What You Need to Know
- Roth IRAs can be a very effective estate planning tool for your clients.
- A Roth IRA's benefits as part of estate planning should be reviewed yearly to determine if clients' circumstances have changed.
- Roth IRAs also provide your clients with tax flexibility in terms of their own retirement withdrawals if needed.
Roth IRAs and Roth IRA conversions have received a lot of press recently. Between the various tax proposals that have been floating around Congress and normal year-end tax planning strategies, Roth IRAs are a popular topic.
Here are two main reasons to consider Roth IRAs as part of your client’s estate planning efforts.
This may seem pretty basic to many readers, but one of the biggest estate planning benefits of a Roth IRA is the fact that there are no required minimum distributions. This is a powerful estate planning tool. The lack of RMDs allows the money in the Roth IRA to grow tax-free for the benefit of a surviving spouse or other beneficiaries.
Besides the impact of RMDs reducing the amount of a traditional IRA, not having to take RMDs from a Roth IRA eliminates the taxes that would otherwise need to be paid on these distributions. These taxes can add up to a substantial amount over a period of years, reducing the size of your client’s estate.
The Secure Act and Inherited IRAs
Since the rules governing inherited IRAs for most non-spousal beneficiaries under the Setting Every Community Up for Retirement Enhancement (Secure) Act went into effect at the beginning of 2020, Roth IRAs have become a very viable estate planning tool.
This is because beneficiaries who are not classified as eligible designated beneficiaries are required to withdraw the entire amount of their inherited IRA within 10 years of inheriting it. The Secure Act eliminated the ability to “stretch” inherited IRAs that was in place for IRAs inherited prior to Jan. 1, 2020, for most non-spousal beneficiaries.
For inherited traditional IRAs, this results in the whole amount being taxed within 10 years of inheriting. The 10-year rule also applies to inherited Roth IRAs. But if the original account owner had met the five-year requirement prior to their death, then withdrawals from the inherited Roth IRA are tax-free.
This makes Roth IRAs a beneficial estate planning tool as taxes that are bunched into a 10-year period can substantially erode the value of an inherited traditional IRA.
For clients who already have Roth IRAs, they are set in terms of their spouse being able to inherit the account and use it as their own. For non-spousal beneficiaries, the main issue is the five-year rule. As with any type of IRA or retirement account, make sure their beneficiary designations are current and that they reflect your client’s desires.
For clients with a Roth 401(k), it’s important that they roll this account over to a Roth IRA once they leave their employer to avoid RMDs.
An additional consideration beyond the estate planning ramifications is the tax diversification a Roth IRA provides once your client is retired. Their changing circumstances might merit using some or all of their Roth IRA to take tax-free distributions in retirement at some point, and they now have the flexibility to do this.