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Stretch IRA's

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If you participate in your company's retirement savings plan, than it is a good idea to check the SPD (summary plan description) to find out what happens to the balance of your retirement savings plan account in the event of your death. In most cases, the funds must be distributed, but this mandatory distribution may trigger unfavorable tax consequences. You may prefer instead to keep the savings invested tax free until the beneficiary (spouse, child, etc.) reaches retirement age so as to benefit from reduced taxation.

If your company's plan does not allow this while employed there, then it should be one of the first things you consider if you ever leave, since at that point, you can roll your savings over to what is called a "stretch IRA."

For illustration, let's look at two examples of what could happen for an employee (let's call him "John") that is laid off or resigns after accumulating $1,000,000 in the company's savings program. In the first case, John elects to do nothing. Should he die before he begins drawing down the balance, the company plan may be required to immediately distributed the balance. That million would get disbursed lump sum to John's heirs, who would then be responsible for the taxes (unless it went to his wife). This massive tax bill is an immediately cash outflow from John's heir's to the IRS.

John can easily avoid this unfavorable tax consequence for his heirs if John elects to make a direct rollover to a "Stretch IRA" of which his heirs are the primary beneficiaries. Stretch IRA's get their name because the withdraw can be stretched for generations beyond the owner's life span. The IRS establishes the minimum amount that must be withdrawn from an IRA account under various circumstances. But the rules allow these distributions to be stretched for as long as the expected lifetime of the first non-spousal beneficiary. So passing an account down to a younger person can maximize the value of the account. In the example above, naming John's children as his beneficiaries to stretch his IRA is an example of good estate planning on John's part.

As with any tax or retirement advice, this information is provided for illustration purposes only. Check with your financial, tax, and/or legal advisor for how the tax code, and this situation applies to you.
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