Inherited Roth IRA
While an inherited Roth IRA can pose tax consequences for beneficiaries, it is a good way to transfer wealth to loved ones without the hassle of probate. Although Roth IRA contributions are not taxed when funds are withdrawn, they are subject to estate tax.
Numerous rules surround inherited Roth IRA accounts, so beneficiaries should obtain counsel from a tax accountant or probate lawyer. Estate tax is assessed on the value of the Roth IRA, but distribution proceeds are exempt from income tax; eliminating tax burdens to spouse and non-spouse beneficiaries.
People often select Roth IRAs over traditional IRAs because there is no withdrawal requirement. Traditional IRAs require account holders to begin withdrawing funds once they reach age 70-1/2.
Account holders can no longer contribute to the IRA, so fewer funds are available to beneficiaries. With Roth IRAs the contributions can grow to provide more inheritance money to heirs.
Roth IRAs offer unique tax-saving advantages not available with traditional IRAs. Account holders pay taxes for IRA contributions upfront, so when money is withdrawn it's tax-free. Depending on how long money stays in the account, funds could grow 5- to 10-times and net substantial tax savings.
Another tax advantage is most people are placed into a higher tax bracket as they age. By paying tax rates of the lower bracket, account holders aren't penalized for improving their financial well-being.
Roth IRAs are one of the most underutilized strategies when it comes to establishing inherited wealth for minor children. William Baldwin of Forbes, shares interesting insights on setting up a Roth IRA for kids in his article "Make Your Kid Rich with a Roth IRA."
This strategy is brilliant if used properly. Baldwin explains that children are allowed to contribute up to $5000 per year in a tax-sheltered retirement account. The catch is that money must be earned via a job. The loophole is the child can receive matching contributions.
The beautiful thing about setting up a Roth IRA for kids is they can't touch the money until they retire. Think about the tax savings on money that's been allowed to accumulate for 50+ years. You can read William Baldwin's Roth IRA article here.
Individuals must meet certain eligibility requirements to open and contribute to a Roth IRA. Individuals must earn income via an employer or as self-employed and earnings must meet modified adjusted gross income requirements.
Roth IRA limits for 2011 are:
• $169,000 for individuals who are married and file a joint tax return
• $107,000 for individuals who file a single, head of household, or married filing separately tax return
• $10,000 for individuals who are married, and file a separate tax return
Roth IRA contributions vary by age. Account holders who are under age 50 are subjected to a regular contribution limit of $5000, while those over 50 can contribute up to $6000. This is referred to as the "catch-up" contribution.
Designating beneficiaries for inherited Roth IRA is quite simple. All that is required is to fill out a beneficiary form provided by the financial institution where the IRA is held. The Roth IRA does not have to be disclosed within the last will and testament and is exempt from the probate process.
It's always best to talk with a financial planner and tax accountant when establishing or receiving an inherited Roth IRA. If you are interested in learning about retirement planning we invite you to peruse our personal finance and investing article library.