The Super Power of Stretch IRAs
Recently, multi-generational IRAs (MGIRAs or “Stretch IRAs”) have become an increasingly popular financial planning tool among advisors looking to assist their clients in preserving wealth for future generations. In fact, an April 2012 article implies that this is a relatively new concept. I can assure you that “Stretch IRAs” have been around for a long, long time!
In the most basic sense, this tool “stretches” IRA distributions over the life expectancy of the next generation to maximize tax deferral and income opportunity. Here is a good example outlining the power of a Stretch IRA in common practice:
John, age 70, has $500,000 in an IRA. John has non-IRA funds that are more than adequate to provide for a comfortable retirement and inheritance for his son, and doesn’t want to take any funds from his IRA unless he is required to do so. John names his spouse Jane, age 60, as beneficiary. Together they agree that, should John die, Jane will not take any distributions from the IRA unless required, leaving the IRA to their grandchild. John dies 10 years later at age 80. Assuming his investments have grown at 6% per year and he has taken distributions as required, his IRA is worth $577,215 at that time. Jane rolls over the funds to a new IRA in her name, and begins taking distributions as required right away at her age 70 ½. Keeping the promise she made to John, she only takes what is required and names her grandson, Sam, as beneficiary of the IRA. She continues distributions until she passes away at age 85, at which time Sam, age 31, becomes the new owner of the IRA. At this time, the account is valued at $635,471.
This newfound wealth for Sam comes as quite a shock, but fortunately he hires a financial advisor to help him deal with the change. Though tempted, he does not choose to take the IRA out in a lump sum (which would result in taxes). Instead, he elects to continue deferring the tax and taking his own required distribution over the next 54 years! See the graph below:
If Sam chose to take the lump sum at age 31 to buy a new car, pay off a mortgage, and squander the rest, he would have only have received a true inheritance of $635,471 (gross of taxes). By taking the distribution throughout his lifetime, he actually received over $4,200,000 of total value (again, before tax) until the account ran out at his age 84.
Obviously, you can see the power in the numbers. In this simple example, an account originally valued at $500,000 actually provided over $5,000,000 in distributions during a combined 80 years of life, assuming a modest 6% rate of return. Beyond the quantitative data, how neat would it be for your heirs to receive a constant monthly reminder (in the form of a check) that their grandparents truly cared about their well being and wanted them to succeed in life? Now that’s what I call something to remember!
If the concept of a Stretch IRA is something that interests you, make sure you discuss with your financial advisor the impact this tool can have on your legacy.