How Much Can a Stretch IRA Be Worth?

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.

Dollar example
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.