Why is a Roth IRA better than a traditional one for beneficiaries?

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Why is a Roth IRA better than a traditional one for beneficiaries?

Concept of Traditional IRA and Roth IRA depicted on paper list in notebook on a wooden table with blank columns for pros and cons.

In a recent episode of her “Women & Money” podcast, personal finance expert Suze Orman provided key insights into the benefits of inheriting a Roth IRA compared to a traditional IRA, emphasizing how the former can simplify the lives of beneficiaries. 

One listener had a question about the best strategy for an inherited Roth IRA, asking for clarification on whether it was best to wait until the 10th year to withdraw funds to allow the money to grow tax-free for that entire period. 

Orman confirmed this, stating, “Absolutely correct. So all you need to remember is that Roth IRAs never have RMDs – required minimum distributions – which is why I love them so much … It would make your beneficiary’s life far easier if they inherited a Roth versus a traditional.”

While Orman’s advice seems relatively straightforward, Benzinga reports that inherited IRAs have many complexities. Beneficiaries can inherit various types of IRAs–Roth, SEP, SIMPLE and traditional. The treatment of taxes for the IRA will stay the same as the original account. Traditional IRAs, funded with pretax dollars, require beneficiaries to pay taxes on withdrawals. Roth IRAs, funded with after-tax dollars, allow for tax-free withdrawals, simplifying tax planning for beneficiaries.

Among the complexities of inherited IRAs, Bankrate shares additional insights into the benefits of Roth IRAs. One advantage is that a Roth IRA reduces some tax concerns in estate planning. Roth IRAs allow you to pass assets to beneficiaries tax-free, meaning they won’t be taxed on the principal amount they inherit. However, Roth IRAs don’t eliminate all tax issues. 

For instance, if a spouse inherits a Roth IRA and wants to treat it as their account, any earnings they withdraw will be taxable until they reach age 59½ and meet the five-year holding period. Likewise, if the inheritor takes a lump-sum distribution from the account, it will be tax-free if they have met that holding period. Otherwise, the earnings withdrawn are taxable. 

Roth IRAs can simplify financial planning for your heirs and help you determine the best ways to manage the inheritance. Considering the benefits of inherited Roth IRAs, it could be worth evaluating your own accounts and how they’ll impact your beneficiaries. A Roth IRA, though not the only choice, could help provide a smoother financial transition for loved ones. 

Navigating the intricacies of retirement accounts isn’t easy. Make the best decisions for yourself and your family by enlisting a seasoned professional to guide you through this process, keeping your unique situation in mind. Consider consulting a financial advisor to better understand the best strategies for passing retirement accounts to your loved ones.