There are a number of reasons to consider Roth IRAs as part of your estate planning efforts, says Think Advisor’s recent article entitled “How and Why to Use Roth IRAs in Estate Planning.”
At the beginning of 2020, the Setting Every Community Up for Retirement Enhancement (SECURE) Act went into effect. The new rule requires a full payout from the inherited IRA within 10 years of the death of the original account holder for non-spouse beneficiaries. And remember, any amount you withdraw is subject to ordinary income taxes.
Previously, a non-spouse beneficiary could defer IRA distributions over the recipient’s lifetime. By using this stretch strategy, an IRA could be passed on from generation to generation while beneficiaries enjoyed deferring income tax (delaying paying taxes to some future period) and the tax-free growth of the balance. But with the SECURE Act, taxes are bunched into a 10-year period and can substantially erode the value of an inherited traditional IRA.
For those who already have a Roth IRA, they’re set in terms of their spouse being able to inherit the account and use it as their own. The 10-year rule also applies to inherited Roth IRAs. However, if the five-year Roth IRA rule was followed prior to the original account owner’s death (they waited five years after their first contribution to a Roth IRA to withdraw their earnings tax free), then withdrawals by non-spousal beneficiaries are tax free.
One of the biggest estate planning benefits of a Roth IRA is the fact that there are no required minimum distributions (RMDs) during the account owner’s lifetime. This is a big estate planning tool and lets the money in the Roth IRA grow tax free for the benefit of a surviving spouse or other beneficiaries. This also eliminates the taxes that would otherwise need to be paid on these distributions.
For those who are eligible to do so, contributing to a Roth IRA each year can help you build a Roth balance to pass on to your beneficiaries. For those who have access to a Roth 401(k) account with an employer-sponsored plan or a solo 401(k) for the self-employed, contributing to a Roth 401(k) can offer a higher contribution limit with no income restrictions, when compared to a Roth IRA. The amount in the Roth 401(k) can later be rolled over to a Roth IRA with no tax consequences, which also avoids RMDs.
A Roth IRA conversion is a strategy to look at for passing IRA assets to non-spousal beneficiaries, either directly or as contingent beneficiaries upon the death of a surviving spouse. It’s a good way for you to prepay taxes for beneficiaries. Beyond prepaying the taxes, the five-year rule can come into play if you didn’t previously have a Roth IRA.
Whether a Roth IRA conversion makes sense as an estate planning tool depends on several variables, including your current tax situation, your age and the taxes that would be incurred by the conversion. Roth IRAs have many potential benefits as a planning tool. With the SECURE Act and the changing tax and estate landscape, a Roth IRA can play a key role in your estate planning in the right circumstances.
As an experienced Massachusetts estate planning attorney, we can talk to you about your needs and discuss all the estate planning tools that would work best for you. Contact us today for a free, no-obligation consultation.