Because it looks like income tax rates will go up in future years (how else will Congress pay for all the bailouts they’re making?), Roth IRAs promise to become even more popular. Although we usually focus attention on the income tax benefits of a Roth IRA, there are also estate planning (and not just estate tax) benefits as well.
First, a Roth IRA lets you leave money to heirs without also leaving an income tax bill. If you had a regular IRA, they would pay income tax on the money they take out – just like you would. But when they take money out of a Roth IRA, they do not pay income tax.
Second, you can leave more to them because the money can keep growing tax free until you die. If you own a regular IRA, you must start taking money out after you turn 70½. If you have to take out $2,000 this year and pay $500 income tax on that money, that’s $500 you can’t leave to your family. But they also don’t get the interest or capital gains the IRA would get on that $500 this year – and every year that it stayed in the IRA. If you own a Roth IRA, you do not have to take distributions after you turn 70½. The entire $2,000 continues to grow as long as you live. Only after you die do your heirs need to take money out of the Roth. Like a regular IRA, they can take the money out over their lifetime (letting it grow tax-free meanwhile). However, unlike a regular IRA, when they do start taking money, they do not pay tax on what they take out.
The third benefit is that you can leave more because you can keep putting money into a Roth IRA as long as you live. With a regular IRA, you can’t make contributions after you turn 70½. All the growth of those after-70½ contributions is tax-free – not only as long as you live but also until your family take the money out.
A Roth IRA is part of your estate. If your estate is big enough ($3.5 million in 2009 – double that if you’re married and do the proper planning), your family could lose as much as 45% of the money in the Roth to federal death taxes. Of course, if the money were in a regular IRA, they’d have to pay not only the estate tax but income tax as well. States may have different rules and may impose state death taxes on a Roth IRA.
When you put money into Roth IRA, you don’t get an income tax deduction like you do when you put money into a regular IRA. But, unlike the regular IRA, as long as you satisfy a few simple rules, you don’t pay tax when you take money out of your Roth. In other words, you can trade an income tax deduction now for tax-free income later.
As with all retirement plans, Congress makes the rules on who can put money into a Roth IRA and when you take money out. Those rules change all the time so make sure you talk with your tax advisers. If you have money in a regular IRA there are limits on your ability to ‘convert’ that to a Roth IRA. Some of those limits disappear beginning January 1, 2010. Again, talk with your advisers.
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Inheritance tax planning is very essential if you really want that your estate goes in the hands of whom you want to. This demands a very strong and calculated financial planning and if all ends meet in a proper way, your family will be free from any further finance problems in future.
Some great that often get overlooked. With a Roth IRA, you have options. No forced withdrawals at age 70 1/2 or inability to continue funding your account. Those extra years of tax-free compounding interest can do wonders for someone who lives into their 80’s, 90’s, or beyond.
It should be noted, though, that while you can fund an IRA past the age of 70 1/2, you can only fund an IRA out of earned income. Unless these folks have a job, they will not be able to contribute further amounts to their Roth IRA.