Estate Planner Sept-Oct 2000 Fulfillment
By creating the Roth individual retirement account (IRA), the Taxpayer Relief Act of 1997 allows your money to grow tax free – not only while you’re alive but also long after you’re gone. While you can’t deduct contributions to Roth IRAs, your qualified distributions are not included in gross income. This means the growth of the assets in a Roth IRA is not subject to income tax.
As with traditional IRAs, if you don’t need Roth funds, defer distributions as long as possible. For traditional IRAs, deferral postpones payment of income tax. For Roth IRAs, deferral lets the assets continue to grow tax free even after your death.
Post-death distributions from Roth IRAs are subject to the rules governing distributions from traditional IRAs and to the terms of the agreement. Two options generally are available for a nonspouse beneficiary: Distributions must be taken either over your beneficiary’s lifetime or by the end of the year after the fifth anniversary of your death. Lifetime payments must begin by the end of the year after you die. Unless the assets are needed sooner, choose the lifetime payment option to continue the tax-free growth of the assets as long as possible.
If your Roth beneficiary is your spouse, special rules apply. He or she may treat the Roth IRA as his or her own, or may roll it over into his or her own Roth IRA. Regardless, the tax-free growth will continue during his or her lifetime without any required distributions – even after age 70 1/2. Your spouse can also name his or her own beneficiary, thus further continuing the tax-free growth
of the assets.
Check the Roth IRA agreement carefully. Are its distribution provisions more restrictive than those required by law? The agreement may not contain all available options. For example, your Roth agreement may require that post-death distributions be made within five years of your death, not over the beneficiary’s lifetime. This would limit the income tax-free growth of the assets.
If your beneficiaries need additional funds, the Roth can provide a source of tax-free income. Distributions to beneficiaries made after you die are not included in
gross income if the account has been open for five years.
Estate Planning Implications
With traditional IRAs, you may take into account the effect of income tax on your beneficiaries in determining how to divide assets among them. For example, you may provide your beneficiary with additional assets of a traditional IRA to offset the income tax they’ll owe. Under a Roth IRA, your beneficiaries have the advantage that any growth of the asset is income tax free.
Because Roth IRAs grow tax free, you should ensure they won’t need to be liquidated to pay estate tax. One way to make liquidity available to your estate is to buy
life insurance through an irrevocable trust.
Creating a trust to hold the Roth IRA proceeds after you die may also be advantageous. The trustee can defer distributions for as long as practical to increase assets for beneficiaries who would otherwise withdraw the proceeds too quickly. Use multiple trusts if significant age disparity exists among beneficiaries. Otherwise, payments will
be based on the oldest beneficiary’s life expectancy.
Benefits Can Continue Long After Death
With careful planning, the tremendous income tax-saving benefits of Roth IRAs
can continue long after your death.