Your primary goal in saving for retirement may be to ensure that you have enough money to cover your expenses during your senior years. But you may also have a secondary goal — to amass enough of a fortune to leave some of that wealth behind to your heirs, whether it’s your grown kids or your grandchildren.
The problem, though, is that most tax-advantaged retirement savings plans make it difficult to leave money behind to your loved ones. That’s because most of these plans impose what are known as required minimum distributions, or RMDs.
RMDs begin at age 72, and the amount you’re forced to remove from your savings each year hinges on your account balance and your life expectancy at the time. Failing to take an RMD results in a huge penalty — losing 50% of the sum you fail to remove.
Not only can RMDs increase your tax burden during retirement (if you’re forced to take withdrawals from a traditional 401(k) or IRA, that money becomes taxable income), but they also effectively force you to spend down your savings in your lifetime rather than leaving it in an account that enjoys beneficial tax treatment. And so if you want to avoid RMDs and get the option to pass wealth down to your heirs, it pays to house your savings in a Roth IRA.
The upside of Roth IRAs
Some people may prefer not to save for retirement in a Roth IRA because there’s no up-front tax break on contributions. By contrast, if you put money into a traditional IRA or 401(k), you won’t pay taxes on the money that goes in.
But Roth IRAs offer numerous benefits. Not only do they allow for tax-free investment gains and tax-free withdrawals in retirement, but they’re also the only tax-advantaged long-term savings plan to not impose RMDs. Even Roth 401(k)s, which also offer tax-free gains and withdrawals, come with RMDs.
Now one tricky thing about Roth IRAs is that higher earners are barred from funding one directly. But if your income is over the yearly limit for contributing to a Roth IRA, you have the option to put money into a traditional IRA and convert it to a Roth afterward.
You’ll pay taxes on that conversion the year you make it, but then you’ll enjoy the tax benefits Roth IRAs offer down the line. And just as importantly, you’ll gain the right to leave your money in your savings plan for as long as you want to.
More options for your hard-earned savings
Some retirees can’t afford to leave their retirement savings untapped because they need that money to cover their expenses. But it may be the case that you end up saving so much for your senior years that you don’t need it all. Or, your investments in your savings plan may perform better than expected, leaving you with more money than what you need.
If you want the option to be as generous as you’d like to be with your loved ones, then a Roth IRA may be the optimal savings plan for you. That way, you get to decide what happens to the money you’ve worked hard to accumulate, not the IRS.