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Stretching an IRA into Future Generations

Imagine that you could wave a magic wand and turn your new grandchild into a millionaire for a head start in life. Believe it or not, even a relatively modest amount tucked away using a “stretch” IRA strategy could, under certain market conditions, evolve into a rather substantial nest egg that your grandchild, or other beneficiary, may enjoy in years to come.

A Long-Term Strategy

The stretch IRA strategy is an Individual Retirement Account (IRA) in which earnings are allowed to grow tax deferred over a beneficiary’s lifetime. If you have an IRA that you do not need for retirement income, you can opt to restrict your withdrawals to the minimum annual distribution required by the Internal Revenue Service (IRS) starting at age 70½. Required minimum distributions are based on your life expectancy and the amount of funds in your account.

If you decide you want to stretch your IRA into future generations, you can establish a trust that allows for the distribution of IRA assets to primary, and possibly secondary, beneficiaries. Upon your death, your beneficiary will be permitted to take distributions over time, based on his or her age and life expectancy. This not only gives the investments in the account a chance to grow and compound, but it also means that income taxes owed on the IRA can be paid over an extended period of time.

If you choose a very young beneficiary, such as a grandchild, the funds in the IRA may compound substantially over the course of a lifetime. Provided the beneficiary does not access funds in the account along the way, due to a disability or other hardship, a considerable sum could amass by the time he or she reaches retirement.

Risks Involved

Before you integrate the stretch IRA strategy into your estate plan, it is important to note that this approach does carry some risk. If IRA assets decline in value, or if inflation erodes the value of your savings, the substantial returns for your heirs may not materialize.

Should you live a very long life, it is also possible that the funds in your IRA may not grow because you must continue to take required distributions. If, for example, longevity is on your side and you live to age 95, the amount you leave to a grandchild may be less than if you had passed on a decade earlier.

Keep in mind, too, that a stretch IRA strategy works best when only the required minimum distributions are withdrawn. If your beneficiary were to withdraw additional funds to buy a car or pay the rent, the account could be quickly depleted.

Finally, it is important to consider the tax implications of including a stretch IRA strategy in your inheritable estate. Under the Tax Relief, Unemployment Insurance Reauthorization, and Job Creation Act of 2010 (2010 Tax Relief Act), the Federal estate tax and generation-skipping transfer (GST) tax, which had been repealed in 2010, has been reinstated, with an exemption amount of $5.43 million and a top tax rate of 40% through 2015.

Despite the inherent risks, a stretch IRA strategy can be a tax-efficient means for passing on savings to future generations. While there is no guarantee that inheriting a stretch IRA can turn your grandchild into a millionaire, it could help contribute toward making his or her retirement more comfortable.

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