Benefits of the "Stretch IRA" : The importance of your IRA Beneficiary Form

I've been perplexed about why financial advisors often put little emphasis or overlook the importance of the IRA Beneficiary form. One of the most important forms you can sign when opening your IRA, the Beneficiary Form is the driving document about who will receive the proceeds from your IRA. However, one of it's most important features is almost never discussed: it's function as a tax saving document. Let me explain.

The Beneficiary form allows the owner of the IRA to stretch out their required minimum distribution over a prolonged period of time instead of taking the less favorable shorter period. Depending on the size of your IRA, and the age of the beneficiary,(the younger the beneficiary the longer the "stretch") this ruling can save an investor thousands and in some cases millions of tax dollars. It's important that you have a financial advisor or other professional that can advise you on how your IRA must be set up. In addition, your beneficiary must also be aware that certain critera must be met.

For example, to realize these trememdous tax saving of the stretch IRA the beneficiary must take the required minimum distribution or RMD in the year after the IRA owners death. This is why a beneficiary should be kept informed of this requirement and you should have a financial advisor or firm that has an understanding of the rules. You probably don't want your IRA to go to the IRS in the less favorable manor. The longer Uncle Sam waits for your money and your beneficiary is kept under the stretch rule the larger the tax savings.

But what if the IRA owner dies and your beneficiary forgets to begin taking the required distributions in the year after their death ? Does the whole lumpsum get taxed by the IRS? Not necessarily. The IRS issued a private letter ruling (PLR200811028) that allowed a 31 year old daughter of a deceased 66 year old parent to keep her stretch benefits eventhough she neglected to take her RMD for 2003 and 2004. She took out all three years 2003, 2004 and 2005 all at once in 2005. However, she had to pay a 50% penalty for her missed years. Remember a private letter ruling only applies to the person who requested it. And the IRS may not be so kind next time. Financial Advisors should review their beneficiary forms for all IRAs they manage. This will provide a tremendous service for their clients.