How and Why You Should Name Beneficiaries for Your Roth IRA
- Naming a beneficiary for your Roth IRA is critical to make sure the money you saved goes to the family members you intended with the most tax benefits possible.
- You can leave a Roth IRA to a beneficiary tax-free, as long as you have owned the account for more than five years.
- Your beneficiaries can stretch out the distributions from a Roth IRA over their lifetime, which is a significant tax benefit.
When you open a Roth IRA with a brokerage like Fidelity or E*TRADE, you fill out a form that names your beneficiaries. These are the people who inherit your IRA after you die. This form is more important than many people realize. Some people leave it blank or leave their Roth IRAs to their estates, which can create complications and cost tax savings.
Roth IRAs are particularly valuable as an estate planning tool. Traditional IRAs require owners to begin taking required minimum distributions (RMDs) at age 70½. As you draw down that Traditional IRA, you are required to pay taxes on the money you take out. With a Roth IRA, there are no required distributions and all the distributions you do take are tax-free. That means you can leave your money in a Roth IRA and allow it to grow and be passed along to your heirs.
Naming beneficiaries gives those people the most tax advantages possible. In this article, we’ll explain why and outline the best practices.
- Why Should You Name Beneficiaries?
- How Do You Name a Beneficiary?
- What Are the Tax Implications of Leaving a Roth IRA?
- How Many Beneficiaries Should You Have?
- Whom Should You Name as a Beneficiary?
- How Often Should You Update Your List of Beneficiaries?
If you don’t name one or more beneficiaries, your Roth IRA will likely either go to your estate or your spouse, depending on the rules at your brokerage. If the money goes to your estate, it will be divided according to the laws in your state. If the money flows through your estate, your spouse or your children may end up with the money. But when you leave it to them that way, your inheritors won’t have access to the same tax benefits they would if you had named them as beneficiaries.
The process varies by brokerage, but is usually pretty simple. You can frequently specify multiple beneficiaries and then set percentages or even fixed amounts. In addition, many custodians will allow you to specify generic categories, such as “To the person I am married to at the time of my death,” versus stating a specific person who might be your wife at the time. Either way, you can usually be as specific as you need to be.
Here is a sample of one designation page:
If you leave your Roth IRA to your spouse, he or she will receive it and can basically treat it as his or her own. Your spouse won’t be required to take distributions or have to pay taxes.
If you name one or more people other than your spouse as a beneficiary, they will need to withdraw a minimum amount each year. You will find worksheets for IRA distributions here. There are several methods for calculating how much they withdraw. The benefit of the Roth IRA, compared with the Traditional IRA, is that your beneficiaries do not pay income tax on the distributions as long as you held the account for more than five years.
Your beneficiaries can also control the amount of distributions and the time over which they take them, depending on how they do the calculations. Stretching out the IRA gives the funds decades of tax-free growth in a Roth IRA.
There is no limit on the number of beneficiaries you can have. How many you should have is a matter of choice.
Most people name their spouses first. Children are frequently named next. If you are not married, you can name any person. Note that because of the rules that enable people to stretch out distributions of an inherited Roth IRA, the people who benefit most are young.
Experts advise checking your beneficiaries at least once a year, perhaps at the same time you rebalance your investments. It’s easy to accidentally leave family members out if you set one up when you first had children, for instance, or if you have recently remarried and have a new spouse. You also may need to update the form if a parent or elderly relative you named as a beneficiary has passed away.
You can mark the date you reviewed your form on your calendar and program in a recurring reminder to update it once a year.