STRETCH YOUR IRA TO HELP YOUR GRANDKIDS

Stretch IRAs are accounts that you can set up to defer taxes indefinitely — not just in your lifetime, but through multiple generations. Here’s how they can work for you — and your loved ones.

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

It’s 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,” that hot new concept being touted by professional retirement and financial planners.

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 70½, and you’ll cut your current income tax bill, to boot!

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. REALLY!

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 new rules:

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Provide a uniform table to determine lifetime required minimum distributions regardless of age.

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Permit a beneficiary to be determined up to the end of the year following the death of the primary owner.

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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.

These new 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

Let’s take an example. Assume I started my IRA at age 29 (I know, I know: I should have started earlier.) and contributed only $2,000 per year until age 69 when I die. That gives me 40 years of compounding, and, at a 7% annual rate of return, my IRA at the end of that time should be worth $399,270. Check it out using the ReesNet.com Financial Calculator.

(The numbers potentially could be bigger. Since 2002, thanks to the Tax Relief Act of 2001, you have been able to contribute $3,000 a year through 2004. It jumps to $4,000 a year starting in 2005, and $5,000 a year starting in 2008. And, since 1843, the average rate of return on stock market investments has been 12.21%.)

Assume that I leave the IRA to my wife (I’m actually a bachelor!), who’s 20 years younger than I am and who lives until she’s 69. That’s another 20 years of tax-deferred compounding, which, at 7%, compounded monthly, brings the value of the account to $1,612,547. Check it out using the ReesNet.com Financial Calculator.

She leaves the account to our newborn granddaughter, who has additional 70 years of compounding. At the same 7% rate, her account is then worth $213,487,584 when she retires! Check it out using the ReesNet.com Financial Calculator.

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

IRAs have been an excellent and extremely popular investment tool. As of 2002, millions of Americans have saved $2.3 trillion for retirement using IRAs.

Is the Stretch IRA Right for You?

But before you jump at Stretch IRAs, recognize that it’s all in the assumptions. Any changes in the assumptions change the potential value of your investment fund. A Stretch IRA assumes:

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You don’t need the money, either before or after retirement. That’s a big assumption.

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You will take the smallest amount of money the law allows, and at the latest time it allows, without penalty (currently at age 70½).

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

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That tax laws will remain constant and not change. (There’s the BIG stretch!)

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

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That your returns don’t 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 seven years ago and got out three years ago — before the market crash — will have a very different rate of return than those who started their investment portfolio two years ago. Nonetheless, the long-term prospects for the market look good, considering its performance since 1843 — 12.21%, in spite of depressions, wars, natural disasters, currency devaluations, burst “bubbles,” goofy presidents, etc.

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. And you have to be sure the account fits YOUR needs.

As Mary Schapiro, president of NASD Regulation, pointed out, “We are worried that this new twist on IRAs may be misunderstood by investors who do not realize that over the many years that a stretch IRA lasts, many things can happen to stunt the huge growth they had hoped to get for their grandchildren.”

But that $213 million looks awfully attractive to me! Better than nothing, even with inflation!!