Many IRA owners would like their IRAs to be inherited by loved ones and ultimately help fund the heirs own retirements or other needs.

This goal is known as the Stretch IRA. The IRA’s life stretches for decades and helps at least two generations. To achieve this goal, both the IRA owner and beneficiaries have to take certain actions.

Before starting, it’s a good idea to discuss this goal with loved ones. Most IRA sponsors report that many heirs simply distribute the full IRA after inheriting it, pay the taxes, and spend the after-tax amount. Let the heirs know your intentions and hopes regarding the IRA.

Also, keep in mind the President proposed ending Stretch IRAs. He doesn’t want IRAs to last much beyond the first generation of owners. The idea hasn’t developed traction in Congress, but anything can happen with legislation.

The first step to establish a Stretch IRA is to name one or more individuals as primary beneficiaries of the IRA. In general, when non-individuals (such as your estate) are named a primary beneficiary or no beneficiary is designated, the entire IRA must be distributed within five years of your passing. There’s an exception for a certain type of trust, but otherwise you can’t have a Stretch IRA when no beneficiary is named or you name the estate, a corporation or other entity, or a nonqualifying trust.

Remember your will and living trust have no effect on who is the IRA beneficiary. The beneficiary designation form filed with the IRA custodian controls who is the beneficiary or beneficiaries.

You don’t have to name a specific individual. You can name a category of identifiable people, such as “my children.” But it is better to name specific individuals.

You also should designate contingent beneficiaries. These are individuals who will inherit the account if the primary beneficiaries either are deceased or disclaim the inheritance. Only those people named as primary or contingent beneficiaries on the beneficiary designation form will be eligible to inherit.

When multiple beneficiaries are named, each must be an individual or a qualifying trust and it must be possible to determine the oldest member of the group.

For most IRA owners, the choice of primary beneficiary is automatically the spouse. Contingent beneficiaries often are automatically the children.

An IRA owner who wants to ensure a Stretch IRA and maximize planning possibilities, should appoint several levels of beneficiaries. For most IRAs, the appropriate listing is for the spouse to be primary beneficiary with the children or a qualified IRA trust as contingent beneficiaries. Some people skip a generation and name the grandchildren as contingent beneficiaries or name the grandchildren as a second level of contingent beneficiaries. Some advisors recommend naming a charity or family foundation as a last resort contingent beneficiary in case everyone already named isn’t able to inherit.

The list won’t be the same for each IRA, because each owner will have different loved ones and interests. The goal is to ensure an individual or charity of your choice will be beneficiary if the higher level beneficiaries are not able to inherit. Otherwise, your estate will be the beneficiary, and the IRA will have to be emptied within five years.

After the IRA owner passes, the estate administrator determines the Designated Beneficiary, a concept introduced by the IRS in 2001 and 2002 regulations. The DB is selected from the primary or contingent beneficiaries. The IRA custodian must be notified of the DB by Sept. 30 of the year following the year of the account owner’s death. The main significance of the DB is that his or her age is used to determine the required distributions. The oldest primary beneficiary usually is the DB. If there is no DB, a Stretch IRA is not possible, which is why you name all those primary and contingent beneficiaries.

When multiple beneficiaries inherit an IRA, they have the option to split the IRA in a tax-free transaction into separate IRAs for each of them. Once an inherited IRA is split into a separate IRA for each beneficiary, each beneficiary can use his or her own age to compute the required distributions.

Several requirements must be met to separate an IRA into different IRAs.

First, all post-death earnings, gains, losses, and contributions of the IRA must be shared pro rata between the different IRAs.

Second, the separate accounts must be established by December 31 of the year after the year in which the owner’s death occurred. This also is the deadline for taking the first required distributions from an inherited IRA. The separation can occur any time in the year of the owner’s death or in the following year. As a practical matter, since the RMDs must be taken by Dec. 31 of the year following the year of the owner’s death, the separation of the IRAs should occur sooner so that the distributions can be computed and taken. In addition, the DB must be determined by September 30 of the year after the year of the owner’s death. Therefore, the real deadline for separating the IRAs is long enough before Sept. 30 for the DB to be established and communicated to the custodian.

Third, separate accounts still can be established after the December 31 deadline. But at that point the required distributions for each IRA must be computing using the life expectancy of the oldest beneficiary of the joint IRA, before the separation. When the separation occurs after the December 31 deadline, each separate IRA must continue using the required distribution schedule of the original joint IRA. The advantages of making a separation of the IRA after missing the initial deadline are that each owner would be able to manage his or her investments and decide whether to take distributions exceeding the minimum.

The Second Level Inheritance

It is possible, even likely, that the initial beneficiary of a Stretch IRA will not live to see the account depleted. The method for calculating required distributions is designed so that the account will not be empty when the beneficiary reaches life expectancy. So, what happens after the initial beneficiary passes away?

After the initial beneficiary dies, the legal rights to the account pass to a successor beneficiary. The successor beneficiary must keep the same distribution schedule and method the initial beneficiary had. The successor will compute the distributions assuming that the initial beneficiary lived.

Exactly who becomes successor beneficiary depends on the terms of the IRA documents. An IRA might allow a beneficiary to name his or her successor. If the beneficiary exercised that right, the designation will be respected. Other IRAs or plans require that the estate of the beneficiary become the successor. The estate also will become the owner if the beneficiary had the right to name a successor and did not do so. The estate, then, is able to designate a successor and transfer the rights to the IRA to that successor.

The original owner might have named a successor beneficiary. Most IRA documents, however, say they won’t follow such a designation, and there are estate planners who question whether such a designation has legal effect. There also are estate planners who believe that when a beneficiary dies, any contingent beneficiaries named by the original owner are the successors. Under most IRAs, however, once a beneficiary inherits an IRA he or she has full title to it, including the right to name a successor, and contingent beneficiaries are out of the picture.

Because there is some uncertainty in the law here, it is possible there could be a dispute between heirs over the rights to an IRA. For example, a sibling might pass away. The other siblings might claim they are successors to the deceased sibling’s share of the IRA, while the deceased sibling’s children make the same claim. The plan documents and perhaps the law of the state of the custodian would determine the successor beneficiary. You might want your estate planner to draft a customized beneficiary designation form or research the law to minimize or avoid a dispute.