Show#352 Airing Sunday, 8/13/06
How would you like to turn your modest IRA or 401(k) into a multi-million dollar benefit for your children or grandchildren? Believe it or not, you can! Most Americans, even retirees living on their retirement accounts, can multiply their IRAs 401(k)s and 403(b)s by as much as ten or twenty times for their heirs. Here to help us “stretch” our imaginations and our assets is Jim Lineweaver, founder of The Lineweaver Financial Group, and Mike Solomon, my law partner.
Question:What happens to an IRA when you die?
Answer: Your retirement funds pass to your main beneficiaries at your death.
It used to be that chances were good your heirs would have had to take the retirement funds out within a short time after your death, creating a hefty income tax bill and losing any future tax deferred growth. Now, however, the IRS' minimum distribution rules allow most people to stretch out withdrawals over the lifetimes of beneficiaries.
This is called a Stretch IRA.
Question:Can you give us an example of how a Stretch IRA works?
Answer: Say you have $125,000 in your IRA, 401(k), or 403(b) at the time you pass away. Your grandchild, age 10, is named as the beneficiary. The law requires him to start taking at least minimum distributions over his life expectancy (though he can take more if needed).
At age 10, your grandchild has a 71 year life expectancy. This means your grandchild would only have to take 1/71st of the total the first year, 1/70th the second year, 1/69th the third year, etc. Assuming the IRA is yielding 7% annually, the account will grow phenomenally over the years.
If your grandchild takes only the minimum distributions each year, by age 65 the IRA account would have grown to more than $1,200,000. And the minimum distributions taken by your grandchild (if invested at 7%) would total almost $1,800,000.
In other words, you've been able to turn your $125,000 IRA into a $3 million dollar benefit for your heir.
You may name children instead of grandchildren. But since their life expectancies won't be as long, their minimum distributions will have to be higher. And that means the growth of your retirement accounts won't be as dramatic.
Question:If you're over 70 ˝, is it too late to form a stretch IRA? Does the stretch recipient have to be the main beneficiary?
Answer: In the past, you couldn't change your beneficiaries to get the benefits of a Stretch IRA once you hit 70 ˝. Now you can engage in Stretch IRA planning at 75, 80, any age. If your child is your beneficiary, you may now change to your grandchild, even if you are 85 years old.
It used to be that married couples who named a spouse as primary beneficiary, and children or grandchildren as secondary, would lose the chance to stretch out minimum distributions over the lifetimes of children or grandchildren. Now it's fine to name a spouse as primary beneficiary. If she dies first, then you die passing your IRA to a grandchild, he'll get the benefit of stretched out minimum distributions over his life expectancy.
Question:Mike, what is a stretch IRA trust?
Answer: In most cases, you'll be better off designating a Stretch IRA Trust for children or grandchildren as beneficiary of your retirement accounts, rather than the kids or grandkids themselves.
For youngsters, a trust allows you to provide management for the funds (another family member or professional trustee) until they're old enough to manage for themselves. A trust also can provide extra bloodline and creditor protections, insulating funds from a child's spouse or creditors.
Question:Jim, what are minimum distributions?
Answer: The primary benefit of IRAs, 401(k)s, 403(b)s, pension and profit sharing plans is that they grow income tax deferred. You only pay income tax when you withdraw funds. So the longer the money stays invested in IRAs or 401(k)s, the more they grow.
But Uncle Sam doesn't't want you to get too much of a good thing, so he requires you to start dipping into your retirement funds when you reach age 70-1/2.
The amount you must withdraw each year for the rest of your life is calculated by dividing your remaining life expectance into the balance of your retirement accounts.
Question:Mike, what happens when you die?
Answer: That depends if you do bad planning, or good planning.
With bad planning, you will have to take the retirement funds out within a short time after your death, creating a hefty income tax bill and losing any future tax deferred growth.
But if you plan properly, you can stretch out withdrawals over the lifetimes of beneficiaries. Maybe over 10, 20, 30 or more years, leaving your remaining funds to keep growing without tax. This is often called a Super or Stretchout retirement fund planning.
Question:Jim, can you give us an example?
Answer: Say you have $125,000 in your IRA, 401(k), or 403(b) at the time you pass away. Your grandchild, age 10, is named as the beneficiary. The law requires him to start taking at least minimum distributions over his life expectance (though he can take more if needed).
At age 10, your grandchild has a 71 year life expectancy. This means your grandchild would only have to take 1/71st of the total the first year, 1/70th the second year, 1/69th the third year, etc. Assuming the IRA is yielding 7% annually, the account will grow phenomenally over the years.
If your grandchild takes only the minimum distributions each year, by age 65 the IRA account would have grown to more than $1,200,000. And the minimum distributions taken by your grandchild (if invested at 7%) would total almost $1,800,000. In other words, you've been able to turn your $125,000 IRA into a $3 million dollar benefit for your heir.
You may name children instead of grandchildren. But since their life expectancies won't be as long, heir minimum distributions will have to be higher. And that means the growth of your retirement accounts won't be as dramatic.
Question:Mike, what if a young beneficiary needs more than just the minimum amount, maybe for education?
Answer: He can always take more than the minimum, even up to the whole amount. But then taxes must be paid on the amounts withdrawn, and there will be less left to grow tax deferred.
Question:Jim, if you're setting up a stretch IRA for a child or grandchild, do you have to cut out or bypass your spouse?
Answer: Under the old rules, yes, but not anymore. Today you can name your spouse as your primary beneficiary on the IRA, and the children or grandchildren as secondary.
If you die before your spouse, she gets the IRA; she can then name the kids or grandkids as her primary beneficiary, and get the stretch benefits. This works but the surviving spouse has to remember to change the IRA to name the children or grandchildren as primary beneficiary.
Question:Mike, I can see the tax benefits of naming young kids or grandkids as beneficiaries, to stretch the tax deferral. But if you name a youngster, they may not be good with money. Won't they take the money out early and destroy the plan?
Answer: That's a big problem. And there are other problems too. If you name a child or grandchild as beneficiary, and they take the money out, those funds may end up with your child's or grandchild's spouse when the heir gets a divorce or dies. You can protect against these problems with a Super or Stretch IRA Trust.
Question:Mike, how's that work?
Answer: Instead of naming your child or grandchild as the beneficiary, you set up a trust now for them, and name the trust as the beneficiary.
For youngsters, a trust allows you to provide management for the funds (another family member or professional trustee) until they're old enough to manage for themselves.
For example, if you make your grandchild the beneficiary, you may name your child, the grandchild's parent, as trustee to manage the IRA funds. The trustee can use the money for the youngster, not himself.
A trust also can provide extra bloodline and creditor protections, insulating funds from a child's or grandchild's spouse or creditors.
One more key benefit of a trust: your heirs will be able to avoid an unnecessary probate. If you simply name your children as beneficiaries, the IRA or other retirement account might have to be probated.
Many retirement plans and IRAs do not allow the beneficiaries to name subsequent beneficiaries. With a trust as beneficiary, no probate will be required at your children's death.
Question:Mike, when do you set up the trust?
Answer: Now, before you die. There won't be anything going into it until you die, though.
Question:Mike, is the trust revocable?
Answer: Usually you'd create a revocable trust, which you can revoke or change while you're alive and competent. After you die, the trust becomes irrevocable and can no longer be changes.
Question:Jim, can you use the stretch trust with a 401(k)?
Answer: That depends on the company administering the 401(k). Many will not let you use a trust to stretch the payments. Ask now. You can do a stretch IRA trust with all IRAs. So you may want to roll your 401(k) to an IRA before you die.
A Stretch IRA Trust can stretch your inheritance for your heirs. When the show is over, stretch your fingers and call Jim Lineweaver for more information about IRA investing, and Mike Solomon about the IRA Trust.
