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Stretch IRAs beyond your wildest dreams

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How would you like to leave your grandchildren a legacy that will make them millionaires several times over? It can be done relatively easily, and you don’t have to be in the class of Donald Trump or Bill Gates, either.

Strategy: Set up a “stretch IRA” to defer taxes indefinitely. The IRA spans several generations before it is raided (other than paying out any required lifetime distributions). Don’t touch the funds while they’re building up in the IRA unless you absolutely have to.

In the short run, the stretch IRA will reduce the withdrawals you’re required to take after reaching age 701/2. That, in turn, will cut your current tax bill. In the long run, you’ll be extending the IRA payouts until your grandchild inherits the account. With the extra compounding over time, your humble account can literally grow into several million dollars.

This strategy comes from the recent simplification of the rules on required distributions. They say you must use a uniform life-expectancy table to calculate required pay-outs.

The new distribution schedule is based on the joint life expectancies of the IRA owner and a beneficiary 10 or more years younger. (A separate distribution table is used for spouses who are less than 10 years apart in age.) But a stretch IRA can stretch out tax deferral even longer.

Example: Tax-deferred compounding power

For simplicity’s sake, let’s assume that you die at age 70 (right before minimum withdrawals must begin) with $500,000 in your IRA. The account earns 8 percent annually. Your spouse, who is 20 years younger, is the sole beneficiary. If your spouse also dies at 70, the account will be worth $2,330,479 at that point. Your grandchild (currently age 5) is the beneficiary named by your spouse in his or her will.

By the time your grandchild is ready to retire, the stretch IRA could be valued in the tens of millions.

Of course, the actual figures for your situation will vary, depending on a number of factors.

For instance, this example assumes that no distributions were made and the account produced a level 8 percent return. If your spouse lives to a ripe old age, the account will be somewhat eroded. Also, the child must take required minimum withdrawals during his lifetime (well before age 701/2), based on your spouse’s life expectancy.

Tip: If one or both of the beneficiaries add IRA contributions to the mix, the savings will be even greater.

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