Stretch your IRA

How would you like to make your grandchildren millionaires? Would it put a smile on your face to insure that your great-grandchildren never have to think about money?

Its easy … if you have the discipline and self control to budget annual savings, if you’re right about any number of assumptions and if you read on.

We’re talking about Stretch IRAs.

Individual Retirement Accounts (IRAs) have been one of the most popular retirement vehicles for the past generation of investors. They let you enjoy tax-deferred savings over an extended period of time.

A Stretch IRA is a term commonly used to describe an IRA established to extend the period of tax-deferred earnings, typically over multiple generations.

In the short run, you can use the concept to reduce the required withdrawal you must take from the account if you’re retired or at least age 70 1/2, and you’ll cut your current income tax bill as well.

Meanwhile, because you are extending the IRA payout until your grandchildren retire (or further, if appropriate), you get substantial additional deferral years to compound the earnings growth. Depending on the earnings and payout rates, potential payouts may approach multi-million-dollar levels.

Distribution rules simplified
All of this becomes possible thanks to rules a few years ago that simplified distribution rules for qualified plans and IRAs. These rules:
Provide a uniform table to determine lifetime required minimum distributions regardless of age.

Permit a beneficiary to be determined up to the end of the year following the death of the primary owner.
Allow the normal life expectancy that would apply at the time of death to be taken into account in the calculation of post-death minimum distributions.
The rules let you determine your minimum distribution each year, based on your current age and account balance. The new distribution schedule is based on the joint life expectancies of you and a survivor who’s at least 10 years younger. It assumes that both begin receiving distributions beginning at age 70. (There’s an even simpler distribution table for spouses who are not more than 10 years apart in age.)

These new rules also allow you to determine your beneficiary up to your death, and to select a beneficiary more than 10 years younger than you. These moves are what combine to reduce current minimum distribution requirements and extend the deferral period. (Remember, you can always take more than the minimum required annual distribution from your retirement plan. These changes affect people who want to take out the lowest required amount.)

Checking out the numbers
Lets take an example. Assume I started my IRA at age 29. (I know, I know: I should have started earlier.) And I plan to contribute $2,000 per year until age 69 when I die. That gives me 40 years of compounding, and, at a 7% rate of return, my IRA at the end of that time should be worth $399,270.

I leave the IRA to my wife, whos 20 years younger than I am and who lives until shes 69. Thats another 20 years of tax-deferred compounding, which, at 7%, compounded monthly, brings the value of the account to $1,612,547.

She leaves the account to our granddaughter, who has additional 70 years of compounding. At the same 7% rate, her account is then worth $213,487,584 when she retires!

I can see the smile on her face now … even if the money becomes all taxable. I can hear her children laughing, freed from any financial concerns.

(The numbers potentially could be bigger. Thanks to the 2001 and 2003 tax cut laws, you have been able to make larger contributions to IRAs. For 2005 and 2006, the contribution limit is $4,000 a year. It will rise to $5,000 a year starting in 2008.)

IRAs have been an excellent and extremely popular investment tool. As of 2004, millions of Americans have saved $3.07 trillion for retirement using IRAs and employer-sponsored defined contribution plans, according to the Investment Company Institute. The IRA total was $1.49 trillion.

Is the Stretch IRA right for you?
But before you jump at Stretch IRAs, recognize that its all in the assumptions. Any changes in the assumptions change the potential value of your investment fund. A Stretch IRA assumes:
You dont need the money, either before or after retirement. That’s a big assumption.

You will take the smallest amount of money the law allows, and at the latest time it allows, without penalty (currently at age 70 1/2).

Your primary beneficiaries die early, before they can deplete the investment fund.

That tax laws will remain constant and not change.

That inflation is minimal, and will not significantly cut into your rate of return and the ending values of the account.

That your returns dont vary. Most Stretch IRAs assume a constant rate of return that can be projected accurately over the long term. In the real world, those investors in the stock market who got in six years ago and got out two years ago — before the market crash — will have a very different rate of return than those who started their investment portfolio two years ago.

Stretch IRAs are a great way to accumulate financial freedom for your heirs. But their true value depends on realistic assumptions being made and realized. Lots of things can happen that will stunt the growth of an IRA. And you have to be sure the account fits YOUR needs.

But that $213 million looks awfully attractive to me!