One of the greatest benefits of an IRA is its ability to provide tax-favored wealth for heirs. An IRA left to a beneficiary can be "stretched" to provide pre-tax compound investment returns for the rest of the beneficiary's life -- or even longer. And these can be distributed totally tax free if it is a Roth IRA.
How much can such a stretch IRA be worth in actual dollars? Compound investment growth is powerful - but how powerful? Here's an illustration.
Grandad died at the end of 2017 leaving $100,000 in an IRA. His grandson Benny is his IRA beneficiary. Benny takes his first RMD from the IRA in 2018 when he is 22 years old. Benny's schedule of RMDs is set by the IRS's Single Life Expectancy Table. This gives him a life expectancy of an additional 61.1 years, or until he is age 83. His inherited IRA can last until then.
The stock market has returned an average of 7% over inflation over the long run. Benny's first RMD is only 1.637% of the IRA's value and doesn't reach 7% until he is over age 68. If this rate of return continues into the future and the IRA invests in stocks, it may grow in value for 46 years -- even while making annual distributions to Benny.
Each year's RMD equals the IRA account balance at the end of the prior year divided by Benny's remaining life expectancy. So Benny's RMD for 2018 is $1,637 ($100,000 / 61.1). During 2018 the IRA grows by 7% to a value of $107,000. Benny takes his RMD at year end. After subtracting the RMD, the year-end account balance for 2018 is $105,363.
The Big Payoff
Repeating this process with a 7% annual return, the IRA grows in value until Benny reaches age 68. Then his RMD has grown to $40,364 and the IRA's balance to $611,801 -- even after having paid out RMDs totaling $571,189! The balance plus the RMD payouts combined total $1,182,990!
Then Benny dies at age 75, when Liz, his named beneficiary, is 40. At that point Benny has received RMDs from the IRA totaling $953,977, and it still has a balance of $518,543 for Liz. She then begins taking RMDs following the same schedule he used. The IRA continues to earn 7% annually.
The stretch IRA pays $ 1.648 million to Benny and Liz combined -- more than 16 times the original $100,000 left to create it.
This chart shows the history of Benny's inherited IRA:
Benny's year-end total RMDs year-end balance
age RMD balance (1) to date (2) plus total RMDs (1+2)
22 $ 1,637 $105,363 : $ 1,637 $ 107,000
30 2,838 158,422 : 19,703 178,125
40 5,661 255,396 : 62,005 317,401
50 11,332 390,012 : 146,551 536,564
60 22,832 541,500 : 316,410 857,909
70 46,659 607,364 : 661,238 1,268,603
80 101,666 235,560 : 1,386,310 1,621,870
83 22,508 0 : 1,648,151 1,648,151
Of course, this is a stylized example. Nobody knows what future investment returns will be and investments may vary.
But an IRA left to a child under age 22 may grow even more than in this example. Never underestimate the potential of a stretch IRA.