If you weren’t already aware, a huge benefit of an IRA is its capability to generate tax-favored money to beneficiaries.
By “stretching” an IRA left to an heir, it can provide pre-tax compound investment returns for the remainder of a beneficiary’s life or even after death. These stretch IRAs can be appropriated completely tax-free if they are Roth IRAs. It makes you think, “Should you be taking advantage of stretch IRAs?”
So, how much could a stretch IRA translate into dollars? Investment growth on a compound basis is impressive, but just how impressive? Let’s take a look.
An Example in Dollars
Grandma passed toward the end of 2017 with $100,000 in an IRA. Her granddaughter is the beneficiary on the IRA. The granddaughter takes her first RMD (required minimum distribution) out of the IRA in 2018 when she is 22 years old. Her RMD schedule is decided by the IRS’s Single Life Expectancy Table. This table gave her an expected life of another 61.1 years, or until she turns 83 years old. The IRA she inherited can last until then.
Over the long run, the stock market returns an average of 7% over inflation. The granddaughter’s initial RMD is only 1.637% of the inherited IRA’s value and will not reach 7% until she is over age 68. Assuming this IRA invests in stocks and this rate of return continues into the future, the IRA might grow in value for 46 years even with annual distributions to the granddaughter.
Every year’s RMD is equal to the IRA account balance at the end of the prior year divided by the beneficiary’s life expectancy. So, the granddaughter’s RMD for 2018 is $1,637 ($100,000 / 61.1). Throughout 2018, the IRA grows 7% ending at $107,000. The granddaughter will take her RMD at the end of the year, and after subtracting the RMD, the total account balance at year’s end for 2018 would be $105,363.
If this process repeats with a continued 7% return annually, the IRA will continue to grow in value until the granddaughter hits the age of 68. At this time, her RMD will have grown to $40,364 and the total IRA balance would be $611,801, and after paying out the RMD the balance would be $571,189. Add the remaining balance and the RMD payouts through the years and the combined total is $1,182,990!
Now let’s say the granddaughter passes at age 75 and her 40 year old son is her named beneficiary. At this point the granddaughter has received $953,977 in RMDs from the IRA and it has a remaining balance of $518,543 for her son. Her son, following the same schedule as his mother, begins taking RMDs and the IRA continues to earn 7%.
Overall the IRA has paid out 1.648 million to the granddaughter and her son combined which is over 16 times the initial $100,000 left to the granddaughter.
Please note that this scenario is just an example. Nobody can actually know what future returns on investments will be and those investments may vary.
Also, something else interesting to note is if the beneficiary is under age 22, that IRA may even grow more than what’s in this example. Stretch IRAs should not be underestimated.
It might be worth checking whether you should be taking advantage of stretch IRAs and we’re happy to help you with exactly that! If you would like someone to take a second look at your retirement plan, including your IRA accounts, schedule a complimentary consultation below or call us at 913-393-1000.
Schedule Complimentary Consultation
Select the office you would like to meet with. We can meet in-person, by virtual meeting, or by phone. Then it’s just two simple steps to schedule a time for your Complimentary Consultation.
Lenexa Office Lee’s Summit Office North Kansas City Office
Investment advisory services offered through Modern Wealth Management, Inc., an SEC Registered Investment Adviser.
The views expressed represent the opinion of Modern Wealth Management an SEC Registered Investment Advisor. Information provided is for illustrative purposes only and does not constitute investment, tax, or legal advice. Modern Wealth Management does not accept any liability for the use of the information discussed. Consult with a qualified financial, legal, or tax professional prior to taking any action.