Roth Rules for Retirees: What About Your Heirs?


For most people, investing in a traditional or Roth IRA has one goal above all others: funding retirement.

But when it comes to choosing whether to convert a traditional IRA into a Roth, it can pay to seriously consider another factor: the best option for your heirs if you die before spending all the assets.

Generally, Roth IRAs treat heirs better by offering more years of tax-free compounding. That can tip the balance in favor of conversion.

People who inherit traditional IRAs must begin withdrawals at some point, paying federal income tax on all investment earnings and deductible contributions. A wife who inherits her husband’s IRA, for example, must begin withdrawals in the year after turning 70 ½, just as she would from her own IRA. Children or other non-spouse beneficiaries generally have to start withdrawals the year after the original owner dies.

In most cases, the beneficiary must take required minimum distributions over his or her expected lifetime, according to government tables. A beneficiary with a life expectancy of 25 years would have to withdraw 1/25th of the account, or 4%, that year, for example. Use the Required Minimum Distribution Calculator to see how this works.

Rules for Roths are quite different. As with all Roth’s, withdrawals are tax-free, regardless of the beneficiary’s relationship to the original owner. In addition, a person who inherits a Roth from a spouse can treat it as if it were his or her own. That means there is no point at which withdrawals are required, potentially adding decades of tax-free compounding.

Non-spouse beneficiaries are required to start withdrawals at some point, though they remain tax-free. The beneficiary can elect to withdraw nothing for five years after the original owner’s death, but then must withdraw everything. Or the beneficiary can make annual withdrawals based on his or her life expectancy.

The tax-free status of withdrawals generally makes Roths more generous to heirs than traditional IRAs. The case is even stronger if the heirs are in a high tax bracket, since tax bills could chew up much of what they inherit from a traditional IRA. Use the Roth IRA Conversion Calculator for insight.

Like most things involving taxes, rules are tricky and there are all sorts of exceptions. IRS Publication 590 has all the details, but the brokerage firm Charles Schwab (Stock Quote: SCHW) boils them down in a much more readable publication.

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