After training thousands of advisors across the country about IRA Distribution Planning, I have discovered the #1 mistake advisors make when giving advice about the “Stretch Option.” It’s an easy mistake to make and an easy one to fix. We have all heard that using the “Stretch Option;” an IRA owner can stretch the distributions and distribution taxes over three generations. This is true, but one small mistake in setting up the beneficiaries can cut the horsepower of the Stretch in half. It’s all in how the beneficiaries are set up. There are two approaches, however only one will offer your prospects the full value of the “Stretch Option.”
Most advisors see the beneficiaries as being in two tiers. First, the IRA owner and spouse take their Required Minimum Distribution then children inherit (Tier 1), and at their death, the grandchildren inherit (Tier 2) and that makes up a three generation Stretch. Sounds logical, but it won’t work.
Here are the problems:
- Only the IRA owner or inheriting spouse can name “Designated Beneficiaries” for the purpose of stretching the distributions.
- Only “Designated Beneficiaries” can use their individual life expectancies for the Stretch payout period.
- If you use the two tier approach as described above, the children, “Designated Beneficiaries”, will be able to use their individual life expectancies to determine the stretch payout period, but the grandchildren, “Successor Beneficiaries”, will have to take distributions based on the remaining life expectancies of their parents rather than using their much longer life expectancies. The reason; they were not designated by the IRA owner or inheriting spouse. This will shorten the deferral period, causing more rapid taxation.
Use the 1 Tier approach. Set up the beneficiaries, children and grandchildren, so they will both inherit at the same time. Using this approach, both the children and grandchildren are considered “Designated Beneficiaries” and the grandchildren now will have the right to spread their required distributions and the distribution taxes over their much longer life expectancies. This will increase the horsepower of the “Stretch Option” and could easily double the total income paid to the beneficiaries. The longer the IRA remains in a tax deferred status, the longer the beneficiaries can earn interest on what otherwise would have been paid to the IRA prematurely.
Most beneficiary forms are completed incorrectly, creating an opportunity for the skilled IRA advisor to fix the problem and capture the account.