The Ninth Wonder of the World: The S-T-R-E-T-C-H IRA

Yep, I’ve been reading again, and this time it’s the book Parlay Your IRA into a Family Fortune by Ed Slott.

So many of us worry about outliving our money, but there are those who will clearly not, and that money has to go somewhere. A will takes care of a lot of things, but it also has the capacity to incur great pain at tax time if details aren’t handled properly to avoid it.

Residual monies left in an IRA account after death can be parlayed not only to enrich your beneficiaries, but in a big way. Just as you will be required to take withdrawals at age 55, your beneficiaries will be required to take lifetime withdrawals, albeit at a much slower pace due to a much younger age. An inherited IRA can be just as tax-deferred or tax-free to the beneficiary as the original owner as long as lump-sums are not paid out.

Hint: if correctly set up according to federal and state laws for your location, monthly IRA withdrawal payments to beneficiaries DO NOT have to be spent—if the beneficiary is very young, and in no immediate need of the money, that IRA can go on working and earning money just as it did for the original owner. Also, as far as I can tell, withdrawal payments don’t have to be SPENT—they can be re-deposited into an Education Savings account or an IRA of one’s own, to continue to grow and serve the beneficiary in more ways than one. Nothing says that money MUST be spent, and anyway, how could someone prove it wasn’t?

Basically, Grandma’s money moves from her purse to your piggy bank, tax-deferred or even tax-free, depending on the original IRA designation—a traditional IRA will incur taxes eventually, and a Roth IRA will not.

Young workers or new entrants into the workforce can always use some help in starting a savings plan—they don’t always get paid enough to start one with maximum contributions right off the bat. Grandma’s monthly checks would come in handy to fill in the balance until Junior earns enough money to do it himself. Even later on, when Junior DOES earn enough money, Grandma could be paying him enough each month to make the full contribution alone—lucky Junior, having Grandma to pay for his retirement with her own, even after her death!

There are some things you need to do and consider before converting all your wealth to the s-t-r-e-t-c-h IRA plan:

1. Name an IRA beneficiary NOW.

2. Make sure your IRA custodial agreement allows the stretch. Some do not.

3. Roll company plan funds (such as a 401k) into an IRA as soon as you can—usually right after you retire of change jobs.

YOU must do these things, and they must be done while you’re still alive. They cannot be enacted or legally overwritten once you die, and your heirs stand to lose what could add up to millions to unnecessary taxes. Why feed Uncle Sam?

An enduring rule about estate planning: the more money you have, the more beneficiaries stand to inherit. Most of us have more than one child or grandchildren who will inherit, and there is a way to accomplish that with a s-t-r-e-t-c-h IRA plan. The IRS says that when multiple beneficiaries are designated, the life expectancy of the oldest one determines the withdrawal schedule for all beneficiaries. The LOOPHOLE in this scenario is the “separate accounts rule,” which allows the inherited IRA to be split into separate inherited IRAs to trigger individual beneficiary withdrawal schedules, which will decrease the monthly amount withdrawn, but stretches out the time the money lasts—this enables the new separate IRA to go on earning money while producing monthly checks. Those monthly checks, again, can be deposited right back into other retirement accounts or an Education Savings account for future college expenses.

The “separate accounts rule” comes in handy when Grandma is a co-beneficiary along with grandchild #2, triggering a life expectancy withdrawal schedule of just a few years—not much time to build up interest or returns, meaning a huge loss of tax-sheltering and saving power for the grandchild. Grandma’s $100,000 residual IRA monies could end up being worth over $8 million over grandchild #2’s lifetime with compounding and tax savings.

There’s much more you need to know if you’re interested in stretching your IRA to enrich your family rather than the IRS, and the book goes into all aspects and contingencies of carrying this maneuver out. Ed Slott advises for long-term planning and earning, not to make a quick buck or cheat the taxman. I urge you to get a copy of this book and learn how to make your hard-won savings do double-duty after you’re gone.

You've heard the term "trust fund babies"? Your great-great grandkids have the opportunity to become "s-t-r-e-t-c-h IRA babies" if this wealth transfer scenario is kept up for a couple of generations. Judging by the way the economy, the business world, and the job market is going NOW, they might NEED it just to survive then.