IRA continues to enjoy tax-deferred growth.
The stretch provision has recently been put on the chopping block in the Senate as a potential source of revenue. A proposal was made to require all inherited IRAs to be liquidated within five years from the date of death. An exception would be made for spouses and children under age 18. Stretch IRAs put in place before 2013 would be grandfathered and allowed to continue. The provision was never voted on, but it is likely to resurface given the government’s need to raise revenue to offset the budget deficit.
Regardless of whether Congress changes the stretch provisions, you should review your beneficiary designations. Make sure your retirement accounts and annuity contracts have a primary beneficiary and a contingent beneficiary in place is the first steps. Naming your estate as the beneficiary and naming non-qualifying trusts are common mistakes that can cause your heirs to miss out on the stretch provisions. Finally, make sure you receive confirmation from the IRA custodian of receipt of the beneficiary designations.