So-called "stretch" individual retirement accounts are inherited IRAs that, under certain conditions, can be stretched out under the Internal Revenue Service's required minimum distribution regulations. However, cashing in the stretch IRA defeats the purpose, and subjects you to the standard IRS rules concerning inherited IRAs. Only a surviving spouse may initially take advantage of stretch IRAs.
The IRS has strict rules regarding inherited IRAs. When inheriting an IRA, contact the account representative to make sure you are following all IRS regulations. Any decision regarding an inherited IRA must be made within nine months of the decedent's death. The beneficiary may make a trustee-to-trustee transfer, which names the decedent as owner of the account with the beneficiary as inheritor.
Stretching the IRA
If the surviving spouse inherits the IRA, the IRS permits him to roll the balance of the inherited IRA into his own IRA account. No other beneficiary may roll over an inherited IRA. For traditional IRAs, the spouse may take required minimum distributions based on the IRS life expectancy charts. Distributions are not required until the spouse reaches the age of 70 1/2. There is no mandatory distribution age for Roth IRAs. Under the stretch IRA, when the spouse dies, the named beneficiary of the IRA may transfer these assets to an inherited IRA and take distributions based on his life expectancy. Since the second beneficiary may be the son or daughter of the spouse, this allows the IRA to "stretch" over generations.
Beneficiaries of inherited IRAs other than the spouse may begin taking the required minimum distributions by Dec. 31 in the year of the decedent's death. To determine the amount, divide the IRA's fair market value as of that date by your age as per the IRS' life expectancy chart. Failure to start taking distributions by the required date may result in an IRS penalty of 50 percent on assets you should have withdrawn. Beneficiaries of non-spousal inherited IRAs cannot make contributions to the account.
The decision on whether to cash out an inherited IRA may depend on the age of the decedent at the time of death. If the decedent was under 70 1/2, the beneficiary may opt for the IRS' five-year rule, which allows assets to be withdrawn before Dec. 31 of the fifth anniversary year of the decedent's death. Under the five-year rule, the IRS waives penalties for required minimum distributions if the account is closed by the due date. If the decedent was taking required minimum distributions at the time of death, the beneficiary may choose between cashing out the entire amount of the inherited IRA or taking distributions based on the beneficiary's life expectancy.
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