Estate Planning Opportunities With a Self-Directed Roth IRA LLC

Roth IRAs, while primarily used for the purposes of retirement, can also be useful for estate planning. The main difference between a Roth IRA and a traditional IRA is that distributions from a Roth account are not taxed. Contributions to the Roth are taxed.

Furthermore, traditional IRAs may be converted to Self-Directed Roth IRA accounts. The question then becomes: How can you use this to your advantage in terms of estate planning?

Understanding the Estate Tax

There’s no way around the fact that an IRA, regardless of the kind, is included as a part of the owner’s estate. When the IRA is inherited, the beneficiary is required to include each distribution as part of their yearly income tax. The distributions can be stretched out for the individual’s entire life expectancy, but yearly distributions are mandatory.

Estate Planning Benefits of Converting to Roth IRA

If you decide to convert a traditional IRA to a Roth IRA, you will have to pay taxes on the amount going into the account, since Roth accounts tax contributions and not distributions. You also don’t have to convert the entire account over to the Roth, but whatever you convert will be taxed, so bear that in mind.

Nonetheless, there are significant benefits to converting to a Roth in terms of estate planning. Some of the major ones are:

Distributions Are No Longer Taxable

You’re going to be basically paying off the taxes on behalf of those who will inherit the account when you convert it to a Roth. In fact, you can leave this as a notice upon your passing to pay off the taxes for the conversion and that would reduce the amount of taxes you would pay on your estate. Each time your beneficiaries take a distribution, the money would not be taxed.

You Are Not Required to Take Roth Distributions During Your Lifetime

With a traditional IRA, you must begin receiving distributions once you hit 70 ½ years of age. Not so with a Roth IRA.

Growth Is Not Taxable

Traditional IRAs have tax-deferred status. Roth IRAs are essentially tax-free. The longer the IRA has had time to mature, the better the potential payoff. The growth of the IRA is tax-free and so are the distributions, giving you and your heirs non-taxable income for the remainder of your lives.

It’s a Great Time to Convert

The new Tax Cuts and Jobs Act has made converting from a traditional to Self-Directed Roth IRA historically cheaper than it’s ever been before. It’s a great time to take advantage of low tax rates in order to save money on the cost of converting.

Executing a Stretch

To execute a stretch, simply pass the IRA to the youngest person in your family. A good example is a grandchild. Since the value of the distribution is prorated over the course of the child’s life, it stands a good chance of being less than account’s annual earnings. Another option would be leaving the Roth IRA to a spouse who would not be required to take any distribution at all. When the spouse passes, the Roth can then be handed over to the youngest child in the family.

Last Updated: 
April 24, 2018

Scott Royal Smith is an asset protection attorney and long-time real estate investor. He's on a mission to help fellow investors free their time, protect their assets, and create lasting wealth.

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