Don't Trust Your Roth To The Kids
Now that the barrier to Roth IRA conversions has finally fallen, you may opt to shift assets from your traditional IRA. But whom will you designate as beneficiaries of the new Roth account? Rather than having it go directly to children or grandchildren, you could name a trust as beneficiary. That option will prevent younger heirs from squandering the funds, and it could stretch the life of the Roth IRA by many decades.
A main attraction of a Roth is that qualified distributions are completely exempt from federal income tax. Furthermore, unlike a traditional IRA, a Roth doesn’t require you to begin taking annual minimum distributions after age 70½. If you don’t need the cash, you don’t have to touch the account.
Before 2010, you couldn’t convert a traditional IRA to a Roth during a year in which your modified adjusted gross income (MAGI) exceeded $100,000. But that MAGI ceiling is now gone for good, although you still have to pay tax in full on a conversion at ordinary income rates. (A one-time tax deferral option was available for conversions in 2010.)
Choosing whether to convert your traditional IRA involves weighing several factors, including your age, your expected tax rate in retirement, and whether you have non-IRA funds to pay conversion taxes. But if converting your account seems wise, you still have to decide whom to name as beneficiaries, and if your children are well established financially, you might decide to leave the account to your grandchildren instead. That could extend the life of the Roth and its tax-free distributions. But it also risks putting large sums in the hands of those who may be too young to handle them responsibly. This is a concern when naming beneficiaries for any asset, not just Roth IRAs.
Designating a trust as the beneficiary could provide extra protection. The money can still ultimately go to your grandkids, but the trust could delay distributions until they reach the age of majority or even longer. In the meantime, a professional trustee could manage the Roth assets, potentially adding to their value during the years until the grandchildren come of age.
Though you don’t have to take distributions from a Roth IRA, your heirs will have to make withdrawals, and that’s true even if the assets go into a trust. The minimum annual payout will be based on the life expectancy of the oldest heir at the time of your death. So, for example, if your oldest grandchild is age 12, the remaining life expectancy will be about 70 years. But if you’re leaving the account, through a trust, to beneficiaries whose ages vary widely, you may want to consider dividing it into two or more trusts, to extend the life of the Roth—and its potential growth—as long as possible for the youngest heirs. We can work with you, your attorney, and your tax advisor to see whether a trust makes sense in your situation.
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