Avoid These Mistakes When Passing Your Roth IRA to Heirs

Avoid These Mistakes When Passing Your Roth IRA to Heirs

Roth IRAs have become increasingly popular over the past several years because they provide tax-free growth and an opportunity to pass along the account to a spouse, children, or other loved one when the initial owner dies. However, the person who established the account must avoid certain mistakes to ensure their heirs don’t get stuck with a huge tax burden.

How a Roth IRA Differs from a Traditional IRA

With a traditional IRA, the investor makes tax-free deposits to the account. It lowers his or her taxable income for the year the contributions occurred but requires tax payments upon withdrawal.

It’s just the opposite for the Roth IRA. Contributions occur on an after-tax basis, meaning the account holder or his or her beneficiaries should pay no taxes on it at withdrawal. This can occur without penalty if the account has existed for five or more years or the investor has reached a minimum age of 59 years and six months. Unfortunately, things won’t go so smoothly if the original account holder makes one of the common mistakes outlined below.

Failing to Name One or More Beneficiaries

If a person who owns a Roth IRA account dies without having named at least one beneficiary, the transfer of funds will go through a will if he or she has one. The situation can become extremely complicated if the deceased didn’t name a beneficiary and has no will.

Anyone who opens a Roth IRA account should name at least one beneficiary right away. The account owner can always change the beneficiary or decide to name one person as primary and the other people as secondary. That means both the original account holder and the person named as the primary beneficiary must be deceased before any secondary beneficiaries can collect.

Choosing the Wrong Person as Beneficiary

Married investors typically list their spouse as the primary beneficiary for their Roth IRA. When that spouse dies, the law allows the money to change hands one more time. It could be more advantageous to transfer the balance of the Roth IRA to a younger relative such as a grandchild. This gives the beneficiary decades to build a tax-free investment rather than the possibility of only a few short years for a spouse. By following an IRS formula, younger beneficiaries can stretch out payments from the Roth IRA over their entire lifetime.

Beneficiaries Can Make Mistakes Too

While the account owner may do things incorrectly, the same can happen with those who inherit the funds. For example, the new account holder might fail to request minimum distributions from the IRA. If this person isn’t a spouse of the deceased, he or she must begin requesting distributions from the account by December 31 the year after the original account holder dies. If he or she fails to do so, IRS law requires the beneficiary to withdraw all funds within five years.

Whether you have invested in a Roth IRA or are the beneficiary of one, we invite you to learn more about the wealth management services available from Aura Wealth Advisors.