The Stretch IRA:

What is a Stretch IRA?

A Stretch IRA is a term used to describe an IRA set up to extend the period of tax-deferred earnings, possibly over multiple generations. After the owner of the IRA dies, his/her beneficiaries will have the longest allowable period of tax-deferral on the required distributions of the IRA. The beneficiaries must start taking their required distributions once they inherit their portion of an IRA so it's important that each beneficiary is informed of your intentions. The younger your beneficiary is, the longer the stretch period and the more money for your beneficiary to grow. thdrawals may result in surrender charges and if you are under 59 ½ and make withdrawals, you are subject to additional tax penalties.

How to set up a Stretch IRA?

• Choose your beneficiaries
The first thing you must do to set up a Stretch IRA is choose your beneficiaries. Choosing Primary and Secondary/Contingent beneficiaries are extremely important.
• Discuss your intentions with an "IRA Expert"
Your IRA must be set up properly for your beneficiaries to benefit from your Stretch IRA so you should work with a person or organization familiar with Stretch IRAs.
• Establish separate accounts for each beneficiary
If you have multiple beneficiaries, you need to set up a separate account for each and designate the percentage of the IRA in the account. Once you die, each beneficiary can choose to have his/her share distributed over his/her life expectancy.
• Review the account with your beneficiaries
It is important to let your heirs know that they will inherit a portion of your IRA assets upon your death and what to do next.

A word of caution needs to be addressed here;
some Banks and other Financial Institutions' are ignorant of the Stretch IRA. So if your IRA account cannot be stretched, your beneficiaries will have to withdraw the funds soon after death and in some cases in a lump sum. That means all taxes are due right away and the long-term value of your IRA will vanish. This completely defeats the purpose of the Stretch IRA and what you are trying to accomplish. Even though the Stretch IRA is permitted and actually encouraged by the new tax laws, it is not automatic if your current IRA isn't set up to take advantage of it.
The IRS regulations stipulate that any designated beneficiary can stretch distributions on an inherited IRA over his or her lifetime. Also, if you have a company 401K that has not been rolled over to an IRA you may have this same issue. Even though the tax laws allow you to Stretch a 401K as well, a good percentage will not allow you to Stretch your 401K simply because they don't. So you need to transfer your 401K to an IRA ASAP.

Is a Stretch IRA right for you?

If you have enough money and income to fund your retirement without dipping into your IRAs, a Stretch IRA might be right for you. Many older persons put all or most of their retirement savings into tax-deferred IRAs with the intention of leaving these as an inheritance for their children. What they didn't anticipate was the tax burden they would be placing on their children or beneficiaries once they inherited the IRAs.
A Stretch IRA can make this tax burden much easier for your children or beneficiaries once they inherit your estate. You will, however, need to review your Stretch IRAs periodically to be sure your named beneficiaries are up to date. Reviewing your beneficiaries and the IRA Company you currently have is needed so you don't make a mistake and cost your family undue taxes because of a simple review.

The Roth IRA Conversion:

With a Roth IRA, unlike a Traditional IRA, you pay the tax up front when you contribute or convert to it, not at the back end when you start taking distributions. This matters greatly, because once you pay the tax up front, you never pay again. And your money in the Roth IRA keeps growing TAX-FREE forever. There is no limit on the amount you can convert from a Traditional IRA to a Roth IRA. There is however a limit on how much you can earn to be eligible; your Modified Adjusted Gross Income must not exceed $100,000 and you cannot file married-separate.
The Roth IRA conversion laws can change and converting your Traditional IRA to a Roth IRA may be disallowed, but for now, you should take advantage if you're able to pay the tax bill for converting. You don't have to convert all or nothing though; you can convert it in stages if you choose. The advantage of converting to a Roth IRA adds to the power of the Stretch IRA in building a family fortune.

Roth IRA Conversion Over 59½

If you're over age 59½, you can use IRA money to pay the conversion tax without incurring a 10% penalty. A Roth IRA conversion can still pay off in this situation, but you have to be looking for a benefit other than the increased size.
One possible benefit would be avoiding the minimum distribution rules that apply to traditional IRAs when you reach age 70½. If you anticipate having financial resources to live without taking the full amount of the required minimum distributions, a Roth IRA conversion may provide a significant benefit. Avoiding minimum distributions after age 70½ is another way of increasing the size of your IRA.
If you can leave your Roth IRA alone while you live to a ripe old age, the amount you leave to your children or other beneficiaries may be greatly enhanced.
Another possible benefit would be to reduce estate tax. Converting to a Roth IRA means "prepaying" the income tax on the IRA. That prepaid income tax reduces the size of your estate, and as a result reduces the amount of estate tax when you die.

Potential Benefits

A rollover may permit you to accomplish one or more of the following:

• Have a larger dollar amount invested in a tax-free vehicle by using other savings to pay tax on the rollover.
• Keep your money invested in a tax-free vehicle for a longer time by avoiding required distributions after age 70½.
• Because the money in your regular IRA to be taxed at a lower rate than if your children inherited the IRA.
• Reduce or eliminate tax on your social security benefits.
• Reduce your estate tax by paying income tax on your IRA before you die.

Increasing the Size of Your IRA

Moving money from a traditional IRA to a Roth IRA has a hidden, but very favorable consequence: it increases the amount of money you have in your IRA. The dollar amount is the same, but the effective amount is larger. This is because the Roth IRA contains only after-tax dollars. Part of your traditional IRA will end up going to Uncle Sam when you cash out, so it's almost as if you don't own the entire IRA.
The better your investment performance, the more tax you end up paying. That's not true for a Roth IRA.

Avoiding Required Distributions

Having more money than you need in retirement is a nice problem to have. But that doesn't mean it isn't a problem, if you reach age 70½ and still don't want to take money out of your IRA. If the tax rules force you to take a distribution you don't need, you're losing the benefit of tax-free compounding when you could otherwise be living on other savings. The Roth IRA provides a way to extend the benefits of IRA investing for as long as you can afford to leave the money in the account, and that can mean more wealth for your later years — or for your heirs.

Reducing the Tax Rate on Distributions

If you have reason to believe there will be a substantial amount left in your IRA when you die, you may wish to consider the tax rate that will apply to the benefits. Unless the IRA will be consumed by your spouse, it may pass to children or other heirs while they're in their prime earning years and therefore in a higher tax bracket than you are. Rolling to a Roth IRA now may avoid having that income taxed at the higher rates that apply to your beneficiaries.

Reducing Tax on Social Security Benefits

If you're receiving social security benefits in the year of the conversion, you may find that the conversion causes you to include more of those benefits in income for that year. Yet many people will end up with overall savings here. The annual distributions you receive from a traditional IRA increase your income.
Depending on your income level, this could cause part of your social security benefit to be taxable, year after year throughout your retirement.
There's a possible one-time hit with the conversion, but after that you may fly under the radar for the tax that might otherwise apply to your annual social security benefits.

Estate Tax Savings

Most people don't have to worry about federal estate tax because of a credit that effectively exempts $1,500,000 from the tax. (This is the amount as of 2005 and is scheduled to increase over the next several years.) If you've accumulated enough wealth to be concerned with the estate tax, a rollover to a Roth IRA may provide an added advantage. The income tax you pay on the rollover reduces the size of your taxable estate (which may reduce the estate tax) without reducing the value of what you leave to your heirs. Estate tax rates are high, so this benefit can be very valuable in those cases where it applies.

Check Your Tax Bracket

Before you roll to a Roth IRA, consider how your tax bracket will affect the overall benefit of the rollover. A disadvantageous tax bracket can mean the rollover will produce costs that outweigh the benefits.
Even when you're in a favorable tax bracket, you have to watch the size of your rollover. If you roll over too large an amount, the bunching of income into one year can cause you to pay tax at a higher rate than if you withdrew money from your regular IRA more gradually. With careful planning you may be able to avoid this consequence by controlling the amount you roll over.