While the benefits are fairly straightforward, there are a few complexities to consider. With some advanced planning, you can further maximize the tax advantages of the Roth IRA for future generations. There are also some mistakes that could wipe out any potential tax benefits.
Are you one of the millions of Americans who have decided to use a Roth IRA to accumulate retirement assets? That may be a wise idea. The Roth IRA has a number of appealing features, including tax-deferred growth and tax-free distributions after age 59½.
One of the other popular aspects of a Roth IRA is that you can use it to leave a tax-free benefit to your loved ones. Unlike a traditional IRA, the Roth doesn’t have required minimum distributions at age 70½. You can leave your assets in the Roth as long as you like, allowing them to grow tax-deferred. When you die, your beneficiaries receive the assets on a tax-free and probate-free basis.
Below are a few common legacy planning mistakes that people often make with their Roth IRAs. Have you covered these issues? If not, you may want to address them sooner rather than later.
Not discussing your plans with your heirs.
The strategy outlined above can be complicated and should only be implemented after careful analysis and planning. Part of that planning should involve a discussion with the beneficiaries in question.
If your intention is truly for them to stretch out the distributions to continue to grow and maximize lifetime income, then you should discuss that with them. Your heirs are generally under no obligation to follow your wishes after you pass away. However, if you explain your goals, they may be more likely to do so.
Not considering nonspousal beneficiaries.
Many Roth IRA owners choose their spouse as a beneficiary by default. While there is good reason to leave those assets to your spouse, there are also compelling reasons to leave your Roth IRA to a younger loved one, like a child or grandchild. That’s especially true if it’s important to you that they are included in your legacy plan.
When a nonspousal beneficiary inherits a Roth, they are usually required to start taking distributions almost immediately. However, they have the ability to stretch those distributions over their life expectancy. If they’re younger, those distributions could then last for decades.
The benefit of doing this is that the longer one’s life expectancy is, the smaller the distributions will be. That leaves more money in the account to continue growing on a tax-deferred basis, further maximizing the account’s tax advantages.
Not naming a contingent beneficiary.
Again, it’s common to name a spouse as a primary beneficiary on a Roth IRA. What happens, though, if your spouse predeceases you and you never change the beneficiary? Or what if you and your spouse die at the same time in some kind of accident?
When the primary beneficiary is also dead, the account then goes to the contingent beneficiary. What if there is no contingent beneficiary? In most cases, the assets are then distributed to the owner’s estate.
That’s a problem, because that distribution is taxable, thus eliminating most of the tax benefit from using a Roth in the first place. Also, the assets will go through probate, again canceling out a key Roth advantage.
Worried that you haven’t planned your Roth properly? Let’s talk about it. Contact us at Gregory Financial Group. We can help you examine your needs and goals and develop a strategy. Let’s connect soon and start the conversation.
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