Roth IRAs are a fantastic way to save for retirement, and they can also amplify your estate plan.
Here are some critical benefits Roth IRAs bring to the table:
- They offer tax-free growth.
- There are no required minimum distributions during your life as long as you are the original account owner or spouse.
- They offer a seamless way to pass on wealth to your spouse and heirs.
- They avoid probate
- Changes to the Secure Act enhance Roth IRA advantages.
Today, we’ll discuss what each of these items could mean for you. Remember, no two investors are alike, so consult with Step by Step Financial to get advice tailored to your situation.
First, Roth IRAs Offer Tax-Free Growth
Roth IRAs are an excellent estate planning tool because they allow you to enjoy tax-free growth. While you invest with after-tax funds, earnings grow tax free, and qualified distributions in retirement remain tax-free.
Building up the tax-free portion of your retirement savings can:
- Bring flexibility and creativity to your income plan
- Help better manage your overall tax situation
- Provide an income buffer
Roth IRAs also make fantastic gifts since they don't impose distribution or transfer taxes, so your heirs can avoid unnecessary taxes.
There Are No Required Minimum Distributions
If you have a traditional IRA, you must take distributions from the account once you reach age 70.5 (72 if you were born after June 30, 1949), known as RMDs (required minimum distributions.)
But this rule doesn't apply to Roth IRAs. It's the opposite: there are no required minimum distributions on Roth IRAs for the original account owner or their spouse. Your heirs will have RMDs once they inherit the account, but if you don’t need the money, you can let it grow tax-free for the rest of your life.
Passing the Wealth On
To Your Spouse
It's relatively simple to transfer the Roth IRA to a surviving spouse. Spouses have several unique options for handling inheriting a Roth IRA that other beneficiaries do not enjoy.
Your spouse can choose to become the account holder in what is called a “spousal transfer.” In this case, they won’t be subject to RMDs during their lifetime, but their beneficiaries will.
The account must meet the five-year holding period rule (the IRA has to exist for five years) to qualify for tax-free withdrawals, and the surviving spouse must be at least 59.5 at the time of their first withdrawal—just as if it had been their account all along.
Since the enactment of the SECURE Act in 2019, beneficiaries who aren’t spouses must deplete the account within ten years. The SECURE Act exempts spouses from this requirement, allowing them to keep the account intact.
If the account meets the five-year rule when the spouse inherits it, they can elect to cash out the Roth IRA tax-free.
To Other Heirs
Roth IRAs can also help you pass on wealth to your heirs efficiently. Since you can list a designated beneficiary, it doesn’t have to go through probate court, streamlining the wealth transfer process.
You Can Avoid the Probate Process
Probate is the legal process your estate goes through after you pass away. Essentially, it validates your will and ensures that all your assets go to the appropriate people.
Many people seek to avoid probate if possible since it can be time-consuming, expensive (legal fees), and public (all proceedings are filed in the public record).
If you name an official beneficiary or multiple beneficiaries on a Roth IRA, the money can simply pass to those designated heirs without stopping in probate first or waiting for the executor to distribute assets.
You can always change your beneficiaries, so double-check who you have designated often to ensure they're still in line with your wishes.
New Tax Changes In The Secure Act And Secure Act 2.0 Further Enhance the Advantages of Roth IRAs
In 2019, Congress passed the SECURE Act, which changed various retirement account rules, including who is eligible to contribute to retirement accounts and adding requirements for mandatory withdrawals. The legislation also adds a new exception to the early withdrawal penalty.
Significant retirement account changes from the first SECURE Act include:
Here’s a quick refresh of the changes that could impact your estate.
- The required minimum distribution age increases to 72, up from 70.5.
- The age limit for IRA contributions is gone (anyone who earns income can contribute).
- Anyone who inherited a retirement account must take distributions within ten years. (There are exceptions noted below.)
Will The Secure Act 2.0 Change Things?
Congress is again discussing retirement security. The Senate approved the Securing a Strong Retirement Act on May 5.
The "SECURE Act 2.0" expands on the original 2019 law.
Key Legislative Changes Proposed In The Secure Act 2.0
The original SECURE Act raised the required mandatory distribution age to 72. SECURE Act 2.0 would raise it to 73 in 2022, 74 in 2029, and 75 in 2032. This delay would allow your money more time to grow before you have to start drawing it down.
Roth-ify Catch-up Contributions
Anyone 50 or older can make catch-up payments to a 401(k) or similar plan. Inflation-indexed catch-up contributions for 2021 are $6,500.
SECURE Act 2.0 maintains catch-up contribution limits for individuals 50 and older but increases them to $10,000 for those 62 to 64 in 2023. This greater ceiling is inflation-indexed.
Employer catch-up payments might be pretax under existing legislation (if the plan sponsor permits). As of Jan. 1, 2022, all catch-up contributions to employer-sponsored eligible retirement plans will be taxed like Roth accounts. You would contribute after-tax dollars up front, but your withdrawals would be tax-free, allowing you to maximize your savings.
Match Roth contributions
Plan sponsors could allow employees to consider part or all matching contributions as Roth 401(k) contributions. Roth employer matching contributions aren't tax-deductible.
SECURE Act 2.0 would compel companies to automatically enroll qualified new employees in defined contribution plans after 2021 at a 3 percent pretax contribution level. This amount would climb by 1% annually to 10 to 15% of the employee's compensation. If they’d like, employees could choose another donation.
Small firms with ten or fewer employees, new businesses (less than three years old), churches, and government plans would be exempt.
It’s Hard to Beat a Roth IRA
Roth IRAs are a fantastic way to grow your wealth while planning for the future. They allow you to take advantage of tax-free growth and withdrawals and keep assets from being subject to income tax when passed on.
Given the proposed changes in the SECURE Act 2.0, Roths could end up being even more valuable in the future.
A Roth IRA can be an ideal way to save money on taxes throughout your lifetime, where you and your heirs can benefit.
Is it time to refresh your estate planning strategy? Give our team a call today.