Legacy And Estate Planning With A Roth IRA

Legacy and estate planning with a Roth IRA may sound like a no-brainer. Roth IRAs intrinsically make phenomenal transfer of wealth vehicles. With reduced estate taxes and no income tax for heirs to pay on withdrawals, establishing a Roth IRA or even converting to one from a Traditional IRA seems to be a simple decision.

However, as with most things financial, estate planning is not as simple as it is often portrayed. Below are three tidbits to keep in mind when planning for the financial security of future generations.

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Conflicts Of Interest Should Be Avoided

Keep in mind not only the account holder's tax situation, but that of the heir. Do not make a conversion that could be detrimental to your livelihood for the sake of your heirs. Likewise, if you are secure without the crutch of an IRA, consider the tax burdens your heirs may inherit. When estate planning, keeping all parties in mind is essential – if either is party is eliminated from the equation, the situation invites ulterior motives to expose their knobby heads.

As Bob Carlson of Investing Daily explained, you should consider converting to a Roth only when “the estate owner's standard of living seems secure without the IRA.”

He continued, stating that when the mentality behind the IRA is considered an emergency fund and a wealth-transferring vehicle, “The goal, then, is to try to ensure the maximum after-tax wealth for heirs.” It is only then that the goal of the account shifts from personal security to the security of future generations.

Estate Taxes

With boundaries established and external motivations in check, understanding how estate taxes function is essential. Without this awareness, informed decisions are impossible, rendering the decision-making process potentially haphazard.

According to the IRS, “The Estate Tax is a tax on your right to transfer property at your death. It consists of an accounting of everything you own or have certain interest in at the date of death.” In other words, what you leave behind can be bequeathed to others, but in doing so, it must be accounted for and assessed by the government. Depending on the size and complexity of the estate, estate tax returns must be filed. For 2014, if an estate exceeds $5,340,000, a filing is required.

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IRA Taxes

IRAs have regulations in place to ensure that the account contents are properly accounted for, and necessary taxes paid. Inherited retirement accounts follow different regulations once the original account holder has passed on; while the basic differences between Roth IRAs and Traditional IRAs remain in place, it is important to be aware that second-generation accounts are not identical to first-generation accounts. For example, inherited Traditional IRAs require MRDs (“Minimum Required Distributions,” the necessary annual withdrawal amount) with the typical taxes due – just as they would during the first-generation. Second-generation Roth accounts function differently, requiring tax-free MRDs. Generally, Roth accounts do not require MRDs from the account holder, but when the account is passed to someone else, the regulations change.

In addition, not all Traditional IRAs or all Roth IRAs are identical; it is therefore necessary to understand the specific regulations of your individual account and not solely rely on the typical situations described herein.