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Beyond Investments- ROTH IRA’s

Published by: Amanda Howerton, CFP® Date: June 26, 2020

Nowadays, advice abounds for finding ways to defer taxes utilizing pre-tax 401(k) contributions and deductible IRA contributions, when eligible.

Investors also have options to defer investment-related taxes from income, dividends, and capital gains via these pre-tax 401(k) and IRA accounts. Over the last decade or so, Roth 401(k) and Roth IRA accounts have become more accessible for the investment income deferrals, even if there is no current-year income tax deduction.

These Roth accounts allow for annual investment income to be tax-free as well as allowing for capital gains to be tax-free. The beauty of the Roth accounts is that there is no required distribution at any age. When withdrawals are made, they are completely tax-free. These Roth accounts can also make for a wonderful legacy gift as the funds grow tax-free, and withdrawals for beneficiaries are also tax-free.

However, tax law changes beginning in 2020 add a wrinkle to the Roth investment decision. If the Roth is viewed as a legacy planning tool, the choice is now more complicated than merely considering tax savings.

Beginning in 2020, most beneficiaries (exceptions include spouses, minor, and beneficiaries less than ten years younger than the account holder), are required to withdraw the full balance of the account within ten years of inheritance.

Previously a beneficiary, such as an adult child, could take distributions over their life expectancy, which could mean 30+ years for those inheriting before their mid-50s. Roth account owners could also name Trusts as beneficiaries to protect the beneficiary from creditors, potential ex-spouses, or themselves (especially if the beneficiary is not yet mature in decision making). The ten-year withdrawal requirement changes some of the protections afforded and increases the beneficiaries’ burden to make wise decisions with the inherited funds.

With the new ten year distribution time frame, clients and advisors should discuss tax savings and long-term estate planning at the same time. If lifetime tax savings are the primary goal, then the Roth strategies may be the right route. If there are legacy, long-term estate planning goals (or concerns), foregoing the Roth and implementing tax-efficient investment accounts (that can accommodate better trust planning) may be the better route.

It has been said before, but worth repeating, “don’t let the tax tail wag the dog.” Each person’s plan will be unique to their personal and family goals. We don’t want to look at each planning decision in a vacuum, but instead, we want to discuss the impact and options as a whole. Our goal is to ask, “What would you like to do? And How can we help?” and then walk hand in hand as we create that plan together.