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Roth IRA as an Estate Planning Tool


The Roth IRA can not only be useful for retirement planning, but it also can be an important part of your estate planning as well. If you have a traditional IRA, converting it to a Roth IRA can be a wise estate planning strategy under certain circumstances.

Pay Now So Your Heirs Won't Have to Pay Later

Suppose you have an infant granddaughter and you want to leave her part of your estate. If you don't need the money for your retirement, you can convert all or part of your traditional IRA to a Roth IRA regardless of your income. Income restrictions no longer apply to Roth conversions. You can name a trust for your granddaughter as the Roth IRA beneficiary. The downside is that you would owe immediate federal income taxes on any accumulated earnings and any tax-deductible contributions made to your traditional IRA. However, if you pay the taxes out of your non-IRA assets, you effectively prepay income taxes for your granddaughter without owing any gift tax or using up any of your estate tax exemption. In addition, by paying the taxes, you are reducing the size of your taxable estate.

A significant benefit of this strategy is that your granddaughter generally will owe no income taxes on any withdrawals, although estate taxes may be due on the value of the account she inherits from you (depending on when you die and the overall value of your estate).

For as long as you're alive, the Roth IRA can grow tax free and you do not have to start making withdrawals at a particular age. A traditional IRA used to require that you begin withdrawing from the account by April 1 of the year following the year you reach age 72.

After You're Gone

When you die, the Roth IRA then becomes subject to the same minimum withdrawal rules as regular IRAs. Your granddaughter must begin making minimum withdrawals based on her life expectancy. If she were still young when you die, she would be required to begin withdrawing only a small amount based on her relatively long life expectancy. Each year, the fraction she would be required to withdraw would grow slightly. However, the rest of the money would continue to grow tax free and could result in a substantial nest egg over time.

More After-Tax Money Goes to Your Heirs

One possible advantage of this strategy is that you may be able to transfer more after-tax money to your heirs. Because of the power of tax-free compounding, the younger the trust beneficiary, the greater the benefit because of the longer time the nest egg has to potentially grow. Your situation might differ, however, so be sure to consult a professional before taking action.