The traditional IRA enables individuals to save tax-deferred until age 70 1/2, after which the IRA owner is required by law to begin withdrawing funds. The amount of your Required Minimum Distribution (RMD) is based on two factors: your IRA account value and your life expectancy. Since both factors change each year, so will the amount of the RMD.

When the owner of an IRA dies, typically the IRA will be inherited by the surviving spouse who will place its holdings into his or her own IRA account, with its own named beneficiary (typically a child). At that time, A younger spouse can “reset” the RMD formula to reflect the spouses’ longer life expectancy—thus “stretching” out the RMDs over more years.

When the spouse passes away, the IRA can either be liquidated (income tax is paid on the entire value of the IRA on the date of death) if no beneficiary is named or it can be “stretched” to the next generation (your child). If the IRA is liquidated, this often can result in income taxes exceeding 50% of the value of the IRA.

If , on the other hand, the spouse names the child as the IRA beneficiary, the child beneficiary has the option of liquidating the IRA and paying the income tax, or leaving the assets in the IRA so no income tax is due. When the assets in the IRA are left in pace, the child beneficiary is only required to take the RMD which will be reset based on the value of the IRA and the child beneficiary’s life expectancy. In other words, the child beneficiary only has to pay income taxes on the amount s/he withdraws each year. Oh and lets not forget—the child is required to take the RMD regardless of the child’s age.

With the “Stretch” IRA, the child beneficiary can also name his or her own beneficiary, and in turn spread the remaining proceeds to a third generation (although that's where it stops).

Note of caution: Some financial institutions do not allow “stretch” IRAs. Before you open an account, or decide to keep the IRA at its existing institution, make sure “stretch” IRAs are permitted. If you plan to avail yourself of the income tax deferrals offered by the “stretch” IRA, make sure you properly designate the IRA beneficiary before you are required to start taking your minimum annual distributions (at 70 ½). Keep your paperwork in a safe place, such as a safe-deposit box. If your heirs cannot locate your IRA beneficiary forms, the institution holding your IRA account may effectuate an immediate liquidation.

IRS Circular 230 Disclosure: As required by U.S. Treasury Regulations, you are hereby advised that any written tax advice contained on this web site is not written or intended to be used (and cannot be used) by any taxpayer for the purpose of avoiding penalties that may be imposed on a taxpayer under the U.S. Internal Revenue Service.