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Roth IRA - An Estate Planning Tool?


When it comes to saving for retirement, many investors already know how well the Roth IRA fends off Uncle Sam. But what they may not realize is that it's equally effective as an estate-planning tool.

Sometimes the most effective tool is the simplest, even when not a tool originally designed for the job at hand. In the world of estate planning, one such powerful tool is the Roth IRA.

As with an IRA of any stripe, the Roth IRA is a retirement account. Unlike its plain vanilla IRA cousin, however, the Roth IRA offers significant estate planning opportunities. When it comes to retirement and estate planning, wouldn't it be nice to kill two birds with one stone?

A recent SmartMoney article titled "Estate Planning With a Roth IRA" tackles the salient differences between a plain vanilla IRA and a Roth IRA, noting that a fundamental distinction is when the income tax is paid. Is it upon deposit or at withdrawal? The article also explores other important distinctions.

You pay taxes only upon withdrawal from a plain vanilla IRA, not upfront upon contribution. Result: every cent can appreciate safely without taxation until the day that you (and the IRS) can start drawing from the account. In addition, shortly after you reach age 70 ½ annual withdrawals become mandatory. These are known as Required Minimum Distributions (RMDs).

On the other hand, a Roth IRA is a plain vanilla IRA in reverse. You pay income taxes upfront at deposit. Result: every cent post-contribution appreciates safely without taxation thereafter. Period. Obviously, this tax-free feature can come in handy for retirement, but consider its inheritance benefit too. What if you were to leave a Roth IRA to an heir by listing them as a beneficiary? First, there is no income taxation burden that accompanies the Roth IRA when withdrawn by your heir. Second, the heir can elect to receive it as a tax-free lump sum or, what is often more useful, take scheduled RMDs over their lifetime much like an annuity (but without any income taxes due).

There are many options when it comes to IRAs, Roth IRAs, and inheriting such accounts. Be sure to consult with qualified legal and financial counsel to evaluate how to leverage a Roth IRA for yourself and your loved ones.

For more information please visit my estate planning website.

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