Using Roth IRAs to Avoid Probate

Roth IRAs are tax-friendly ways to save for retirement. They can also provide a great way to leave money -- lots of it, if you're a supersaver -- to your heirs without probate.

Roth IRA Basics

Contributions Not tax-deductible. Current limit (2002-2004) is $3,000/year per person. That's the total you can contribute to all your IRAs, whether traditional or Roth.

Eligibility You can make a full $3,000 contribution if your adjusted gross income is less than $95,000 (or, for a married couple, $150,000). If it's more than that but less than $110,000 ($160,000 for a couple), you can contribute less, depending on the exact amount of your income. If your AGI exceeds $110,000 ($160,000 for a couple), you cannot create or contribute to a Roth IRA. It doesn't matter whether or not you are covered by a retirement plan at work.

Withdrawals You can withdraw your after-tax contributions at any time; they will not be taxed, and you will not owe any penalty. If you withdraw any earnings on those contributions, however, before you reach age 59 1/2 and have had the account at least five years, they are "unqualified distributions" unless you have become disabled or need money to buy your first home. That means you will have to pay income tax on the amount you take out. You may also have to pay an early distribution tax.

Converting an Existing IRA If your adjusted gross income (or, if you are married and file jointly, your household AGI) is less than $100,000, you can convert a traditional IRA (or part of it) into a Roth IRA. You must pay tax on the money that goes into the Roth IRA as if it were ordinary income.

Unlike an IRA, Keogh, 401(k) or 403(b) plan, contributions to a Roth IRA are not tax-deductible. So what makes a Roth IRA so attractive? The big selling point is that when you're ready to withdraw money from the account, qualified distributions -- which may include the income your contributions have earned over the years -- are not taxed. Generally, distributions are qualified if the account has been open for five years and you are at least 59 1/2 years old. Another advantage is that your contributions are never taxed when you withdraw them.

That can make a huge difference if the account value grows significantly and you want to withdraw money while you're still in a higher tax bracket. Think of it this way: It's far better to pay a tax on the $1 you contribute to a Roth IRA now, and no tax on the $10 you withdraw 30 years later, than it is to pay no tax on the $1 you contribute to a conventional retirement plan and a hefty federal income tax (up to 38.6%) on everything you withdraw later. The longer you save, the bigger the likely benefits. Some financial advice-givers opine that a Roth IRA must be open for at least ten years for it to beat out a traditional IRA.

Unlike traditional plans, the Roth IRA also provides a way to pass a large amount of money, without probate, at your death. With a traditional IRA, you must start making withdrawals after you reach age 70 1/2. The amount you must withdraw each year depends on your age and the age of the beneficiary of the account -- that is, the person you've named to inherit it at your death. The idea is that you will use up your retirement account by the time you die.

Please note, a Roth IRA has no mandatory withdrawals. That means you can let the account keep accumulating income, tax-free, until your death, when it will pass to the person you've named. The only constraints on the amount of money you can pile up are the contribution limits (currently, $3,000 per person per year) and your investment choices.

Passing this money to your heirs is easy, and it doesn't cost a dime. All you do is name someone, on the form the account custodian gives you, to inherit whatever is in the account at your death. If you name more than one beneficiary, they'll split the money equally unless you specify otherwise. You don't need to mention the IRA in your will or living trust; the beneficiary form takes care of everything.

After your death, the beneficiary will need only a certified copy of the death certificate to claim the funds, quickly and without probate.