Since their introduction in 1974, Individual Retirement Accounts, or IRAs, have become a cornerstone of many investment portfolios, providing a road to financial security for millions of Americans. In setting up a will or trust, however, many people unknowingly miss the opportunity to maximize the value of their IRA or 401(k), which is often times the biggest asset left to heirs. As a result of this missed opportunity, most beneficiaries who inherit IRAs end up paying more taxes than what’s necessary.

The best way to maximize an IRA intended for an inheritance is to set up a “stretch” by taking advantage of an important IRS tax code provision.

Before 2002, beneficiaries of an IRA, 401(k) or other type of retirement plan, had no other option than to receive their inheritance in a lump sum. This led to huge tax liabilities, especially in cases where these inherited IRAs were large.

For example, at that time if you had a household income of $100,000 per year and suddenly inherited an IRA of $200,000, your income tax rate would shoot up to the top tax bracket, and you would end up owing 40 percent of your annual income and inheritance to the government. The worst part was that there were very few options for getting out of this situation.

Fortunately, in 2002, a tax code provision came into effect allowing beneficiaries to defer taxes on the majority of inherited IRAs, making a huge difference in both immediate tax liabilities, as well as the lifetime value of the inherited account. In order to take advantage of this provision, investors in IRAs and their beneficiaries must correctly set up everything in a will or trust.

To effectively stretch an inherited IRA, you need to know a few things. Stretching IRAs can get complicated, and you’ll probably want to consult with a qualified estate planner or financial professional for more details, but here are the important points to keep in mind:

• The custodial document and beneficiary form must permit the IRA stretch provision.

• A non-spouse beneficiary cannot roll the account assets into his or her own account.

• A living person must be named as the beneficiary of the IRA.

• If multiple beneficiaries inherit the IRA and each wants to use their own life expectancy in setting up a stretch, the account must be split by December 31 of the year after the account owner’s death.

Unfortunately, many don’t know about the stretch provision and fail to use it. It doesn’t cost anything to set up a stretch, but, in order for it to work, not only must the account holder set up the stretch, but the beneficiary must also know how to implement it.

To make sure you don’t miss anything when setting up a stretch IRA or implementing a stretch, your best bet is to consult a professional, such as an estate planner or financial advisor who is experienced with IRAs and knowledgeable about the details regarding stretching the account.

Radon Stancil, CFP®, and Rick Parkes, LUTC® of Diversified Estate Services have 45 years of combined experience in the financial services industry and assist North Carolina residents with their comprehensive financial needs including IRA management, retirement income planning, investing, tax planning, risk reduction and estate planning. For more information please call (919) 787-8866 or visit www.desllc.org