When new babies come into this world, they’re cute, cuddly and they smell great (most of the time). People talk about how a baby may have daddy’s face or mommy’s eyes or a feature from grandma. That is indeed wonderful and a true gift from above. In respect to multigenerational finances I often help people stretch their IRA’s across multiple generations. Here is an example of how we do it and what it means to the family – multigenerational. This only applies to IRA’s, not 401(k)’s or other forms of retirement plans so its very important to make sure that if you leave an employer or retire you get all of your retirement assets consolidated into an IRA you own and control and can take advantage of the stretch. Since retirement plans are tax deductible and tax deferred good old Uncle Sam can’t wait for you take the money out of your retirement plans because it’s taxable income to you and tax to him. People often don’t pay much attention to naming beneficiaries on accounts – retirement or otherwise – any financial account can have a beneficiary and I suggest you take advantage of it. For example, Mason is a 70 year old man with $250,000 in his IRA. He doesn’t need the money to live but must begin taking RMD’s (required minimum distributions) once he reaches 70 ½. He names his wife Natalie as the primary beneficiary (a critical step, without this, the stretch won’t work) (if you name your spouse as beneficiary and (s)he is more than 10 years younger than you it can substantially reduce the RMD you’re required to take) and subsequently passes away. Now Natalie can roll the entire IRA into her IRA, tax free. She needs to now take minimum distributions and she is now 76 years old. Her RMD’s are based on a 22 year life expectancy. She names her daughter Jennifer as her beneficiary. Again the naming of the beneficiary is critical to this process unfolding correctly. Many years later Natalie dies and Jennifer is now the beneficiary of her mom’s IRA. Instead of taking a lump sum and paying income taxes on the whole account, Jennifer is going to roll the account into what is known as a BDA-IRA (beneficiary designation account Individual Retirement Account) and continue the tax deferred growth. Jennifer is required to take minimum distributions over her life expectancy which at the time is 31.4 years. She names her son Max as the beneficiary of her IRA so the process can continue when she passes away – Max can take his mom’s remaining RMD’s. When the RMD’s are taken, they are taxable income to the recipient but the amount left in the IRA account continues to grow tax deferred – earning interest for you and your family on money you would have otherwise paid in income taxes. This illustration shows one IRA stretched over three generations and earning the family $1,225,765 in income from a $250,000 account balance – with a modest 6% growth of the money. The total income tax savings here is over $270,000 assuming a 28% income tax rate. If anyone in the family were to take a lump sum distribution it would increase the tax bracket to either 33% or 35%, causing more taxes to be due. Thinking in through does wonders for helping avoid unnecessary expenses and taxes. Who is the beneficiary of your IRA? Do you have an old employer sponsored retirement plan that isn’t yet in your IRA? Get it to the IRA – now.
These examples are hypothetical and for illustrative purposes only. The rates of return do not represent any actual investment and cannot be guaranteed. Any investment involves potential loss of principal. Please consult your financial advisor prior to making any investment decision. Cambridge does not provide tax advice.