Creative Estate Planning With a Roth IRA

Tax Help: Using the Roth IRA for Estate Planning

Parents must give serious thought to protecting their family through creative estate tax planning. While life insurance and trusts should be a part of every plan, Roth IRAs can be an elegant tool you can use to pass some of your wealth to your children on a tax-free basis.

First, let’s take a quick look at the Roth IRA. A Roth IRA is an after-tax retirement device that produces huge tax savings because all tax distributions are tax-free. The initial disadvantage of a Roth IRA is the fact that contributions are not tax deductible as with traditional IRAs or 401(k)s. The advantage of a Roth IRA, however, is that all distributions are tax-free once the person reaches the age of 59½. So how can you work with a Roth IRA to pass assets to your child?

One of the biggest keys to retirement planning is time. The extra years the individual spends saving and compounding earnings for retirement, the bigger the nest egg they should have when the retirement day arrives. Looking back, suppose you had this amount of time to start investing for retirement when you were 16.

The bedrock goal of estate planning is to pass as much of your estate as possible to your family on a tax-free basis. Parents can transfer relatively small amounts of funds to your children now that if handled advantageously can turn in a secure future for tomorrow.

For example, if parents have a 16 year-old child with a Roth IRA, you and the child can contribute $4,000 in 2007 if they earn at least $4000. That $4,000 is going to grow tax-free for 43 years and could be worth over $240,000 with a 10% compounded return. And the withdrawal after age 59 1/2 will be tax free.

There are other applicable advantages to opening a Roth IRA for your child.
As a parent, it is basic that you teach your child the value of assets and the importance of foregoing immediate amusement or “stuff” for future gain. Opening a Roth IRA gives you another opportunity to sit down and teach your child the value of saving and investing. Of course, if you are walking the walk with you own Roth IRA ,401k and other retirement planning your advise should get a good reception.

One parent made the same agreement with each of three children. If they got a part time job they had to put 10% of their gross income in their Roth IRA. The parents would then put in $3 for every $1 the child contributed to their Roth IRA. For example, if the child earned $2500 they put $250 in their IRA and the parents put in $750 for a total of $1000.

Before you rush out to open a Roth IRA for your child, you must determine if your child is eligible to open a Roth IRA. To open a Roth IRA, your son or daughter must be working at least part-time for an employer that reports their wages to the IRS. Hiring your child to cut the lawn each week is not going to cut it, nor will this strategy work for your 5 year-old. Unless of course, they are working as a child model. Quite a few teenagers, however, have summer and part-time jobs that should be satisfactory for IRS rules. To avoid any trouble, you should always consult with your tax advisor.

A further problem concerns the maturity level of your child. Keep in mind that the Roth IRA will be opened in their name. Your son or daughter will have the legal right to do what they will with the outline. It is strongly suggested that parents clearly explain the result of taking funds out of the rundown, but the choice ultimately lies with them. As difficult as it is, try to be objective in evaluating how you child will react to knowing the funds is sitting in an account. If you have concerns you should probably investigate other tax investing strategies.

Opening and continuing a Roth IRA for your children can be a very positive means of transferring funds to them and teaching them important life lessons. If your child exercises restraint, and stick-to-itiveness your relatively small contribution to their Roth IRA, along with their later contributions, can grow into a life changing tax-free sum of money