Using a Roth IRA as an Estate Planning Tool

A Roth IRA does not have to be used as just a retirement plan; it can also be a way to transfer assets tax-free to the next generation.

Unlike a traditional IRA, contributions to a Roth IRA are taxed, which means that the distributions are tax-free. Also, unlike a traditional IRA, you are also not required to take any distributions on a Roth IRA, regardless of your age. If you don’t need the money for retirement, you can leave all of it in the IRA to grow tax-free and eventually pass on to your heirs.

If your spouse is the beneficiary on your Roth IRA, your spouse can become the owner of the account. Your spouse can either put the IRA in his or her name or roll it over into a new IRA, and the IRS will treat the IRA as if your spouse had always owned it. Just like you, your spouse does not need to take any distributions from the IRA if they are not needed.

The rules for a child or grandchild (or other non-spouse) who inherits an IRA are different than those for a spouse. They must withdraw all of the assets in the inherited account within 10 years. There are no required distributions during those 10 years, but it must all be distributed by the 10th year.

Certain non-spouse beneficiaries are treated like spouses, which means they can treat the IRA as their own:

  • Disabled or chronically ill individuals
  • Individuals who are not more than 10 years younger than the account owner
  • Minor children. Once the child reaches the age of majority, he or she has 10 years to withdraw the money from the account.

The benefit of a Roth IRA for your heirs is that the assets will be distributed tax-free. As long as you opened and began making contributions to the Roth IRA more than five years before you died, the distributions will not be taxed when the beneficiary takes distributions.

Another consideration is that money you leave your heirs in a Roth IRA does not go through the probate process. This can make it easier for your beneficiaries to access the funds quickly. But make sure that you name a beneficiary on your account. If no beneficiary is named, the account will go to your estate and will then have to go through probate. Also, be sure to regularly check that your beneficiary designations are up to date.

Leaving your heirs a tax-free Roth IRA may not always be the best plan. In figuring out the best type of IRA to leave to your beneficiaries, you need to consider whether your beneficiary’s tax rate will be higher or lower than your tax rate when you fund the IRA. In general, if your beneficiary’s tax rate is higher than your tax rate, then you should leave your beneficiary a Roth IRA. Because the funds in a Roth IRA are taxed before they are put into the IRA, it makes sense to fund it when your tax rate is lower. On the other hand, if your beneficiary’s tax rate is lower than your tax rate, a traditional IRA might make more sense. That way, you won’t pay the taxes at your higher rate; instead, your beneficiary will pay at their lower tax rate.

Many clients have questions about who to name as beneficiaries on both Roth IRAs and traditional IRAs, and also whether to name a trust as a beneficiary. The answers to these questions depend on the individual circumstances, age(s) of the beneficiary (ies) and overall estate plan goals. These decisions are an important part of the estate planning process. You can begin this process by calling Wenzel Bennett & Harris at ( 989) 356-6128 and scheduling an estate planning consultation.

If you have specific questions about your situation or would like to learn more, reach out to the team at WBH here.

Read more articles:

Preserving the Family Vacation Home for Generations to Come

Summer is winding down and if you are one of the lucky ones, you got to spend some time at a family vacation home. How do you make sure your children and grandchildren can enjoy that second home as much as you did? The question for owners of vacation homes in planning...

The Tax Consequences of Selling a House After the Death of a Spouse

If your spouse dies, you may have to decide whether or when to sell your house. There are some tax considerations that go into that decision.  The biggest concern when selling property is capital gains taxes.  A capital gain is the difference between the "basis" in...

Using a QTIP Trust in Estate Planning

Estate planning is crucial when managing valuable assets and ensuring the smooth transfer of wealth to future generations. There are various types of estate planning tools available, some of which may be more useful depending on your circumstances. For some, a...

When Should I Include a Pour Over Will in My Estate Plan?

In creating an estate plan, you are proactively taking steps to ensure that your assets will be distributed according to your wishes in the wake of your death.  One tool available to you in estate planning is known as a trust. There are numerous kinds of trusts. If...

When Can Someone Be Declared Legally Incompetent?

If a loved one is experiencing memory loss or suddenly making poor decisions, you may be in a situation where it becomes necessary to ask the probate court to appoint a guardian and/or a conservator for them. This is a complicated process, so we strongly encourage our...

Majority of Adult Children Cannot Support Boomer Parents, Surveys Find

A recent survey by the American Advisors Group (AAG) finds that 55 percent of adult children say they are not financially prepared to help their Baby Boomer parents cope with rising inflation and living expenses. “Americans want to see their parents age with grace and...

Older Adults Lack Information in Search for Long-Term Care

According to a recent national study, nearly a quarter of Americans aged 50 and older say they – or a loved one – needed long-term care in 2022. The findings further suggest that seniors and their caregivers could benefit from more consumer-friendly information and...

Claiming Social Security Benefits at Age 70

If you are about to turn 70, congratulations on reaching a big milestone.  And if you also have delayed claiming Social Security retirement benefits up till now, you are joining a select group -- only 6.5 percent of Social Security recipients put off collecting their...

You Can Just Say No: Declining to Act as an Agent Under a Power of Attorney

Acting as an agent under a power of attorney is a big responsibility and it isn’t something everyone can take on. It is possible to resign or refuse the position. There are two main types of powers of attorney – financial and medical. As the agent under a power of...

Don’t Wait Until You’re Sick to Create an Estate Plan

In the wake of the pandemic, rising inflation, mass shooting tragedies, and other events, more people recognize that they need to plan for the future. Yet while financial planning has been at the top of many Americans’ minds, a vast majority of people have stalled in...