Kelly Ruggles, President of American Reliance Group, Inc., is a well-known educator and fee-based financial
planner. Kelly Ruggles is the author of "Financial Concerns For Retirement"©2006, Kelly C. Ruggles.

Stretch Benefit Plans
©2008, Kelly C. Ruggles

Such plans preserve assets long after death, providing heirs huge financial benefit

July, 2008
by Kelly C. Ruggles

Special to the Journal of Business

A-Rod, Tiger, Danika Patrick, and big-name movie stars have them.

What am I talking about? Financial distribution plans, which control individual retirement account (IRA) and 401(k) assets at death and dictate how the decedent wishes his or her wealth to be distributed. These distribution plans, known as stretch benefit plans, multigenerational IRAs, or legacy IRAs, are growing in popularity.

What a stretch plan does, if drafted correctly, is allow an individual to protect much of his or her wealth from taxes long after death. This is accomplished by allowing non-spouse heirs, typically children, to stretch out the distribution of the bequeathed IRA, thus eliminating taxes that otherwise would be due in the year of the IRA owner's death.

Professionally drafting such plans is important because, contrary to popular belief, the balance in the average person's IRA account can double or triple in size between the time they are mandated by law, at age 70 1/2 to begin withdrawing "required minimum distributions" (RMDs) annually from their IRA, and when they die.

Douglas Lineberry, an attorney at Lineberry & Kenney, PLLC, of Tacoma, who specializes in asset protection, says, "It's not uncommon to leverage a $100,000 IRA into several million dollars."

For example, a man at age 63 starts a stretch plan with $200,000 he has in his IRA. Without withdrawals and a reasonable 8 percent rate of return, he will have nearly doubled the investment by the time he's forced to begin withdrawing at age 71 1/2. At that time, annual earned interest would be about $29,000, and his RMD less than $13,000. RMDs are based on life expectancy tables set forth by the Internal Revenue Service.

If the client dies at age 85, names his wife as his primary beneficiary, and she dies two years later, they would have earned about $834,000 in interest over the years from when the stretch plan was put in effect at an 8 percent return. During that period their combined required distributions would be more than $455,000. Keep in mind, that's more than twice the amount of money in the man's plan when he was 63.

The key point here is that the account still would have grown to $600,000 (original balance, plus interest, minus RMD payments) that could go to the couple's children. Those children, by taking minimum RMDs after the death of their mother when the oldest child was 60, again projected on life expectancies of age 85, could receive an additional $2 million in RMD payments before the plan started and funded by their father ran out of money. The alternative would be for the children to pay the tax up front and divide the proceeds, which would amount to only around $380,000.

Lineberry believes that in many instances an even better design of a stretch plan is through a conduit trust, in which the trust is named as the beneficiary of the plan.

Ken Ball, a legacy attorney for Meta Law Inc., of Ventura, Calif., says conduit trusts, like normal stretch plans, can be worded to require that RMD payments be made over the life expectancy of the oldest beneficiary. Yet, he takes the idea of conduit trusts one step further, and says the client can create individualized conduit trusts for each of his non-spouse beneficiaries, which would extend his legacy even longer for younger beneficiaries, whose life expectancies for RMD calculations would exceed that of the oldest beneficiary.

Lineberry says that, to reduce costs, Ball's idea of drafting individual conduit trusts can be merged with the original stretch plan, resulting in the client's plan to distribute his or her assets being contained in one document.

An important distinction between a stretch plan with an individual or individuals named as beneficiaries and one channeled through a trust, such as a conduit trust, is who has the authority to withdraw the money above the minimum RMD amount, and when. Individual beneficiaries can withdraw 100 percent of their share of the inheritance any time after the death of the client. In contrast, the named trustee of a conduit trust, after the client dies, is the only one who can authorize withdrawals above the minimum RMD amount.

As Ball says, "If you are concerned about the spending habits of your heirs, then this (a conduit trust) may be a good choice for you."

As a whole, heirs are less knowledgeable in financial matters than trustees and easily could fall into the trap of regularly withdrawing more than the minimum RMD, or even all of the account, and end up costing themselves and possibly their children large sums of money.

Lineberry says it might not be wise to draft a conduit trust for a specific beneficiary if the beneficiary is incarcerated, has addiction problems, or is experiencing extreme health issues. In such instances, he recommends an accumulation trust, where the trustee doesn't issue the RMD to the heir, and instead reinvests that money for the beneficiary. He says the earlier mentioned composite stretch plan that includes multiple beneficiaries, with varying life-expectancy rates, can include both conduit-trust beneficiaries and accumulation-trust beneficiaries.

Although the client can amend a stretch plan as desired, only limited changes can be made after the client's death. For example, those named as conduit-trust beneficiaries or accumulation-trust beneficiaries are allowed to change their designation shortly after the death of the client, but only once. A situation in which that would be prudent is if a conduit-trust beneficiary planned to file for bankruptcy and faced losing the inheritance unless he or she switched to an accumulation-trust designation.

In summation, I believe stretch plans are one of the greatest ways for average Americans to pass along wealth to future generations. Heirs who live into their 80s likely would have ample income from the original plan to support their needs, and could choose to pass the savings in their own IRAs or 401(k) plans on to their children.

Kelly C. Ruggles is a fee-based financial planner located in Spokane.
Kelly C. Ruggles, President of American Reliance Group, Inc., is a registered investment advisor.

©2008, Kelly C. Ruggles

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