Let Your IRA Fund Your Young Beneficiary’s Retirement
© Shane Flait (2011)

Leaving some of all of your IRA to your young child or grandchild can enormously help fund his own retirement. Unfortunately today, young people are already burdened with high taxation, perhaps poor job prospects, and many living costs that make it difficult to fund their retirement. But the tax-deferred or tax-free growth over many years of their inherited IRA from you may solve much of their retirement concerns. Here’s how.

Although, the young beneficiary of your bequeathed IRA must begin making minimum required distributions (MRDs) every year from it after your death, those MRDs due to his young age can be a very small percent (perhaps under 2%) of it for many years. That means its investment growth rate can offset that small yearly MRD loss to grow enormously during the years to grow enormously over all those years until he retires.   

The size of his yearly MRD is based on the number of years he’s statistically expected to live, called his remaining life expectancy (RLE) – according to an IRA table. According to that IRS table[1] a beneficiary at age 30 has a remaining life expectancy of 53.3 years. And that leaves plenty of time for his IRA investment to grow and compound.

To be clear, if you die leaving your grandchild as the IRA designated beneficiary, he must begin withdrawing his MRD annually the year after you die. If he turns 30 years old then, he must withdraw a fraction of the value of that IRA at the end of the year you die. That fraction is only 1 divided by (his remaining life expectancy) which is 0.01876 = 1/53.3.  That’s less than a 2% withdrawal for that year. 

For the following year, he again calculates his withdrawal fraction for his MRD by reducing his 53.3 life expectancy at 30 by ‘1’. So the withdrawal fraction is = 0.01912 = 1/ (52.3) = 1/(53.3 – 1). The MRD is simply this new fraction time the whatever the value of the IRA at the end of the previous year. That amount is still under 2%.  The MRD of each subsequent year is calculated the same way – reducing the RLE by 1 and applying the fraction to the value of the IRA at the end of the previous year.

Since he’s so young, you can see the fraction used to calculate the MRD will remain small compared to relatively conservative growth rates for, perhaps, quite a long time. That means that the IRA should increase in value for quite a while if only the MRD amount is withdrawn each year.  The tax-deferred growth of the IRA eliminates any yearly taxation – tax free growth if it’s a Roth IRA.

What will a $10,000 IRA legacy grow to?

That all depends on the growth rates of that IRA investment. As an example, when your young beneficiary reaches age 65, the value of a $10,000 IRA you leave him will have increased by a factor of 2, 4, or 8 at the growth rates of 5%, 7%, and 9% respectively. But that’s not all the benefits he gets!

That’s because by the age of 65, your beneficiary has taken total RMD withdrawals of just over $18,000, $29,000, or $46,000 respectively under those growth rates of 5%, 7%, and 9%.  So that add another factor to his benefits of approximately 2X, 3X, and 4X for each growth rate. And that’s not all either!

If he reinvested those withdrawals back into his own IRA – assuming he had earning income to allow him to do so - that initial $10,000 IRA you left him, would have increased by over 4x, 7x, or 12x under projected growth rates of 5%, 7% or 9% respectively. So that’s quite a legacy – even if you left him only $10,000 at your death!

The figure shows how a bequeathed IRA of only $10,000 would increase – annually withdrawing only the MRD - as he got older – under growth rates of 5%, 7% and 9%.

Of course the key is that he doesn’t touch that money – beyond taking those required MRDs. If you can make it clear to him the benefits that will accrue over time, he or she may think twice about dipping into it early.

 

 

 

Shane Flait is a writer and educator. See more at www.EasyRetirementKnowHow.com