There are significant tax benefits in using a Self-Directed Roth IRA LLC to make investments. However, the Roth IRA also offers several very exciting estate planning opportunities.
Generally, a Self-directed Roth IRA is an after-tax account. So, the Roth IRA holder can benefit from tax-free investment growth, so long as a Roth IRA distribution isn’t taken before a five-year holding period. Furthermore, the Roth IRA holder cannot be under the age of 59½. In addition, a Roth IRA holder is not subject to the required minimum distribution rules (“RMD”).
At IRA Financial, we provide a customized Self-Directed Roth IRA LLC Estate Planning Solution. This means your family may receive tax-free use of your Roth IRA funds. If you convert a pre-tax IRA to a Roth IRA, you can use it as a valuable estate-planning tool for estate owners who may be subject to estate taxes. The basic exclusion amount for determining the amount of the unified credit against estate tax under IRC Section 2010 will be $13,610,000 for decedents who died in 2024, a $690,000 increase from 2023. That means that if your estate is under $13,610,000 if you pass in 2024, there will be no federal estate tax on your estate.
Estate Tax Basics
In general, an IRA (traditional or Roth), includes the owner’s gross estate. You can’t avoid that. But if you inherit a traditional IRA, the beneficiary must include all distributions in gross income just as the original owner would have. This means distributions will have a tax at the beneficiary’s ordinary income tax rate.
The beneficiary is able to stretch out the distributions over his or her life expectancy. Nevertheless, annual distributions are a requirement that’s taxable. But when a Traditional IRA goes to a spouse or child, the beneficiary must pay ordinary income tax on the IRA distribution amount. This will reduce the amount of Traditional IRA funds available to spend.
Converting a Traditional IRA to a Roth IRA – Estate Planning Benefits
When you convert a Traditional IRA to a Roth IRA, it’s as though a distribution is taken. So, you would be subject to ordinary income taxes on the converted amount.
Note: there is no restriction on the amount of IRA funds that you can convert at one time.
The first estate tax benefit of a Roth IRA conversion is that the Roth IRA holder’s estate is reduced by the income taxes paid on the amount of the Roth IRA conversion. There are several estate planning benefits to paying tax on the Roth conversion.
Turning Taxable Distributions into Tax-Free Distributions
When you do a Roth IRA conversion, you essentially pay taxes on the IRA funds for your heirs. They’ll owe the taxes in the future when they take a distribution from the inherited IRA. Instead, the Roth IRA holder is paying the tax now, out of his/her taxable estate. So this avoids estate and gift taxes on that amount. Therefore, when your beneficiary takes a distribution from the inherited Roth IRA, those Roth IRA distributions are tax-free
Pay Tax & Reduce Estate Taxes
Paying the taxes now reduces the size of your estate and any estate tax bill. This isn’t a factor for estates below the taxable level, but it can be important for taxable estates.
Lifetime of Tax Benefits
A Roth IRA conversion can provide lifetime income tax benefits to the Roth IRA holder. It can also benefit your beneficiaries. When you maintain a traditional IRA, after age 70 ½, you must take minimum annual distributions. This is subject to income tax.
But if it turns out that you don’t need this money for spending or living purposes, it simply increases the taxes you must pay. In addition, being required to take a Traditional IRA distribution may increase your income enough to push you into a higher tax bracket. It may also reduce itemized deductions, increase taxes on Social Security benefits, and have other effects.
The older you become, the higher the distributions and taxes become. With a Roth IRA, you or your beneficiaries could benefit from tax-free appreciation of the Roth IRA assets as well as generating tax-free income to live off of.
Tax-Free Growth & Tax-Free Income
Once the Traditional IRA converts to a Roth IRA, the Roth IRA holder and his or her beneficiaries are able to benefit from tax-free growth and income generated by the Roth IRA. In other words, the assets of the Roth IRA will be able to grow tax-free.
All “qualified distributions” from the Roth IRA will be tax-free. This allows the Roth IRA holder or his or her beneficiaries to live off the Roth IRA funds without ever paying tax on the income.
Take Advantage of Historical Low Tax Rates
Even though a lot has been made with the increasing Obamacare tax rates, our current income tax rates are still at historical lows. Therefore, it is conceivable that income tax rates will rise in the future. This is more of a reality due to the high levels of debt that the Government uses to stimulate the economy.
A Roth IRA conversion now versus later is potentially a tax savvy decision. Of course, that is if the Roth IRA grows at a respectful rate and tax rates increase. Having a Roth IRA to use or offer to your beneficiaries in a high tax environment will prove to be extremely beneficial.
The Self-Directed Roth Stretch IRA
Unlike the original Roth IRA owner, a non-spousal beneficiary of a Roth IRA must take minimum distributions over his or her life expectancy.
Note: a spousal beneficiary of a Roth IRA is not required to take a Roth IRA distribution.
In the case of a non-spousal Roth IRA beneficiary, when the beneficiary is relatively young, there is the potential for the distributions to be less than the annual earnings of the Roth IRA. Therefore, the Roth IRA grows while the distributions are being taken. Of course, the beneficiary can take more than the minimum. They can even tale the entire Roth IRA, at any time, tax-free.
In other words, using a Self-Directed Roth Stretch IRA will allow an individual to transfer tax-free assets to children or other beneficiaries. This allows those individuals to benefit from tax-free income while the Roth IRA contributes to grow tax-free.
Conclusion
The Self-Directed Roth IRA is the best legal tax shelter that can benefit the Roth IRA owner during their lifetime as well as their heirs upon death. The Self-Directed Roth IRA will allow one to invest in alternative assets and generate tax-free income and gains so long as the Roth IRA owner is over the age of 591/2 and the Roth has been opened at least 5 years. In addition, so long as one’s estate is less than $13,610,000 in 2024, they would not be subject to any federal estate tax, which would allow them to pass the Roth IRA tax-free to a surviving spouse. The surviving spouse would then be able to move the Roth IRA in his or her name and take tax-free Roth IRA distributions so long as they were over the age of 591/2 and the Roth has been opened at least 5 years. Moreover, if the Self-Directed Roth IRA is then left to a non-spouse beneficiary, such as a child, the non-spouse beneficiary would have ten years to pull the funds out of the Self-Directed Roth IRA tax-free.
