Estate planning and Roth conversions.

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The long-term growth potential of Roth IRAs is greatly underestimated and has significant estate planning implications:  Because there are no minimum required withdrawals from a Roth IRA during the original owner’s lifetime, the long-term impact of compound growth can be striking.  For example, a $500,000 balance in a Roth IRA at age 45 can, at a fairly modest annual growth rate of 6% and no withdrawals, grow to a total of $3.8M by age 85 – all of which is tax-free.  If then left to a 45-year old heir, that heir would only be required to take annual, tax-free withdrawals beginning at an annual rate of about 2.5%, far lower than the presumed market return of 6%.  With minimum mandatory withdrawals, the inherited Roth account would still be growing until about the time the heir turns 70 -about twenty five years after the Roth was inherited.  Under such a scenario, the Roth could produce in excess of $10M in tax-free income during the heir’s lifetime. 

While foregoing annual withdrawals may entail economic sacrifice on the part of the original account owner, the amount of money ultimately generated for one’s heirs by use of a Roth IRA can, under the right circumstances, constitute a major estate planning opportunity.  But because annual Roth IRA contributions are limited to $5000, ($6000 if age 50 or older) and because Roth 401(k) accounts hold only employee contributions, and not contributions from the employer. it can be challenging to build up a sizeable Roth account with either a Roth IRA or a Roth 401(k).  This is especially true since Roth IRAs only became available in 1998.  Thus, the major opportunity to build up a Roth account is often via a Roth conversion.