How to Stretch Your IRA Into a Family Fortune

Your individual retirement account (IRA) can do much more than provide funds for your retirement — it can be stretched to provide millions of dollars in payouts to your children, grandchildren or others you choose to be beneficiaries.

Example: An IRA balance of only $100,000 may provide more than $8 million in future distributions when left to a young child.

What you need to know…

stretching an IRA

Most IRA owners think of their IRAs as providing savings only for themselves — and their spouses, if married.

This is largely because traditional IRAs are subject to annual required minimum distributions (RMDs) that begin at age 70½ and cause the IRA’s funds to be distributed over the life expectancy of its owner.

IRA owners typically believe that if they live to their full life expectancies (or longer), there will be little or nothing left in their IRAs to leave to heirs.

Surprise: The life expectancies that govern mandatory IRA distributions as given in IRS tables are not actual life expectancies. The IRS life expectancies are much longer than actual average life expectancies.

The table below shows the life expectancies as provided by the IRS’s “Uniform Lifetime Table” for IRA distributions, which is used by most IRA owners (single persons and married persons with spouses not more than 10 years younger) to determine the size of RMDs, versus actual average life expectancies as given by the National Center for Health Statistics.

Life Expectancies

Key: As a result of the difference, you may be able to leave funds in an IRA for much longer than you expect.

Moreover, initial RMDs may be so small that your IRA will continue to grow in value for years after distributions begin.

Explanation: At age 70½, when RMDs start, life expectancy under the IRS table is 27.4 years.

Each year’s RMD is determined by dividing the IRA balance by the number of years in life expectancy — so at age 70½, the RMD is 1/27.4, or 3.6%, of the IRA’s value. If your IRA earns more than this, it will continue to grow in value in spite of the distributions.

So, if you take only minimum distributions each year from your IRA and it earns 8% annually, it will continue to grow until you reach age 88! (Under the IRS table, the RMD won’t reach 8% of the IRA’s value until then.)

the stretch

Once a beneficiary receives an IRA, its value may resume growing at a much faster rate.

Rule: A beneficiary can take required distributions over his/her life expectancy starting in the year after the inheritance. But if the beneficiary is young, life expectancy may be 50, 60 or 70 years, or even more, making initial RMDs so small that the IRA can grow rapidly.

Example: A grandparent leaves a $100,000 balance in an IRA that earns 8% annually to a one-year-old grandchild. The child’s life expectancy under the IRS single life tables used by beneficiaries is 81.6 years, so the initial RMD is only 1.2% of the IRA balance.

Under the applicable IRS life expectancy table, the RMD won’t reach 8% of the IRA balance until the grandchild is 70 years old. If the child takes minimum distributions, the IRA balance will grow for 69 years — even with the child taking minimum distributions from it all that time.

In total, over the 82 years of the child’s life expectancy, the IRA will pay the child $8,167,629 dollars — more than eight million dollars from the initial $100,000.

how to do it

Steps to make the most of your IRAs…

Roll over funds from other retirement accounts into IRAs. This will let you use the “stretch IRA” strategy for as much of your retirement savings as possible.

Open Roth IRAs or convert traditional IRAs to Roths if eligible. These are even better to stretch than traditional IRAs. Distributions from them are tax free and there are no required minimum distributions for the original IRA owner. (Beneficiaries must take RMDs.) This lets you save funds in them for longer periods to earn more compounding.

Plan retirement spending to preserve IRAs. Build your investment portfolio for your retirement years. Best: Plan to consume IRA funds last. This will provide more tax-favored compounding within the IRA for you, and help you leave a bigger IRA balance to heirs.

Rules for the stretch

The beneficiary who takes a stretch IRA must be a named person, not your estate.

Be sure the custodial agreement with your IRA trustee provides for allowing a stretch IRA — not all do.

Either have separate IRAs for each beneficiary or formally “split” your IRA among them, such as by designating a set percentage as going to each. Traps…

If an IRA with multiple beneficiaries isn’t split up, the life expectancy of the oldest governs distributions for the others.

If a non-person (such as a charity) is co-beneficiary of an IRA, its life span of zero applies to all other co-beneficiaries, forcing them to take rapid distributions — and eliminating the stretch.

When an IRA is left to a spouse, to use its funds to set up a stretch IRA for a child (or other beneficiary), the spouse must first convert the inherited IRA into his own IRA (only a spouse can do this), and then name the child (or other party) as beneficiary.

After the spouse dies, the inherited IRA must be retitled with the deceased owner’s name in it, or the IRS will deem it distributed and taxable.

Example: “Frederic Jackson, IRA (deceased June 15, 2006) for the benefit of Sandra Jackson, beneficiary.”

Important: Convince your beneficiaries of the importance of taking minimum “stretch” distributions. If they empty your IRA of cash as soon as they inherit it, all the potential decades of future compounding will be lost.

Saver: A trust can be named as beneficiary of your IRA to pass through payments to an heir, assuring that only minimum RMDs are taken (unless the trustee deems there is good reason to take larger distributions) so compounding is maximized.

Many technical rules apply to trusts and IRAs generally, so consult an IRA expert.

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