by Alvin Wolcott, CPA, MPAcc

Roth IRAs and Roth 401(k)s have become a favorite topic for CPAs over the past several years.  Roth IRAs are great vehicles to accumulate savings that grow tax free and can also be distributed tax free.  Many CPAs, myself included, enjoy calculating the Roth IRA conversions break-even point compared to leaving your investments in traditional retirement plans.  The answer is different for everyone due to the numerous assumptions entering the fold. 

One sure fire way to come out ahead on a Roth IRA is to convert pre-tax retirement dollars into a Roth IRA during low or no income tax years. This allows you to take advantage of your lower tax brackets and possibly avoid wasting itemized deductions.  If you can convert to a Roth IRA with zero or near zero tax rates-- you can’t lose.  For those that qualify, making a regular Roth contribution is another sure fire retirement solution. 

In short, the longer you leave your money invested in a Roth IRA, the more tax free growth you earn.  So start your Roth IRA early, and let your investment’s work for you. A Roth IRA also has estate planning advantages over a traditional IRA. Leaving your Roth IRA to a spouse or child allows the opportunity to stretch distributions over an extended period.

To illustrate how this could work, let’s take a look at an estate with several different heirs and several types of assets:

Situation: A married taxpayer with children plans to divide his estate between his spouse, his children and a favorite charity.  There is a traditional IRA, a Roth IRA and taxable brokerage account.

With the traditional IRA all three proposed beneficiaries are considered tax favorable.  The children because they have a long life expectancy to stretch out distributions, the spouse since she can roll-over the IRA to a spousal IRA, and the charity since it is tax-exempt.  In this case, it’s likely the most beneficial result is to leave the traditional IRA for the charity since it doesn’t just delay income taxes, it is completely exempt from income taxes!

From the Estate tax perspective leaving the traditional IRA to the children poses a problem; income tax must be paid.  In a taxable estate, currently greater than $5 million, there is a double whammy as the asset is immediately reduced first by estate taxes and then by income taxes. 

In the case of the Roth IRA, charity is not an income tax favored choice since the charity is already tax exempt.  Thus the taxpayer should leave the Roth IRA to his spouse or children.

So far we have determined that the charity should inherit the traditional IRA.  This leaves the Roth IRA and the taxable brokerage account to be divided between the spouse and the children.  The question remains, what is the best income tax scenario for the Roth IRA?  If the Roth IRA is left to the children, they can stretch the payments out tax-free over their lifetime, a great result.

On the other hand, if the Roth IRA is left to the surviving spouse, the result is even better.  Since the surviving spouse actually rolls the Roth IRA into her own Roth IRA, she does not need to make any required minimum distributions during her lifetime.  She can then leave the Roth IRA to her children at her death where it will be treated as an inherited Roth IRA and distributions to the children can be stretched over their lifetime.

In summary, the surviving spouse inherits the Roth IRA via a tax free rollover, the charity inherits the traditional IRA income and estate tax free and the children inherit the taxable brokerage account income tax free as a result of the step-up in basis upon death.

If you would like to explore how to get the most from your investment accounts please call to schedule an appointment with Scott or Alvin.  We would be happy to review your current investments and investment vehicles to see if a Roth IRA will improve your overall lifetime tax results.