By: Colleen Weber
Investment / News and Updates
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By Colleen Weber, CFP®, CPA
For high-net-worth families, transferring wealth to the next generation in a tax-efficient way can present new challenges to your financial plan. The complexities of income tax, capital gains tax, estate tax, and generation-skipping transfer tax can make it feel daunting to leave a meaningful legacy for your loved ones without burdening them with high tax obligations.
The good news is there are strategies available to simplify your estate plan and bestow upon your children and grandchildren a gift that enjoys tax-free growth indefinitely. Keep reading to explore how Roth IRAs can be a key component to help you leave a lasting and tax-efficient legacy for the next generation.
Tax Benefits of Roth IRAs
A Roth is an incredible tool to help you limit and manage your tax liability in retirement and beyond. You contribute after-tax funds to the account and then your contributions grow tax-free. As long as you meet certain requirements, all withdrawals will be tax-free in retirement.
The best part about Roth IRAs from an estate-planning perspective is that they do not have an RMD requirement. With most tax-deferred retirement accounts, the owner must begin taking required minimum distributions (RMDs) when they reach age 73, regardless of whether they need the money to live. But this is not the case with Roths.
How Does a Roth IRA Help You Leave a Lasting Legacy?
Essentially, not taking RMDs means you can leave the money in your Roth to grow for your lifetime, even making additional contributions after you retire if you continue to earn an income. You can then use this nest egg as an estate planning tool to provide a tax-efficient inheritance for future generations. If you’re looking for a way to set aside a meaningful legacy for your kids and grandkids, a Roth IRA is a great way to do it.
The funds in the account will pass income-tax-free and as long as you have your beneficiary designations in order, the account will pass outside of probate, which can save significant time and money for your heirs.
Depending on the type of beneficiary you name (spouse or non-spouse), there will be different rules regarding the timing of distributions from the inherited account. In most cases, your beneficiary will have up to 10 years to withdraw funds, giving them that much more time to let the account grow tax-free.
What if I’m Not Eligible?
There’s no doubt that Roth IRAs boast many pros, but one major limitation is that most high-income earners don’t qualify. As of 2023, you’re ineligible to contribute to a Roth IRA if you make more than $153,000 as an individual or $228,000 as a married couple. Thankfully, you aren’t out of luck. Here’s how you can still reap the rewards of a Roth IRA and leave a lasting legacy for your heirs.
A Roth IRA conversion is when you move funds from a pre-tax retirement account (401(k), 403(b), traditional IRA, etc.) into a Roth IRA. Because the contributions made to your original account are pre-tax, you will be required to pay taxes on everything coming out of the account before it’s deposited into the new Roth IRA.
With the taxes paid, the conversion can occur. Your funds can now grow tax-free regardless of how high you climb up the tax bracket ladder. The primary goal of a Roth IRA conversion is to lower your tax bill in the future.
Roth conversions can be performed a little bit at a time. That way, you can convert just enough of your account to bring your taxable income for the year to the top of your tax bracket without pushing it into a higher one. A Roth conversion strategy can be used over a span of years to move money from pre-tax retirement accounts to a Roth IRA while limiting your tax liability. In many cases, it is important to have outside funds available to pay income tax on a Roth conversion.
A backdoor Roth IRA is an IRS-sanctioned loophole that lets high-income earners reap the benefits of a Roth without violating the income limits.
Let’s say your income exceeds the legal limit for a Roth IRA, but you still want to fund an account. First, you will need to open a traditional IRA and fund it with non-deductible contributions. Then you will immediately convert your non-deductible IRA to a Roth IRA and repeat this process each year in order to take advantage of tax-free growth.
In this scenario, you can avoid the IRA income limits, but you cannot avoid the annual contribution limits. For 2023, you can fund a maximum of $6,500 (or $7,500 if over the age of 50). This may seem small, but over time you can amass a sizable nest egg that can be passed tax-free to your loved ones.
As with anything tax-related, consult a wealth advisor to position your money in a way that minimizes tax liability and maximizes growth.
Leave a Lasting Legacy
If after reading this, you still have questions about integrating a Roth IRA into your estate plan or simply wish to review your overall financial situation, we’re eager to assist you! At Colleen Weber CPA, CFP, our mission is to provide you with the guidance and support you need (and deserve) to retire with confidence and create a lasting legacy you can take pride in. If you’re looking for a financial planner who genuinely understands your unique situation and empowers you to make confident financial choices, don’t hesitate to get in touch with me and book a free introductory meeting online or call (952) 470-0750.
Colleen Weber is a fee-only financial advisor, CERTIFIED FINANCIAL PLANNER™ professional, and CPA with more than 15 years of financial planning experience. Providing comprehensive financial planning and wealth management, she specializes in serving clients nearing retirement, retirees, busy professionals, and women. She is passionate about developing financial plans that save clients on taxes and investment strategies that help them pursue their goals. Learn more about Colleen by connecting with her on LinkedIn or booking a complimentary phone call meeting.