INHERITING A ROTH IRA ACCOUNT

ROTH IRA ACCOUNTS ARE FUNDAMENTALLY DIFFERENT

This blog explored the topic of inheriting an individual retirement account (IRA) in a previous blog. It is necessary to explore the topic of inheriting a Roth IRA, as a Roth IRA is fundamentally different from a traditional IRA. Some of the differences between a Roth IRA and a traditional IRA:

• Taxing event – The money going into a Roth IRA is taxed prior to going into the account, while a traditional IRA is generally deposited as pre-taxed income and only taxed after withdrawal from the IRA.   
• Withdrawal of income – The money in a Roth IRA can be withdrawn free of tax liability, while the withdrawal of money from a traditional IRA would be a taxable event.
• Tax free growth – both types of IRA accounts allow the money to grow tax free year to year.
• Income limits – There are generally no limitations to the amount you can contribute to your traditional IRA, provided the money is earned income. A Roth IRA, however, has income thresholds or limits, different depending on your tax filing status.
• Withdrawal rules –
  • Traditional IRA
    • A traditional IRA requires that the owner of the account withdrawal the money by the time they are 70 and one-half years old. This provides some reasonable period of time for the government to tax the money.
    • The holder of traditional IRA may withdraw up to $10,000 to use as the down payment on a qualified first-time home purchase.
  • Roth IRA
    • Since the money in a Roth IRA is already taxed, there is no requirement that the Roth IRA account owner must withdraw the money; in other words there is no monthly minimum distribution.
    • The owner must also be at least 59 and one-half years old.
    • In addition, there is a time restriction, insofar as the Roth IRA account owner must wait at least five years from the creation of the Roth IRA before withdrawing the money from the account.

• Income reduction – In addition to the fact that the money going into a traditional IRA is pre-tax, it also reduces the final adjusted gross income of the account holder, allowing them to receive other beneficial tax credits, such the student loan interest deduction.

ROTH IRA AS PART OF ESTATE PLAN

The only real withdrawal limitation on a Roth IRA is that the initial seed funding must be deposited at least five years prior to withdrawal. That means that the heir can withdrawal the money over many years with little concern for tax consequences. The real issue that needs to be addressed with respect to leaving a Roth IRA to an heir speaks to the tax consequences. If the Roth IRA account owner already owns the IRA and opened it without consideration as leaving it to an heir, the decision is relatively simple. The owner simply has to decide how to dispose of the account. Will he/she try and use it up during their lifetime or leave it to the estate? For those who do not have a Roth IRA, they should consider the tax consequences of investing in a Roth IRA. Perhaps investing in a Roth will be enough to draw down their income so as to qualify them for some very beneficial tax credits, thereby making the marginal tax rate in the inception or the opening of the Roth IRA rather low.  On the other hand, if the marginal tax rate at the inception are not so low, it may pay to consider what the tax rate would be for whomsoever would receive the Roth IRA. Some states do not have income taxes and would make any distribution incur a very low marginal tax rate.