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Greetings!
 In this our last newsletter for 2010, I would ask you to read closely the article titled The Constructionist Principle. If you read nothing else this month, if you do nothing else for yourself this week, read this!! It contains the single most important step to engaging in a new outlook to, not only better finances, but a better career, better relationships, and indeed, a better life! Try it, and happy holidays to you all!
As always, I encourage you to give us any feedback on issues you would like to see in this forum and feel free to forward this newsletter along to your family, friends and colleagues.
I thank you for your continued patronage to Dowley & Company. |
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Stretch IRA: Unlock the Power of Tax Re-Compounding
Over the last quarter century, as many in the baby boomer generation have worked to accumulate money for their retirement, assets have been growing in qualified retirement plans in a way that has never occurred in previous generations. These retirement plan recipients then take those dollars and roll them into their IRAs for retirement distributions. As expected, many of them will die with these IRAs in tact with significant values associated with them. While spouses can simply roll the proceeds to their own IRA and continue distributions, many of the non-spouse beneficiaries of these inherited IRAs are unaware of the options available to them. Since they are required to take minimum distributions in a timely manner or suffer punitive penalties by the IRS, it has become imperative that the heirs understand the options available to them and understand the potential impact on their future wealth of choosing an effective distribution pattern from these plans. These distribution patterns can mean the difference between a retirement nest egg for children and grandchildren or can leave them impoverished if mishandled.
What is a Stretch IRA?
A Stretch IRA is a technique to transfer wealth to your heirs by means of an inherited IRA. It offers the opportunity to continue tax deferral over several generations. It provides a significant planning opportunity that allows the assets in the original qualified plan, or IRA account, to continue growing for the eventual benefit of children, grandchildren or beyond.
Let's assume you're an IRA owner and you have a spouse to whom you have assigned as your primary beneficiary. At the time if your death, the IRA assets would flow into your spouse's IRA on a tax free basis. If the surviving spouse then names one or more of your children as beneficiaries, the remaining assets, at the time of the surviving spouse's death, would then flow into inherited IRAs for those beneficiaries.
Under current tax law, the IRS requires those non-spouse heirs to pay taxes on minimum withdrawals from the inherited IRA's based on their life expectancy (thus avoiding punitive penalties). All the remaining assets, beyond the minimum distributions, are allowed to stay in the IRA and grow tax deferred. Assuming your heirs withdraw just the minimum required and don't remove any additional money from the inherited IRA, the legacy would continue to grow for the use of those children and any additional family for generations.
Because the Stretch IRAs is a complicated investment tool, the stakes are high and advice should be secured to insure it is handled correctly and to eliminate any errors. Simple mistakes can eliminate the Stretch IRA option. The assets must be transferred directly from custodian to custodian to properly register inherited IRA in order to become a Stretch IRA. If the heirs take possession of the assets in any way, or the transfer is mishandled, there could be serious tax consequences and a significant tax bill could result that would eliminate a tax free growth opportunity.
To look at one example, let's assume an IRA owner dies at age 80 with a balance of $500,000 and has a 37 year old beneficiary. Further assuming that the beneficiary correctly rolls over those assets to an inherited IRA, the original balance will grow to more than a million dollars over 25 years at a constant 6% growth rate and that no additional distributions are taken beyond the minimum required by the IRS!
This is a tremendous opportunity of using tax deferral to compound an inheritance. Caution should be used however in estate planning. It should be noted that the IRA assets should not be required to be used to pay any estate expenses at your death. Sufficient assets need to be acquired elsewhere to handle this or the tax deferral possibilities are lost. It should also be noted that IRA beneficiaries need to be trained to understand the minimum distribution requirements and encouraged to take only the minimum to maximize the potential of these benefits.
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The Construction Principle
It has long been the position of ours that how clients speak is indicative of their inner emotions, and a guide to how they act. If they speak negatively or in disparaging terms of themselves or their situation, they frequently take actions that bring the emotion to reality. Their negative experiences "prove" themselves right and thus confirm that they have an accurate sense of reality. The Social Construction Principle says that the way we use language, both verbal and non verbal, powerfully shapes our perceptions of our environment and how we interact with it. It says that language and how we use it, influences everything from our relationships and social interactions to decision making about careers and how we use and feel about money. As David Cooperrider, the founder of Appreciative Inquiry put it, "Words create worlds." As we do life planning, it is useful to note the background and biases that our clients bring to the financial planning process. It is frequent that people who are raised in households of abuse, scarcity, and addiction experience very difficult relationships with money. It is manifested in ways that they speak of their situation and the reality they have created for themselves. They exhibit what I christened in a recent presentation, signs of "toxic language". These are words or phrases that come laden with hidden meaning. Most commonly, I hear the expression, "I should...", "I need to...", "I ought to...". These are expressions of desire to accomplish that are laced with feelings of obligation. The question is, whose obligation is it? If I say, "I need to go home and rearrange my sock drawer.", What I really mean is that I feel "compelled" to do it or I feel a strong "desire" to do so. I do not "have to" however. My world will not collapse and I will not starve to death with a messy sock drawer. The difference the words create is enormous. By engaging my "compulsion", I retain the sense of choice. Now, rearranging my sock drawer is what I "choose" to do, not something I "should" do. The "should" connotes some third party extending a sense of obligation that is often unintended or is the application of some ancient parental motivation. Other toxic expressions include "Yes but..." and, "can't". These expressions often precede a rationale to promote the idea of a self-imposed limitation that keeps us doing the same old things within self imposed boundaries according to what we think is "realistic" or "comfortable". This could be viewed as a way to keep us in the shackles of conforming behavior. Once again, this way of speaking takes the idea of choice out of the equation and limits us in unintended ways. By choosing and using different language in our lives, we consciously allow ourselves to embrace other possibilities in our lives and open ourselves new things we had not considered. This benefits us enormously emotionally and eventually, financially as well. With that, I leave you with a question: How is your vocabulary? My thanks to Ed Jacobson for his contributions to this article. Chris Dowley November 2010
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About Us
Dowley & Company is an independent Financial Advisory Firm started
in 1997 motivated by the idea of making full service financial planning
available to individuals and families.
We pride ourselves in helping independent minded clients break
through limitations and get to a place of greater affluence they might
not achieve on their own.
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