As with an IRA of any stripe, the Roth IRA is a retirement account. Unlike its "plain vanilla" IRA cousin, however, the Roth IRA offers significant estate planning opportunities. When it comes to retirement and estate planning, wouldn't it be nice to kill two birds with one stone? Regular readers know I am all about economies of scale and efficiencies.
A recent SmartMoney article titled "Estate Planning With a Roth IRA," tackles the salient differences between a plain vanilla IRA and a Roth IRA, noting that a fundamental distinction is when the income tax is paid. Is the income tax hit triggered upon deposit or at withdrawal?
You pay taxes only upon withdrawal from a plain vanilla IRA, not upfront upon contribution. Result: every cent can appreciate safely without taxation until the day that you (and the IRS) can start drawing from the account. In addition, shortly after you reach age 701/2 annual withdrawals become mandatory. These are known as Required Minimum Distributions (RMDs).
On the other hand, a Roth IRA a plain vanilla IRA in reverse. You pay income taxes upfront at deposit. Result: every cent post-contribution appreciates safely without taxation thereafter. Period. Obviously, this tax-free feature can come in handy for in retirement, but consider its inheritance benefit, too.
What if you were to leave a Roth IRA to an heir by listing them as a beneficiary? First, there is no income taxation burden that accompanies the Roth IRA when withdrawn by your heir. Second, the heir can elect to receive it as a tax-free lump sum or, what is often more useful, take scheduled RMDs over their lifetime much like an annuity (but without any income taxes due).
The article also explores other important distinctions. Indeed, there are many options when it comes to IRAs, Roth IRAs, and inheriting such accounts. Be sure to consult with qualified legal and financial counsel to evaluate how to leverage a Roth IRA for yourself and your loved ones.
Reference: SmartMoney (February 5, 2013) "Estate Planning With a Roth IRA"
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