Roth IRA for Estate Planning: A Tax-Efficient Legacy Strategy

Many people know that Roth IRAs have specific benefits for retirees who own them – namely, that the money in Roth IRAs isn’t taxable if you meet the requirements. That can make a Roth IRA a great addition to a tax-diverse portfolio.

But did you know Roth IRAs also have tax benefits for those who inherit them? The tax-free treatment continues for the beneficiary as long as they don’t take distributions from the Roth IRA until at least five years from when it was opened. Clearly, passing down wealth without a tax bill attached to it can be a great gift for your heirs. Let’s see how it works and how you can still get the benefits of a Roth even if you don’t have one yet or don’t currently qualify to contribute to one.

WHY CONSIDER ROTH IRAS FOR ESTATE PLANNING?

If you’re not familiar, here are some Roth IRA basics:

• You don’t get a tax deduction when you contribute to a Roth IRA, but it will grow tax-free and withdrawals are tax-free in retirement if you meet the requirements. That means the growth in your account can escape taxation completely.
• Not everyone is allowed to make Roth contributions – there are income limits. But there’s a way around this, which we’ll explain.
• There are no Required Minimum Distributions in retirement – the money is tax-free anyway, so the IRS doesn’t care if you leave it all in there.

This makes Roth IRAs a great type of account to pass wealth to your heirs. You can place money in the Roth, let it grow tax-free for the rest of your life and then leave the entire tax-free amount to your beneficiaries. It can be especially valuable to heirs who are in a high tax bracket or state.

ARE ROTH IRAS SUBJECT TO ESTATE TAX?

It’s important to note that the entire value of your estate may be subject to federal estate tax upon your death, no matter what type of accounts or assets you own. This applies to very high-value estates (more than about $14 million in 2025) and the tax would be paid by the estate before being passed down to the heirs – although it would reduce the amount the heirs receive.

So, you can’t reduce or escape estate tax simply by placing money in a Roth, only income tax. There are other strategies you may be able to use to reduce your estate tax bill – talk to a financial advisor, who can help you with the estate planning process, and an estate attorney to get help with estate planning guidance.

ROTH IRA VS. TRADITIONAL IRA FOR ESTATE PLANNING

Let’s look at the difference for your heirs if they inherit a traditional IRA vs. a Roth IRA.

The rules about who has to take RMDs on an inherited IRA and when are complicated.

In this example, the original owner was not taking RMDs and left the IRA to their adult child. The beneficiary is 60 years old, inherited $1 million and is in the 32% marginal tax bracket. We’re assuming the account accumulates $500,000 in earnings by the tenth year after death and the beneficiary empties the account over the 10 years, which is a common scenario when leaving money to adult children.

Distributions from IRAs

No distributions are required until the tenth year, from either the Traditional IRA or Roth IRA. But, of course, they may be taken strategically as needed.

Source: IRS

As you can see, in this example, the traditional IRA beneficiary would owe $480k in taxes taking distributions over 10 years. In contrast, the Roth beneficiary won’t owe any federal income tax, regardless of how much they withdraw.

Key question – Could the original owner have converted their Traditional IRA to a Roth IRA at a tax bracket lower than 32%? If they had, the taxes paid at a lower rate by the original owner would be a nice, tax-free gift to the beneficiary.

Over the next ten years, you can see how the traditional IRA beneficiary could pay $480K in taxes. And at the end of 10 years, they must withdraw the remaining amount and pay tax. If the beneficiary defers distributions as long as possible, this large withdrawal could place them into the highest 37% marginal tax bracket and cost even more in taxes.

The Roth beneficiary also must withdraw the entire potential $1 million+ balance by the end of tenth year. But not a dollar will be taxed.

As we said, the rules for RMDs for spouse and nonspouse beneficiaries are complicated, and this is just one example.

HOW YOU CAN USE ROTH IRAS IN YOUR ESTATE PLANNING STRATEGY

If you’re thinking way ahead to the future and you’re eligible to contribute to a Roth, great. Once you’ve decided a Roth makes sense for you, you can start contributing.

But what if you’re already in retirement and don’t have a Roth? Or if you make too much money to contribute to a Roth? You have additional options for getting money into a Roth.

BACKDOOR ROTH STRATEGY

If you’re still in your working years but can’t contribute to a Roth because of the income limits, you can make nondeductible contributions to a traditional IRA. You can then immediately convert that money to a Roth with no limitation. This is known as a backdoor Roth.

ROTH CONVERSIONS

If you’re already retired or have a large amount of money in your traditional IRA that you’ve decided to pass down, you can convert that money to a Roth IRA as well. Any tax-deductible contributions you made to the IRA will be counted and taxed as regular income upon the conversion.

A large conversion can easily push you into a higher tax bracket and have other repercussions, so let’s take a closer look.

WHEN AND HOW TO DO A ROTH CONVERSION FOR ESTATE PLANNING

Because pretax money being converted to a Roth will be taxed, it’s smart to do it when your other income is low and you’re not already in a higher tax bracket. For people who are considering a conversion as part of an estate planning strategy, this often means early retirement.

In early retirement, you obviously won’t be working. Beyond that, you may not have begun taking Social Security yet. And you may not be at an age required to take RMDs from your accounts, either. If you live frugally, these may be the lowest-income years of your adult life and the best point to do a conversion.

COMMON MISTAKES TO AVOID

A SINGLE CONVERSION

Still, a big conversion is one of the things to watch out for. It can push you into a higher tax bracket and trigger a very large tax bill. So many times, it’s smart to break it into smaller conversions over the course of several years.

TRIGGERING MEDICARE SURCHARGES

If you’re at least age 65, any increase in your income – including a Roth conversion – should grab your attention. That’s because if you make a certain amount of money, your Medicare premiums will cost more.

Even being $1 over the threshold is enough to trigger Medicare’s Income-Related Monthly Adjustment Amount, or IRMAA. It’s an important reason to be strategic when deciding how much to convert each year.

NOT ALIGNING YOUR ROTH STRATEGY WITH YOUR OVERALL PLAN

A Roth conversion could benefit you, but they do have downsides. It’s important to consider your full financial picture when deciding if – and how and when – it makes sense for you. A financial advisor can help you make that determination and develop a tax-efficient planning strategy that could include Roth conversions.

WORK WITH A FINANCIAL ADVISOR TO PERSONALIZE YOUR ROTH STRATEGY

Estate planning is complex and involves decisions about gifting, charitable giving, trusts, estate planning roles and more. Whether to include Roth IRAs in your estate plan – and how to get one if you don’t have one – is just one of many pieces that need to fit together to form the complete picture.

You should consult a tax and estate planner as you decide whether to use a Roth IRA in your estate plan. A financial advisor can also guide you on how it fits into your overall plan.