Updated: May 3, 2013 12:14PM
Originally published: March 7, 2005
Why is everyone making such a big deal out of IRAs when you can only contribute a relatively small amount every year? I’ll answer that: Because small amounts can grow into big fortunes over the years, especially if growth is tax-deferred.
And if you don’t spend all of your IRA in your lifetime, that tax-deferred growth can extend for your children’s lives as well.
That’s the premise of a new book by IRA expert Ed Slott, Parlay Your IRA Into a Family Fortune (Viking Adult, 320 pages, $24.95).
At first glance, you might think it’s a book of instructions for very wealthy people. But Slott points out that just a few dollars every week, growing tax-sheltered over time, can build up to a substantial amount of money over the years.
The example Slott uses is someone who contributes just $11 a day to an IRA, which totals $333.33 a month and adds up to the current allowable $4,000 a year. Assuming an 8 percent annual growth rate, which is well below the stock market’s long-term historical returns, the account would be worth $489,383 in 30 years. Or $1,119,124 in 50 years!
Stick with it
That’s surely an incentive to start saving in your IRA as early as possible -- and stick to it over the years. (If you’re looking for places to start an IRA with as little as $100 and invest in the stock market, check my recent online column on this subject at www.TerrySavage.com.) And if you qualify for a Roth IRA (with income under $110,000 on a single return or $160,000 on a joint return), then all of the money will be yours at retirement, completely tax-free.
Most people would just be happy to have “enough” money to last for their retirement years. But there is a distinct possibility that you might not use up all your IRA money, or even that you might die before you start using your IRA.
That’s why it’s so important to choose a beneficiary for your IRA.
That choice gives your heirs the opportunity to stretch out withdrawals from your IRA, delaying taxes and continuing the tax-deferred growth of the remaining money.
To take advantage of these “IRA Stretch” rules, you must name an individual as beneficiary of an IRA. Only an individual beneficiary can withdraw the money in the inherited IRA account over his or her projected lifetime.
That’s where the possibilities begin.
Suppose, using Slott’s example, a deceased grandfather made his infant granddaughter the beneficiary of a $10,000 IRA. Under the IRA distribution rules, the money must be withdrawn over her projected lifetime of 81.6 years. So this year, the required withdrawal would be $122. That would buy a lot of baby food! The remainder keeps growing tax-deferred. The granddaughter’s life expectancy factor drops by one year, every year, increasing the amount that must be withdrawn. But it’s likely the account will continue to grow by more than the amount taken out each year.
Assuming an average growth rate of 8 percent, Slott figures that by the time she must empty the account at age 82, the $10,000 IRA she inherited from her grandfather would have paid her $816,762.
Of course, you can’t count on having a granddaughter smart and disciplined enough to only take out the required minimum each year. And since a minor cannot be the beneficiary of an IRA, the court will name a guardian, who might not know about stretch rules. So you might want to leave your IRA to a trust as beneficiary, including written instructions to the trustee about the benefit of taking the required minimum distribution.
What to do now
When you open your IRA, be sure to name a beneficiary, and a “contingent beneficiary” in case the person you named dies before you do. Make sure the custodian allows the ultimate stretch out of payments over the lifetime of your beneficiary.
Most important, if you have an old 40l(k) account sitting at a previous employer, be sure to roll it into an IRA and name a beneficiary.
Many company plans require that account balances be distributed immediately upon death to the beneficiary, which eliminates the stretch possibility.
I highly recommend Parlay Your IRA Into a Family Fortune (Viking, $24.95) for additional strategies and detailed explanations. And you can find more about IRAs at Slott’s Web site: www.IRAHelp.com. You truly can create a family fortune with your IRA -- and Ed Slott’s help. And that’s The Savage Truth.
Terry Savage is a registered investment adviser. Distributed by Creators Syndicate.