Roth Conversions Estate Planning Perspective
By: Martin M. Shenkman, CPA, MBA, JD
Roth IRA Conversions
Money Matters Radio – Estate Planning Checklist
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Introduction/Overview: The hot topic remains Roth conversions. Should you, or shouldn’t you, convert your regular IRA to a Roth? While there has been much analysis, and sophisticated models have been developed to help you make the analysis, what about the estate planning perspectives on the issue?
First, a quickie review. The benefit of converting your IRA to a Roth is that there are no minimum required distributions from a Roth for you as the contributor, no income tax cost on taking money out when you do. All good stuff. But you have to pay the income tax upfront in order to convert. Too many people that shouldn’t convert seem to be doing so. While we cannot provide a full analysis in this short summary a few comments might help:
- If you expect tax rates to rise (everyone at higher income levels does) it’s cheaper to pay tax now at lower rates.
- If you’ll need to pull money out of your Roth soon conversion is unlikely to make sense. If you can defer touching the money, for decades conversion makes more sense. If you will never likely need to touch the money in the post-converted Roth then conversion is looking even sweeter.
- If you have to use money in your IRA to pay the tax on conversion fuggetaboutit! If you have adequate non-retirement assets outside of your IRS to pay the tax incurred on conversion, then conversion might make sense.
- There is no requirement to convert all. Some of the answers above might make conversion make sense for part of our IRA that you can fund tax payments from outside assets and that you will unlikely need to touch. It is not an all or nothing decision.
What unique estate planning issues are involved in this decision process? Consider the following items?
√ Asset Protection:
- Protecting assets from creditors and malpractice claimants is a big part of many estate plans. For some folks it is a more worrisome issue than estate taxes. If your state law protects IRA assets from claimants, verify that it also protects Roth IRA assets as well.
- If you have qualified ERISA plan assets you might be better off keeping them inside that plan than rolling out to an IRA or Roth because the protections may be better.
- If you pay the tax on conversion with non-retirement assets and your converted Roth is protected under state law, you’ve removed at-risk assets (cash) from the reach of claimants while increasing the economic value of assets protected inside the Roth IRA. This is because the Roth IRA is post-tax dollars and the regular IRA is pre-tax dollars. It is not clear what success a claimant may have arguing that your payment of the taxes to the IRS was a fraudulent transfer.
√ Reduce Your Estate: If you convert and pay income tax now the tax you pay is removed from the value of your estate. In some close call cases that might be enough to push your estate below the threshold at which an estate tax return has to be filed. If you have to pay estate tax it should reduce the tax due. That is a neat savings!
√ Great Asset to Bequeath: A Roth IRA is a tax free asset to bequeath to heirs. Your heirs can then stretch out the payments over their lifetime. That’s a double winner. If you are leaving some assets to your grandchildren, what a great, perhaps almost ideal asset to bequeath!
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