Keep It Together, Part 2

Parlay Your IRA into a Family Fortune: 3 Easy Steps for creating a lifetime supply of tax-deferred, even tax-free, wealth for you and your family
by Ed Slott

(Page 3 of 3)

There can be only one designated beneficiary to an IRA. So, if you have multiple IRAs, you need to designate a beneficiary for each of them to gain the stretch for all the accounts. If you have one IRA but multiple heirs (three kids, for example), you can split the IRA among your children (or they can split it among themselves after you're gone) so that each child can claim the title of designated beneficiary on his or her separate share of the inherited IRA and can thus stretch that share out over a long period of time. (For more on splitting IRAs, see Chapter Six.)

The stretch is based on the projected life expectancy of your designated beneficiary (or designated beneficiaries in the case of multiple IRAs) according to his or her age the year after you die. The younger the named beneficiary is, the longer the stretch.

For example, if at your death your designated beneficiary is your 29-year-old daughter, she can stretch the inherited IRA over a projected life expectancy of 53.3 years, according to the Single Life Expectancy table. If you died in 2004 when she is age 29, she would then use her age in 2005 (age 30) to calculate her first required minimum distribution for that year.

She needs to use the life expectancy table only once. For each succeeding year, she just subtracts one year from the life expectancy figure. In this example, the required distribution for 2006 (her second distribution year) would be calculated using a 52.3-year life expectancy (53.3 years less 1 year = 52.3 years). For the third year the life expectancy would be 51.3 years, then 50.3 years, 49.3 years, and so on until the original 53.3-year term has expired, unless she completely withdraws the IRA before that time. She can always withdraw more than the required amount.

If she dies before the 53.3-year term has expired and there is still a balance in the IRA, then her beneficiary can continue to stretch the remaining years left on the original 53.3-year schedule. That's why it is so important for every beneficiary to name a successor beneficiary of his or her own as soon as he or she inherits so there will be someone named to keep the stretch going on schedule if the original beneficiary dies prematurely. (This will help to avoid probate and other will-related problems that might also endanger the stretch - see Chapter Two.) There will be more on naming successor beneficiaries in Part Two.

FAQ

Q.Ed, if I have no designated beneficiary, does this mean no one will inherit my IRA?

A.Someone will get it, and it may even be the person you would have wanted. It also may not be. Either way, the huge benefit of the stretch IRA is lost, and it cannot be reclaimed after you're gone.

The Power of the Stretch - Victoria's Millions

Let's see in real numbers what happens if we were to milk a stretch IRA for all it's worth. The power of the stretch IRA lies in its compounding over time. Therefore, the younger your IRA beneficiary, the longer the life expectancy, thus the longer he or she can spread out required withdrawals and compound the IRA in value. So, let's use a 1-year-old as an example. I'll call her Victoria.

Born in 2003, Victoria is named beneficiary of her grandfather's IRA when he passes on later in 2003. Victoria's life expectancy begins at age 1, the year after her grandfather's death. According to IRS projections based on actuarial figures drawn from the Single Life Expectancy table for inherited IRAs (Table 1), the life expectancy of a 1-year-old is 81.6 years. That is her stretch period.

Let's say the December 31, 2003, value of the IRA Victoria inherits from her grandfather is $100,000. Based on her life expectancy of 81.6 years, Victoria is required to withdraw only $1,225 ($100,000 divided by 81.6 years = $1,225, or 1.225 percent) from the IRA in 2004. The balance can keep growing tax-deferred. Because her life expectancy factor will drop by one each year, in 2005 she will have to withdraw based on 80.6 years (divide the balance by 80.6 years), then by 79.6 years in 2006, 78.6 years in 2007, 77.6 years in 2008, and so on down the line. Therefore, by taking only the required minimum distribution each year, Victoria will not have to empty the account until she is 82 years old. If we assume an average growth rate of 8 percent over her life expectancy of 81.6 years, by the time she has to empty the account, that $100,000 IRA she inherited from her grandfather would have paid her an astonishing $8,167,629.

Many people have IRAs worth more than $100,000 when they pass on, so I can hear what you are thinking: "If little Victoria could parlay her $100,000 IRA into $8 million what could my family do with my $200,000 (or $250,000) IRA?"

Here's how it works, based on the bottom-line even figure of $100,000 I originally used. For a $200,000 IRA, simply multiply the $8,167,629 result by 2. For a $250,000 IRA, multiply the result by 2.5.

For example, if 1-year-old Victoria had inherited a $250,000 IRA from her grandfather in 2004, she would withdraw a total of $20,419,073 over her lifetime. How did I get that? $8,167,629 by 2.5 = $20,419,073. Think of it. If 1-year-old Victoria had inherited a $1 million IRA from her grandfather, she would receive an astounding $81,676,290 over her lifetime.

These are amazing numbers, which may not sound realistic to you, but consider this fact: The amount little Victoria begins with in each example is very realistic, because it is not unusual for people these days to have accumulated $100,000 or much more in their IRA nest eggs. By stretching withdrawals, a huge pile of cash is fully attainable for anyone with an IRA, even a modest one.

This is why the stretch IRA concept truly is the Ninth Wonder of the World.

The Heck with My Kids -
I Want to Enjoy the Money Myself!

"Ed, this is a great strategy you've come up with for turning my heirs into potential millionaires on my retirement money, but I want to eat filet mignon and lots and lots of carbs in the time I have left on this planet (my beneficiaries can eat cat food for all I care). What do I do now to parlay my IRA for me to enjoy?"

The starting figure I use in all my examples of what your family can parlay your IRA into when they inherit is what's left over in your IRA after you've gone to your great reward having had a high old time in your retirement. (Virtually everyone leaves some amount over. I think it may be in our genes not to deplete every last nickel.) Of course I have taken your own retirement fund growth and spending into account. It's not your job to make your beneficiaries rich. Start with yourself.

But imagine a tax-free retirement for yourself on top of leaving a tax-free inheritance that pays tax-free money to your beneficiaries every month for the rest of their lives. It doesn't get better than that. You can achieve these goals if you begin now by parlaying your IRA first on your own behalf - and you don't have to start with much at all to reach some pretty amazing results.

If your main concern is your own retirement needs, then it makes even more sense to grow your IRA for as long as possible before it is absolutely needed and, when that day comes, to take only the minimum amounts that you must under the regular required minimum distribution (RMD) rules. This will leave more for you.

The best way to parlay your IRA for yourself first is to convert to a Roth IRA as soon as you qualify. Here's why:

With a Roth IRA, unlike a traditional IRA, you pay the tax up front when you contribute or convert to it, not at the back end when you start taking distributions. Why does this matter? Because after you pay the tax up front, you never pay it again; your money in the Roth keeps growing tax-free forever, and that's what boosts your exponential return over time.

To use a farm analogy, it's like paying tax on the seed so the crop can grow free. Remember our mantra: The longer you keep your IRA sheltered from taxes, the more money your family will accumulate. Well, that goes for you too. Don't buy into the argument that tax-deferred is always better than tax-free. YOU SIMPLY CANNOT BEAT A ZERO PERCENT TAX RATE ON IRA WITHDRAWALS! The Roth IRA is the way to get Uncle Sam out of your wealth- building potential permanently!

© 2005 Viking, a division of Penguin Putnam, used by permission.

About the Author

Ed Slott is a highly sought-after professional speaker, CPA, and tax adviser. His diverse client list includes major corporations such as Fidelity Investments, American Express, Merrill Lynch, Nationwide Insurance, and Oppenheimer Funds. Ed Slott frequently appears in The Wall Street Journal, The New York Times, USA Today, and on broadcast television and radio programs nationwide. He is publisher of the popular monthly newsletter "Ed Slott's IRA Advisor." For more information about Ed Slott and his numerous speaking engagements, please visit his website: www.irahelp.com.