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
The Stretch IRA Means You Get to Be the Bank
Do you remember when you first applied for a home mortgage and had to figure out whether to take a 15-year loan or a 30-year one? Remember becoming aware of the huge difference in interest you would have to pay the bank the longer it took you to pay off the loan-and thus, how much more money the bank makes on you since you are paying more interest?
The stretch IRA works the same way-only in reverse. It works to your benefit-not Uncle Sam's - because the longer you take to withdraw from your IRA and pay tax on it, the greater the interest compounding, all of which grows tax-deferred (or tax-free in a Roth IRA) in your name!
How do you set up your IRA to take advantage of this sweet deal? That depends on what you want to accomplish. To find out, ask yourself the following questions:
Is your objective to build an estate for your beneficiaries f Or to spend all you can on yourself-in other words, how much do you care about what happens to your IRA after you're gone? Some people don't care-a widow, a widower, or a single person, for example, who may have no kids or grandkids, just distant relatives. Others may not care because they want to take care of Number One first; after that, let the chips fall where they may. That's fine, but you still want to make the most of the money in your IRA while you are alive-and make it available for you, not Uncle Sam!
What keeps you up at night? Do you worry about: Running out of money before running out of time? Making sure your spouse is taken care of for the rest of his or her life? Making sure your children get the most benefit out of your IRA? Making sure everything is clear to your family and everyone gets his or her fair share? Whether you have considered beneficiaries from prior marriages (and do you want to)? Having liability concerns such as alimony payments and child support as a result of divorce, or lawsuits, malpractice claims, and bankruptcy issues?
Do you want post-death control? In other words, what good is the stretch if a beneficiary won't take advantage of it? Maybe he or she wants all the money now instead of in installments taken out over time for growth purposes, because that new Ferrari is calling, and it can't wait. Or maybe there are special circumstances, such as disability, incompetence, lack of knowledge and/or interest in financial matters on the part of the beneficiaries, or lack of maturity and sophistication in the case of minor children. If it's likely your child or other beneficiary will not exercise the stretch, then it is something you need not plan for-you can simply designate the child (or other person) you named beneficiary and let the child do as he or she pleases; this will at least guarantee that the stretch option exists for the child in the event he or she eventually sees the light. If you have more than one child, only one of whom is the responsible type who will maximize the stretch, it might be better to leave other assets (a non-IRA bank account or fund, a piece of the family business, or a home) to the child who probably wouldn't stretch, and bequeath your IRA to the child who will; this way, you can leave both children the inheritance that works best for them according to their aims. And if you really want to exercise post-death control by making sure your beneficiaries have no other choice but to take full advantage of the stretch according to your direct guidance, you can name a trust as your IRA beneficiary for their benefit and state in it the degree of post-death control you wish.
Do you have charitable intentions? Leaving an IRA to charity in whole or in part renders the stretch option moot. Besides, charities just want the cash all at once so they can put it to good use immediately.
Some additional questions you will need to ask yourself include:
How old are the beneficiaries you are considering (when will lifetime distributions begin)?
Are those beneficiaries still working?
Will your beneficiaries need to tap into your IRA for living expenses?
Should you leave a Roth stretch IRA instead of a traditional stretch IRA if you are a candidate for a Roth?
Your answers to these questions will tell you a lot about yourself and your options, as well as your short- and long-term goals for your retirement nest egg. What you find out will guide you in making the right beneficiary and other choices to achieve those goals.
Can Your IRA Be Stretched?
You'd certainly hate to go through this whole book salivating over the incredible amounts of cash your IRA can be parlayed into for your family, only to find out that your retirement fund cannot be stretched, wouldn't you? Well, relax. In just about all cases, an IRA can be stretched-provided you set it up properly (I'll get to that in a moment). The reason I hedge and say in "just about air cases is that, believe it or not, some banks and other financial institutions are ignorant of the stretch IRA-the option for your IRA beneficiaries to extend distributions on inherited IRAs over the rest of their lives-or so unclear about the tax laws that they do not allow it.
If your retirement account cannot be stretched, your beneficiaries will have to withdraw the funds soon after death and in some cases in a lump sum. That means all taxes are due right away and the long-term value of your tax-deferred retirement account will vanish. That completely defeats the benefits of the stretch and the fundamental concept of this book, which is to keep your IRA away from the IRS for as long as possible. Even though the stretch IRA is permitted and actually encouraged by the tax law, it is not automatic if your retirement plan is not set up properly to take advantage of it.
So, let's ask again: Can your IRA be stretched?
Yes, if you do three things (and they are all easy). Skip or backslide on any one of these points and you'll be sick at the millions of dollars you will have cost yourself and your family in potential wealth:
1. Name an IRA beneficiary NOW-by filling out an IRA beneficiary form for each IRA you own, designating a person (or persons)-as opposed to an entity-as your named beneficiary. Inform beneficiaries where each is kept, and regularly update each form to stay current.
2. Make sure your IRA custodial agreement allows the stretch. Not all do.
3. Roll company plan funds, such as a 401 (k) fund, into an IRA as soon as you can-usually right after you change jobs or retire.
Only you (not your heirs) can do these three things, and they are all you can do to ensure the stretch for your beneficiaries. (It's still possible, of course, for your beneficiaries to screw up the stretch when they inherit by not inheriting properly. That's where Part Two comes in. It tells your beneficiaries what they must do-and how to do it-to capitalize on the potential bonanza you've served up on a silver platter.)