How Can a Roth IRA Reduce the Tax Burden Facing Your Heirs?

10.30.17There’s more than retirement savings power in a Roth IRA. Used properly, it can help cut your beneficiary’s tax liability, regardless of if and when tax reform becomes reality.

If you’re interested in reducing the taxes your heirs will have to pay, you’re probably concerned about the discussion about tax reform going on in Washington these days. Unfortunately, there’s no way to be certain what, if any, changes will actually occur. In the meantime, your estate planning attorney can help you structure your estate, so that less of it ends up being consumed by taxes. That includes moving funds into non-taxable accounts, including Roth IRAs.

Motley Fool’s recent article, “A Clever Way to Cut Your Heirs' Income Taxes,” says the money you put into a Roth retirement savings account has already been taxed. It was taxed on the contributions you made or as a rollover from a tax-deferred retirement savings account. As a result, everything in that account is now non-taxable for income-tax purposes. As the Roth has been open for at least five years prior to your death, the money in that account won’t be subject to federal income taxes.

In the event you leave the money in your Roth rather than spending it during your retirement, after your death, the account will be transferred to the person you designated as a beneficiary. At that point, the Roth account will be subject to the IRS's rules for inherited IRAs.

The beneficiary must then begin to take distributions based on their predicted lifespan (pursuant to the IRS’s actuarial tables). If your beneficiary doesn't simply blow the money in the account right away, the balance in the Roth will continue to grow tax-free, providing them with some untaxed income in the future.

In order for this to work, you’ll want to avoid spending any of the money in the Roth account while you are alive.  This means that you should make sure you have other sources of income to finance your retirement.

Remember that you can do a Roth conversion at any age, even if you did not set up a Roth account before retirement.

Reference: Motley Fool (September 14, 2017) “A Clever Way to Cut Your Heirs' Income Taxes”

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