Your Roth IRA beneficiary decision has to be considered very carefully. That’s because IRA beneficiary rules are very specific to the IRA and also because a Roth is a very different animal than a traditional IRA.
The real power of a Roth IRA comes over time. The longer you keep the Roth (rather than spend it), the more powerful it becomes (as compared to the regular IRA).
Remember, if you select a Roth over a regular IRA, you don’t get an immediate tax deduction. Instead, you get tax-free growth and withdrawals. If you take a “normal” IRA and convert it, you also have to consider the IRA Roth conversion tax. So you need lots of tax-free growth and withdrawals in order to make up for that deduction you forgo.
The people who really super-charge the Roth are those who don’t even need or want to take any withdrawals from their account. These folks pass the Roth on to their heirs and let them continue the tax-free growth and withdrawals for years and years and years. That being the case, the best beneficiary of your Roth is the youngest beneficiary.
Why?
Well…if you have a Roth and your beneficiary inherits the account, they will be forced to make withdrawals (even though they are tax-free) based on their age. The younger the beneficiary, the lower the required withdrawal. The lower the withdrawal, the longer the money lasts. The longer the money lasts, the greater the benefit of tax-free growth. This is a wonderful family continuation plan.
So all things being equal, if you or your spouse don’t need the money in the Roth, name a very young beneficiary – like a grandchild.
If you opened a Roth IRA account, how did you select your beneficiaries?
OK…on to your weekend reading assignments:
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David Haycock says
Thanks for the tip it was very useful.
Belmont Thornton says
Choosing your IRA is not a task of hurry. Thanks for the tip which would be useful to many people. An expert consultation is advised before you take any such steps.
Darren says
Thanks for the tip Neal. Isn’t there also a provision to name your spouse as the beneficiary, have them roll it over to their own IRA, and then avoid RMDs during their life?
Can’t they then name their youngest beneficiary, and thus prolon withdrawals even more?
JoeTaxpayer says
While a Roth has no RMD for the living, beneficiaries must take an RMD each year.
A 10 year old’s divisor is 72.8, or less than 1.4%. It would take 23 years to get to 50, a 2% withdrawal, so the account would still be growing nicely. Not till 25 more years (age 58) would it be over 4% and perhaps start to eat into the principal.
If handled through a trust or a very responsible beneficiary, a $100K Roth can turn into all that kid needs to retire as an adult.
Nunzio Bruno says
Great point! A lot of the DIY’ers out there don’t give the beneficiary designation on something like a Roth the attention it deserves. They just get one because someone told them it’s a good idea. Roth’s can be great tools when thinking about an estate plan as well and spreading wealth between generations. Even if you aren’t close to retirement yet, beneficiaries should be on everything, and something like a Roth absolutely warrants a convo. Nice post!!
Evan says
There are also some cool things you can do with a trust as owner as to prevent that youngest beneficiary from raping and pillaging the corpus when he or she hits 18/21.
I always have to remind people while there is an RMD there is no upper limit to which can be invaded.