Roth IRAs – What can they do for your Estate Plan?

Roth IRAs – What can they do for your Estate Plan?

Generally, “estate planning” centers around the concept of passing assets to the next generation with the government taking as little as possible in the process.  Usually the 401k, IRA and other tax deferred retirement accounts are the least favorable assets to pass to the next generation, because these retirement assets are not only subject to inheritance taxes, but also federal income tax.  Since ALL distributions from these retirement accounts may be reportable as ordinary income, a significant inheritance of these assets could bump your heirs into the highest tax bracket, which today is 39.6%.  What will the highest tax bracket be when it comes time for your heirs to inherit your estate?  Your guess is as good as mine, but let’s take a look at some historical numbers:

The highest tax bracket in 1944 was 94%.
The highest tax bracket in 1986 was 50%.

When planning for the transfer of assets, the only thing we can say for certain about income taxes is this:  We have no idea what the tax brackets will be.
From an estate planning standpoint, Roth IRAs are being underutilized as a way to pass assets to the next generation.  A Roth IRA is funded with after-tax dollars, grows tax-deferred, and distributions (both contributions and gains) are tax-free in retirement.  This differs from the traditional IRA, which is funded with pre-tax dollars, grows tax-deferred, and is fully taxable in retirement.

Since 2010, there is no income limit to convert all or part of your Traditional IRA to a Roth IRA.  Converting your IRA to a Roth IRA will cause the amount converted to be included in your income, and accordingly, subject to federal income tax.  Now, this conversion may trigger a significant amount of income tax, but it eliminates income tax liability for your beneficiaries.

Estate planning is not the only reason to consider a Roth IRA.  A young person leaving an employer may wish to convert his or her 401k to a Roth IRA.  Of course, this creates income tax liability, but the years of tax-free growth may far exceed the income tax paid today.
Like Traditional IRAs, Roth IRAs come with an early distribution penalty of 10% if funds are withdrawn prior to age 591/2, but the penalty may have far less impact within the Roth IRA.  The 10% penalty for early distributions from a Traditional IRA applies to the whole account, whereas the 10% penalty on early distributions from a Roth IRA only applies to the growth.

When might a Roth IRA be right for you?  If you agree with any of the following statements, you’ll want to review the Roth IRA with a financial advisor:

–          I believe taxes will be higher for me in the future than they are for me today.
–          I want to leave my assets to my loved ones with the least amount of tax.

Registered Representative Securities offered through Cambridge Investment Research, Inc., a Broker/Dealer, Member FINRA/SIPC.  Investment Advisor Representative Cambridge Investment Research Advisors, Inc., a registered investment adviser.  Cambridge and Conte Wealth Advisors, LLC are not affiliated.