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Smart estate planning will minimize the tax bill your heirs pay when you die, and a Roth IRA is one of the most effective tools that can be used for that purpose. Aside from all the other positive characteristics of Roth IRAs, there are two reasons for including one in your estate planning.
- You are not required to take minimum annual distributions from your Roth account. If you don’t need the money, the account can continue to grow in value until your heirs receive it.
- A Roth account is not included as part of an estate in a probate process. The balance will go directly to your designated beneficiary.
Key Takeaways
- You don’t have to take annual distributions from a Roth IRA during your lifetime, so if you don’t need the money you can leave it all to your heirs.
- Heirs in most cases can make tax-free withdrawals over a five-year period from the Roth IRA.
- Spouses who inherit Roth IRAs can treat the accounts as their own. That is, there are no deadlines for withdrawals.
You Can Leave the Whole Account to Your Heirs
One of the major advantages of a Roth IRA, unlike traditional IRAs and many other types of retirement plans, is that you don’t have to take any required minimum distributions (RMDs) during your lifetime. Since you already paid the income taxes due on that money, the Internal Revenue Service (IRS) doesn’t care when you use it.
So if you don’t need the money for living expenses, you can just leave it in the account to keep growing tax-free. This makes a Roth IRA an especially good vehicle for wealth transfer.
How Your Heirs Can Avoid Taxes
A spouse can choose to become the account holder of the Roth IRA without any changes. That is, no taxes should be owed on withdrawals from the account and no minimum distributions are required.
Children and other heirs cannot do that. Most must withdraw all of the money in the Roth account within five calendar years of the date when it was inherited in order to keep the money tax-free.
Be sure to keep the beneficiary designations on your Roth IRA and other financial accounts up to date, so the money will go where you want it to go without delay.
Roth IRAs Help You Avoid Probate
Like proceeds from a traditional retirement account or a life insurance policy, the money you leave your heirs in the form of a Roth IRA doesn’t have to go through the probate process. This simplifies and speeds up the disbursing of funds to your loved ones and can reduce the cost of settling your estate.
Mutual fund companies, banks, brokerage firms, and other financial institutions that serve as custodians for Roth IRAs will typically require you to designate a beneficiary, and sometimes alternate beneficiaries, when you open your account. Don’t name your estate as a beneficiary or you’ll lose the opportunity to bypass probate.
It’s important to designate a beneficiary to ensure that your wishes are carried out after you die. It’s equally important to review your beneficiary designations periodically to make sure they are up to date, especially after major life events, such as marriage, divorce, the birth of a child, or the death of a previous beneficiary. For example, your current spouse might not appreciate seeing your Roth IRA go to a former spouse because you forgot to update the form.