Roth IRA Vs. Stretch IRA Conversion

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A Roth IRA is an individual retirement account that allows you to set aside after-tax money for retirement. It grows tax-deferred and you can withdraw the funds tax-free in retirement. A stretch IRA is an estate-planning tool used to extend the financial life of an IRA across multiple generations. In other words, it provides the opportunity to "stretch" an IRA’s tax-deferred growth potential longer than the original owners’ lifetime. The stretch IRA concept can be used with both traditional and Roth IRAs.

Overview of Roth IRAs

Roth IRAs are a great investment option for retirement but you must follow the rules. In 2013, you must earn less than $127,000 to participate in a Roth IRA if you are single and $188,000 if you are married filing jointly. The maximum you can contribute is $5,500 per year, or $6,500 if you are 50 or older. To be eligible for tax-free withdrawals in retirement, you must be at least 59 1/2 and have your IRA account open for at least five years. However, unlike traditional IRAs that require you to start taking required minimum distributions when you turn 70 1/2, there is no such requirement with Roth IRAs, so if you don’t need the money, you can leave it your account and pass the full amount on to your loved ones.

The Stretch IRA Strategy

When you die, a beneficiary -- such as a spouse, child or grandchild -- inherits your IRA and has the option to open a stretch or beneficiary account, which then allows her to take withdrawals over her own life expectancy. The longer the life expectancy, the less she is required to take out each year and the greater the opportunity to stretch out the IRA to give the funds extra years to grow tax-deferred.

Roth IRA vs. Traditional IRA Stretch Conversion

When you convert an IRA to a stretch IRA, the same IRA rules remain in place, depending on whether it was a traditional or Roth IRA to begin with. For example, Roth IRAs are funded with after-tax money and withdrawals are tax-free. If you inherit one, your withdrawals are likewise tax-free. If you inherit a traditional IRA, where withdrawals are taxed, you continue to pay tax on withdrawals. Income tax would have to be paid as money comes out of the IRA.

Stretch IRAs Rules

Stretch IRA rules vary based on the relationship of the heir to the original owner. For example, non-spousal heirs, regardless of their age or the type of IRA, must take required minimum distributions based on their life expectancy. However, spouses who inherit an IRA have the flexibility to roll it into their own IRA. In the case of a traditional IRA, they would have to start taking required minimum distributions when they reach 70 1/2, but if it was a Roth IRA, there would be no such requirement.