Another installment of our reporter’s extended interview with noted retirement specialist Phil Cannella, founder and CEO of First Senior Financial Group and host of The Crash Proof Retirement Show™.
Question: Tell me about your activities in the area of estate protection.
Phil Cannella: Every month, I hold educational programs for retirees who want to improve their tax positions as well as training sessions for financial advisors who want to shed their general practitioner status and become IRA specialists. I tell both groups that I can promise my clients three generations of income with a Roth IRA.
Q: Three generations? Seriously?
Phil Cannella: When you understand the math and tax laws that exist to help retirees and know how to make them work for your situation, the confidence to make such a bold statement follows.
Q: Can you be more specific?
Phil Cannella: OK, pay attention now. A stretched Roth IRA earns you about 300% more money than a stretched traditional IRA. A Roth IRA can be stretched across multiple generations. When you leave the golden goose intact and only withdraw the golden eggs—the minimum amount required—the principal continues to grow and will be there for the next generation to enjoy. Here’s how: say, for example, that you leave your $500,000 Roth IRA to your grandson, who is 35 years old when you die. According to the IRS, his life expectancy is 48.5 years. The formula for calculating your grandson’s RMD is: account Balance ÷ life Expectancy = Required Minimum distribution In this case, the calculation is: $500,000 / 48.5 = $10,309. He comes out with a first-year RMD of $10,309. That’s just over 2% of the $500,000 account balance. If your grandson invests the remaining balance wisely, his account could potentially grow at an average rate of 8% to 10% per year. Including his withdrawals, he would realize a 6% to 8% increase of his balance every year.
Q: That gets pretty complicated.
Phil Cannella: It’s not as complicated as it sounds. Let’s continue with this example so you can see how it works. In the first year, your grandson takes his RMD of $10,309, which leaves a balance of $489,691. Let’s say your grandson’s investments pull an 8% return that year. At the end of the year his $489,691 has grown to $528,866. Now, his second year RMD falls due. He’s a year older, so he removes one year from his life expectancy (according to IRS rules). Now his life expectancy is 47.5 years. Remembering the formula, the calculation becomes: $528,866 / 47.5 = $11,134.02. Again, this is just over 2% of his balance. In year three, your grandson has a really good investment return and earns 10%. He takes a $12,247 income and his account balance balloons to $569,505. In other words, your grandson is taking a tax-free income from his inherited Roth IRA, but his account is growing instead of shrinking.
Q: And that can go on indefinitely?
Phil Cannella: In this example and according to the RMD schedule, your grandson will exhaust his account by age 83—because his life expectancy keeps going down and the RMD percentage will keep going up. But guess how much money he will have realized from your $500,000 account? Assuming an average 8% annual return, your grandson will have received over $5 million in tax-free income by the time he exhausts the account. If your grandson died before he reached age 83, the remaining account balance could then pass to his beneficiaries, who would then continue your grandson’s RMD schedule.
Q: So he could leave it to someone else, too?
Phil Cannella: Well, technically, the IRS doesn’t allow the RMD to reset again after the first beneficiary. However, one effective estate planning solution is to split beneficiaries by percentage—so theoretically, you could leave 50% of your Roth to your grandson and 50% to your daughter, and each would operate as a separate account, with separate RMDs based on each person’s life expectancy. In this way, you will be providing a tax-free income for two (and perhaps more) generations of your heirs. Now that’s a guaranteed way to get your family to visit you after you’ve passed.
