The Grandchild’s Inherited Retirement Account

Yesterday’s post discussed the likelihood of leaving your children an inheritance—in particular an inherited retirement account of some kind.

As long as inheritance is likely, you might consider skipping your children and leaving some or all of your unspent retirement account to your grandchildren, especially if your kids are doing well enough on their own.

There’s three reasons this might be a particularly good idea. First, your grandchildren may still be facing their high-cost years and can better use the money. You know: college education, their first house, the cost of raising their own kids. Second, being younger, they may not yet have reached their peak earning years, and might therefore be in a lower income tax bracket—a consideration in the case of a traditional IRA which throws off lots of taxable income. Third, their younger age means they are allowed a longer period over which to stretch out distributions.

Here’s an example. Let’s say the facts are almost the same as in yesterday’s post: Three brothers each with a $100,000 account—a taxable investment account, a traditional IRA and a Roth IRA. But their named beneficiaries, instead of being their children, are their granddaughters (Patty, Maxine, and Laverne) . And they are age 25, with a life expectancy-based distribution period of 58.2 years. Here is the inflation-adjusted annual after-tax distribution each of the girls projects:

Patty (taxable account): $3,821 per year
Maxine (traditional IRA): $3,727 per year
Laverne (Roth IRA): $5,325 per year

But if instead the girls take only required minimum distributions, and reinvest the proceeds, here is what they project they can accumulate over a 59-year distribution period:

Patty (taxable account): $3,827,572
Maxine (traditional IRA): $4,671,516
Laverne (Roth IRA): $6,673,594

Myth has it that Einstein thought compound interest to be one of the miracles of the universe. And that was before the advent of IRA’s.