Why A Roth IRA Is A Great Addition To Your Estate Plan

Estate planning is essential for executing your final wishes efficiently and meaningfully. And while wills and trusts are standard tools, it’s possible to optimize accounts you already have to transfer wealth to loved ones effectively.

By design, Roth IRAs are tax-efficient savings tools for retirement. But when combined with your greater estate planning goals, they can help protect your wealth after your passing. Below we’re reviewing the ins and outs of IRAs and how you could use them as a core component of your estate plan.

A Reminder About Roth IRAs

A Roth IRA is a retirement savings account that you fund with after-tax dollars. The amount in your Roth IRA grows tax-free, and qualified distributions could be tax-free (by following the rules). 

Consistently investing in Roth IRAs typically makes sense for those who believe they will be in a higher tax bracket by the time they retire than when they made the contributions. Unlike traditional IRAs, a Roth IRA will not lower your taxable income for the year the contributions are made.

What Is a Qualified Distribution?

Qualified distributions are tax- and penalty-free, as long as they follow specific criteria:

You must have had the account for at least five years and be older than 59.5. If you do not meet these standards, you may still be able to make qualified distributions for events like,

  • Buying your first home
  • Paying for a child’s college tuition
  • Covering eligible medical expenses exceeding 7.5% of your AGI

At any time, you are allowed to withdraw anything you contributed to your Roth IRA without penalty or tax. But withdrawing earnings or growth from the account would be considered a non-qualified distribution if those withdrawals don’t meet the criteria outlined above.

Non-qualified distributions are subject to ordinary income tax and a 10% early withdrawal penalty. If you are over 59.5 but have not had the account for at least five years, any withdrawals you make will count as non-qualified distributions. These would be subject to ordinary income tax but not the 10% penalty.

Why Roth IRAs Work for Your Estate Plan

Below are a few reasons we recommend incorporating Roth IRAs into your estate plan.

Give More to Your Heirs

Unlike traditional IRAs, there are no required minimum distributions (RMD), meaning your money can sit in the account and grow for as long as you like. The absence of RMDs is part of the reason why Roth IRAs can work well as a tool for transferring assets to loved ones after your passing.

If you were never to take a distribution during your lifetime, your heirs could inherit the whole account, including contributions and earnings.

Roth IRAs Avoid Probate

When you die, your estate goes through a process known as probate. Probate is a public, court-sanctioned procedure designed to ensure that your assets are transferred to the right people. To help avoid probate, there are things you can do now, like naming beneficiaries for your accounts, establishing trusts, or creating joint ownership of property and accounts.

Money left to your heirs in a traditional or Roth IRA account does not need to go through probate. In turn, this strategy can help expedite and streamline the wealth transfer process.

Heirs May Not Need to Pay Taxes on Distributions

As long as your Roth IRA has exceeded the five-year holding criteria, your heirs can take qualified distributions without tax or penalty from the inherited Roth IRA. They can choose to keep the money growing within the account, but they may be subject to a distribution timeline, which we will discuss below.

Rules to Keep in Mind

When a spouse inherits a Roth IRA, they can treat the account as their own. There are no withdrawal requirements, and they can allow the account to continue growing for as long as they like.

If someone other than a spouse inherited the account, they must take all distributions from the account within 10 years of inheriting it.

There are a few exceptions to this rule for certain individuals, including,

  • A child of the original account holder under the age of 18
  • Chronically ill or permanently disabled beneficiaries
  • Someone who is less than 10 years younger than the original account holder (like a friend or sibling)

Build a Tax-Efficient Estate Plan with Us

Sound estate planning is a beautiful gift to leave for your family. As you work with your attorney or other estate planning professionals, it’s essential to consider the most efficient tools possible for transferring wealth to loved ones.

Our team is happy to help talk through this strategy further and discuss how it may be able to play a role in your plan. Contact us today to get started.

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