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May 11, 2009

Stretching Your IRA

ATT00261Individual Retirement Accounts (IRAs) are a key component in most Americans’ retirement plans.  Those of us who are currently participating in a 401k or other employer-sponsored pension plan, will most likely, roll those assets into our own IRA at retirement.

Retirement takes careful and thoughtful planning.  Deciding on what assets are to be used to produce retirement income, and in what order, is no easy task.  IRAs offer a number of advantages over other assets.  First, they grow tax-deferred, which means you only pay income tax on the amount you withdraw each year.  The remaining balance grows on a tax deferred basis. Second, IRA assets provide creditor protection.  In our litigious society, it makes sense to protect your assets whenever possible.  Third, IRA assets pass to your heirs without the cost, nor the delays of probate court.

If you do not expect to deplete the assets in your IRA in retirement, then you may wish to consider more efficient ways to transfer your wealth to your heirs.  For many Americans, this means using the Stretch IRA concept.

The Stretch IRA is a simple, cost efficient way to maximize your legacy to your children and grandchildren.  Here is how it works.  At retirement, you delay taking any withdrawals from your IRA as long as possible.  When you do start withdrawing assets from the IRA, you take as little as possible.  The law requires you to begin withdrawals in the year you turn 70½, and it also dictates the required minimum distribution is based on your life expectancy. If you should make withdrawals from your IRA prior to the age of 59½, you may be subject to taxes and penalties.

You name your spouse (if applicable) as the  primary beneficiary, with your heirs as secondary beneficiaries.  At your death, your spouse has the option to disclaim the IRA if he or she does not need the income, or roll it over into his or her own IRA.  If you choose to disclaim the IRA, your beneficiaries cannot roll the IRA into their own, but they can take minimum required distributions based on their current age and life expectancy and
stretch the tax advantages of your IRA for decades to come.  If the latter, then the surviving spouse can name his or her heirs as primary beneficiaries.  At the surviving spouses’ death, the heirs can stretch the IRA benefits for their lifetime.  Since they will be most likely younger, they may be able to enjoy income, tax-deferred growth and asset protection for their entire life.  The power of tax deferral and compound growth is
truly remarkable.  Let’s look at an example.

John, age 70, owns an IRA with a current value of $250,000.  He begins taking out the required minimum distributions and names his wife Maria, age 66, as his primary heir, and his daughter Sara, age 33, as his secondary beneficiary. Ten years later, John dies and Maria elects to roll over the IRA into her own IRA.  The value of the IRA, assuming a 6% growth rate, would be $295,106 despite John taking the minimum distributions for 10 years.  Maria next names her daughter Sara as the primary beneficiary, and her grandson,
Michael, as the secondary beneficiary.  She takes out the required minimum distributions each year.

At age 86, Maria passes on leaving Sara the IRA.  The value of the IRA (assuming a 6% growth rate) is now $308,759 despite the fact that both John and Maria took out the minimum required distributions for a total of 20 years.  Sara elects to receive the required minimum distributions based on her current life expectancy.  Since she is now age 53, her life expectancy is another 31.4 years.  If she were to pass away in 25 years, 6.4 years before her life expectancy, her son Michael would be entitled to receive the balance of $296,550, or continue Sara’s required minimum distributions for the remaining time period.


In this example, both Maria or Sara could have disclaimed the IRA, thus passing it on to the next generation.  If Sara disclaimed the IRA, then Michael could have received a lifetime of income, tax-deferred growth, and asset protection.

Naming a trust as your beneficiary adds an extra layer of protection and a greater degree of control over the IRA assets.  In a trust, you can insure that the trustee only pays out the required distributions.  Without a trust, it is left up to the beneficiary.   An additional benefit of using trusts is you can dictate who the secondary recipients are at the primary
beneficiary’s death.  Trusts can be costly.  So, careful consideration must be made to determine the appropriate course of action.  In addition, for those with estates over $3.5 million, estate taxes throw a bit of a monkey wrench into this strategy.  In such a case, it may make sense to review other possible IRA strategies.

Ten Steps to Stretch Your IRA

1.      The retiring spouses name each other as the primary beneficiary of their own IRA, with children and/or grandchildren as secondary beneficiaries.

2.      Each spouse can wait until age 70½ to start taking withdrawals.

3.      The withdrawal amount can be limited to the minimum amount required by law.

4.      At the death of the first spouse, the surviving spouse can disclaim the IRA or roll the balance into their own IRA.

5.      The surviving spouse continues to take required minimum withdrawals for life.

6.      The surviving spouse retains the right to change, add or delete beneficiaries.

7.      At the death of the surviving spouse, the beneficiary receives the balance of the IRA.

8.      The beneficiaries are entitled by law to continue taking minimum distributions based now on their life expectancy.

9.      The IRA continues to grow tax-deferred and provides creditor protection for their heirs.

10. Heirs may choose to disclaim his or her beneficiary status, leaving more for the next generation of beneficiaries.

Your Money Concepts’ financial advisor is here to help.  We are happy to work with you and your other professional advisors to insure you the greatest diversity of opportunities in your financial planning.  If your advisor can be of any help, please give him or her a call.

Please feel free to pass this along to anyone you think might benefit from this information.  We appreciate all referrals.