We all like to think that we make rational and wise decisions when managing our money. But most of us are influenced far more by our emotions than our brains. Why do smart people make irrational investment decisions so commonly and so easily? The fascinating study of behavioral economics and decision science fills many books, but let’s look at a few of the ways in which investors’ minds play tricks on them.
At year-end 2005, Individual Retirement Accounts (IRAs) held more than $3.9 trillion in assets. In addition, IRA assets are expected to reach $4.3 trillion by the end of 2006.1 A significant portion of this wealth may not be used by the current generation. Through careful planning, a “stretch IRA” may prolong payouts from your IRA over multiple generations.
A “stretch IRA” is not a separate type of IRA under the tax code, but instead, is a catchall phrase for a strategy of extending an IRA’s benefits after the original owner’s death. By not using all of your IRA assets within your lifetime, the assets in your IRA may be available to those who survive you. Payouts can potentially be available for you, your children and possibly, even your grandchildren.
How It Works: An IRA owner names his or her spouse as the IRA beneficiary. When the IRA owner passes away, the IRA proceeds pass to the surviving spouse. The surviving spouse names his or her children or grandchildren as his or her IRA beneficiaries. Upon the surviving spouse’s death, the younger life expectancy of the children or grandchildren as beneficiaries will be used to determine the remaining required minimum distributions.2 Depending on the amount that is distributed to the second generation beneficiary, any remaining amount in the IRA can then, in turn, pass the stretch IRA down to a third generation upon the death of the second generation beneficiary.
Unlocking the Stretch IRA Potential
The keys to a stretch IRA are: (A) Each generation in control of the assets takes only required minimum distributions; and (B) you and the beneficiaries take the least amount of money, at the latest allowable time, allowing multigenerational tax-deferred compounding.
There are a few caveats to consider. Stretch IRAs assume a constant rate of return on the underlying investment, and the first and second generations beneficiaries’ life expectancies are not extremely long. Also, inflation may erode your IRA’s purchasing power.
For more information please call Brian P. Jacobs at 661-290-2022.