One of the many benefits of a Roth IRA includes tax-free distributions in retirement. This often makes it a valuable asset in estate planning for those looking to pass as much of their wealth as possible to their heirs.
When you use an IRA Trust and designate a Roth IRA beneficiary, you can direct the distribution of the funds upon your death without it being subject to probate. You will want to work with an estate planning attorney to learn about the complexities of Roth IRA regulations and avoid common IRA Beneficiary Form mistakes. However, here is a simplified overview of the benefits and considerations of using Roth IRAs in your estate planning.
Converting a traditional IRA to a Roth IRA
A Roth IRA can take many years to build a substantial amount of money because you’re limited in the amount you can contribute each year. If your earnings are too high, you will be barred from contributing to a Roth IRA, so a Roth IRA Conversion may still be a path for you and your beneficiaries.
Converting a traditional IRA into a Roth IRA is a quick fix, but it comes at a cost in the form of a conversion tax bill. Depending on several factors, this can still mean lower costs than when dealing with a traditional IRA.
Additionally, if you are considering using an IRA Trust, traditional IRAs are set up to be liquidated once you hit the age threshold of 70.5 years. If you are not relying on this money for your retirement, transferring funds to a Roth IRA can save you money in the long run because you will no longer be required to pay minimum distributions.
Roth IRA Beneficiary Distributions
In most cases, heirs can take tax-free withdrawals from a Roth IRA over a 10-year period. Spouses who inherit Roth IRAs can treat the accounts as their own. Depending on the relationship with the original owner, beneficiaries have several options for asset distribution. Here is a breakdown:
- The 10-Year Rule
For estate planning purposes, account owners and beneficiaries should note that there is a 10-Year Rule for beneficiaries of a Roth IRA, meaning earnings are taxable if the account is less than 10 years old when they begin distributing the assets.
- Inheriting a Roth IRA as a Spouse
- Spouses will have the option for a spousal transfer meaning, upon inheritance, they can transfer the assets into their own new or existing Roth IRA, and it will exist as if it was their own.
- Spouses may also decide to open an inherited IRA- 10-year method or life expectancy method, where they will have a designated amount of time to withdraw all assets.
- Finally, they can take an untaxed lump-sum distribution as long as the account falls under the 10-year rule.
The best option will vary depending on how it will be used and whether it will become part of the inheritance of children or other beneficiaries upon the death of the spouse.
- Inheriting a Roth IRA as a Non-Spouse
Heirs can open Inherited IRAs but they must withdraw all of the funds within 10 years of the death of the original IRA owner. They can stretch these distributions over the 10 years, they can take a tax-free lump sum distribution depending, or they can allow the assets to continue to grow tax free over the 10 year period and then withdraw a lump sum on the 10 year anniversary. The best way to distribute will depend on how they plan to use that money, and whether they plan to pass it on as part of their own estate.
Additionally, a trust can be used to give additional protection to these assets for beneficiaries who may have creditor or predator issues. A trust can be used to preserve the IRA assets for generations to come if desired.
- Distribution Rules
Those inheriting a ROTH IRA have a window of 10 years past the benefactor’s death to distribute assets. Exceptions to this rule are spouses, minor children, persons with disabilities or chronic illness, and those within a 10-year age difference of the decedent such as a sibling.
Interested in integrating a Roth IRA as part of your new existing estate plan?
The rules of handling a ROTH IRA are complex. You’ll want additional guidance about conversion tax, beneficiary forms and designations, and other estate planning considerations so you can make the best plan for the future. If you’re ready to take the next steps in protecting your wealth for the future, contact the team at Smith Barid today.