Roth IRA as an Estate Planning Tool

The Roth IRA is not only one of the most significant developments in retirement planning in recent years, but it also can be an important part of your estate planning as well. If you have a Traditional IRA, converting it to a Roth IRA can be a wise estate planning strategy under certain circumstances.

Pay Now So Your Heirs Won't Have to Pay Later

Suppose you have an infant granddaughter and you want to leave her part of your estate. If you don't need the money for your retirement, you can convert all or part of your Traditional IRA to a Roth IRA as long as your adjusted gross income for the year is no more than $100,000. You can name a trust for your granddaughter as the Roth IRA beneficiary. The downside is that you would owe immediate federal income taxes on any accumulated earnings and any tax-deductible contributions made to your Traditional IRA. However, if you pay the taxes out of your non-IRA assets, you effectively prepay income taxes for your granddaughter without owing any gift tax or using up any of your $3,500,000 estate-tax exemption. In addition, by paying the taxes, you are reducing the size of your taxable estate.

A significant benefit of this strategy is that your granddaughter generally will owe no income taxes on any withdrawals although estate taxes may be due on the value of the account she inherits from you.

For as long as you're alive, the Roth IRA will grow tax free and you do not have to start making withdrawals at a particular age, unlike the Traditional IRA, which requires that you begin withdrawing from the account by April 1 of the year following the year you reach age 70 1/2.

After You're Gone

When you die, the Roth IRA then becomes subject to the same minimum withdrawal rules as regular IRAs. Your granddaughter must begin making minimum withdrawals based on her life expectancy. If she were still young when you die, she would be required to begin withdrawing only a small amount based on her relatively long life expectancy. Each year, the fraction she is required to withdraw would grow slightly. However, the rest of the money would continue to grow tax free and could result in a substantial nest egg over time.

More After-Tax Money Goes to Your Heirs

The major advantage of this strategy is that you can transfer more after-tax money to your heirs. Because of the power of tax free compounding, the younger the trust beneficiary, the greater the benefit because of the longer time the nest egg has to grow. If you have any questions about this or any other estate planning strategy, please give us a call.

Disclosures:

  • Consult a tax advisor for advice.
  • To send an email that contains confidential information, please visit the Secure Message Center where there are additional instructions about whether to use Secure Email or Online Banking messaging.
  • Mutual funds, annuities, and other investment products:
    Not FDIC-insured May lose value No bank guarantee