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The IRA Stretch—How Far Will Your Retirement Dollars Go?

Dave Van Horn
4 min read
The IRA Stretch—How Far Will Your Retirement Dollars Go?

Sometimes, when my cousin Mike and I are hanging out around his pool, just relaxing, we like to talk about investing strategies.

Usually, we end up debating about our IRA’s (Individual Retirement Accounts). Both of us are pretty successful guys, with Mike and his wife being what I consider high-income earners. Mike’s beef is that working his IRA account (self-directed that is) on a regular basis is a lot of work.

I really can’t argue with him there, as it can take quite a bit of effort to find enough deals to deploy capital into, which are fairly safe and also provide a nice yield.

Related:Why You Need to Start Your IRA Now…and Any Other Tax-Free or Tax-Deferred Vehicle You Can

But, that’s just one part of the problem. I pointed out, remembering from my financial planning days, a crazy statistic on how most retirement money never actually gets spent by the retiree(s). Instead, the bulk is eaten up by taxes, with whatever’s left going to their heirs.

So, Mike’s point is what the hell are we doing all of this self-directed IRA work for anyway, if we’re never going to get to spend it?

In fact, if we really need our IRA money to live on, we’ve got bigger problems. In other words, we should just have another cocktail, or maybe a cigar, and just continue hanging out around the pool.

But, then I pointed out to him how much he likes his daughter and that he could lower her tax burden and maybe set her up down the road. I asked him if he ever considered the IRA Stretch.

What is the IRA Stretch?

Although much content is available online about this strategy, the Investopedia definition of Stretch IRA actually describes it very accurately:

“An estate planning concept that is applied to extend the financial life of an Individual Retirement Account (IRA) across multiple generations. A stretch IRA strategy allows the original beneficiary of an IRA to distribute assets to a designated second-generation beneficiary, or even a third- or fourth-generation (or more) beneficiary.

By using this strategy, the IRA can be passed on from generation to generation while beneficiaries enjoy tax-deferred and/or tax-free growth as long as possible. The term “stretch” does not represent a specific type of IRA; rather it is a financial strategy that allows people to stretch out the life – and therefore the tax advantages – of an IRA.

Stretching out an IRA gives the funds in the IRA more time – potentially decades – to compound tax-deferred. This provides the opportunity to grow the funds significantly for future generations.

With a traditional IRA, the owner has to begin taking the required minimum distribution (RMD) by April 1 of the year after turning 70.5.

The RMD is calculated by taking the account balance on December 31 of the previous year, and dividing that number by the number of years left in the owner’s life expectancy (as listed in the IRS’ ‘Uniform Lifetime’ table.) Each year, the RMD is calculated by dividing the account balance by the remaining life expectancy.

Non-spousal heirs of any age, regardless of the type of IRA, must take RMDs based on their life expectancy. The younger the beneficiary, the lower the RMD, which allows more funds to remain in the IRA to stretch the IRA over time.”

Implementing the Stretch IRA

Most folks like my cousin just make their spouse the beneficiary.

If he does that, she will have a few options on when she starts taking distributions depending on her age, but at the end of the day the money that was once part of his account will be made available and taxed over her remaining lifespan.

Related: Why You Need to Start Your IRA NOW…and Any Other Tax-Free or Tax-Deferred Vehicle You Can

If Mike were to employ the IRA stretch concept, especially since there is a low likelihood he and his wife would ever need the money anyway, he could make his daughter the beneficiary.

This will possibly reduce or defer inheritance taxes, while giving his account more years to compound and grow since his daughter has a longer lifespan than his wife, thus stretching out the number of years they can spread out distributions from the account.

Personally, I’m taking it a step further with my grandson being beneficiary, since I already know my spouse and kids are pretty well set.

Threats to the Stretch

Obviously, we all want to avoid taxes, so it’s very important it is to have the right advisor (see article: Who’s Your Financial Advisor?).

But, it’s also just as important to teach your heirs how these things work. If you’ve already passed and they don’t understand, then guess who wins…the government.

Another potential threat to the stretch is legislation. In a recent decision by the US Supreme Court, it stated that inherited IRAs are not ‘retirement funds’ according the bankruptcy code and thus not protected.

Now, when doing estate planning, you’ll need to be more particular than ever when considering potential beneficiaries of your IRAs. I’m sure a properly worded trust can protect the assets from the financially distressed beneficiary.

But, I’m just thinking of pouring another drink and maybe taking another dip in my cousin Mike’s pool, so I certainly don’t blame those who think it’s too much work.

Regardless, the IRA Stretch is a valuable and underutilized estate planning strategy, especially for those who are establishing a portfolio of notes or real estate properties, which have enough liquidation value or will produce enough cash flow to support them in their retirement years.

So, for those on BiggerPockets, what strategies are you employing or considering for your estate planning? And, how far are you stretching your IRA?

Be sure to leave your comments below!

Note By BiggerPockets: These are opinions written by the author and do not necessarily represent the opinions of BiggerPockets.