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  • Barry Boscoe

Roth IRA Conversion

2010 brings a very unique advantage regarding estate planning opportunities never presented before. This opportunity deals with a traditional IRA and the ability to convert some or all of the IRA to a Roth IRA. The law in 2010 provides for a conversion regardless of your earned income and allows for the spreading of the payment of tax liability. The advantage is that the IRA can be converted and left to your heirs while also providing your heirs with tax-free income for decades to come. Currently, you can make contributions to a traditional IRA with “before tax” dollars. Your investment is allowed to grow “tax-deferred” since amounts earned, including the contributions and appreciation, are not taxed until distributions are made. Once you attain 70 ½, you must begin to take the “required minimum distribution,” or RMD. The RMD must be taken no later than April 1 of the year after the calendar year in which you reached age 70 ½. The period of distribution cannot exceed the joint life expectancy of you and your beneficiary. Forced distributions result in income taxes to you each year once you have attained 70 ½, which continuously diminishes the tax-deferred amount remaining in the account. In contrast, Roth IRA contributions are made with “after tax” dollars. The result is that all the appreciation within the Roth IRA grows tax-free. The benefit is that when you begin to withdraw money from the Roth IRA at retirement, or when distributions are made to you or your beneficiaries, they are made tax-free. The pre-death RMD rules discussed above do not apply to Roth IRAs. Thus, if you convert your traditional IRA to a Roth, you will not be required to take RMDs during your lifetime. However, having said that, your beneficiaries will be required to take RMDs over their life expectancy even though you were not. The beautiful part about this is that neither you nor your beneficiaries, even though they have received an inherited Roth IRA, will be subject to income taxation, unlike the traditional IRA. On May 17, 2006, President George W. Bush signed into being the Tax Increase Prevention and Reconciliation Act of 2005 (TIPRA). TIPRA including provisions concerning conversions or traditional IRAs to Roth IRAs. The current existing income limitation for converting a traditional IRA to a Roth IRA will not apply in 2010; thus, all individuals will be entitled to convert a traditional IRA to a Roth IRA regardless of their earned income. Naturally, you will have to pay income taxes on the converted amount. However, if the conversion is made in a timely manner in 2010, you will be eligible to have half of the converted amount taxed in 2011 and the other half taxed in 2012, allowing you to stretch out the income taxes related to the 2010 conversion. The end result will be taxes due on April 15, 2012 and April 15, 2013, respectively. This one time tax deferral benefit will only apply in 2010. Any conversion made in 2011 or thereafter will require the converted amount to be included in your gross income for the tax year in which the conversion takes place. Now that we have discussed TIPRA and the availability of converting the IRA while at the same time stretching out the income taxes, let’s spend a moment to discuss the benefits of a Roth IRA conversion. The significant tax benefits which can be achieved in many cases will be worth the cost of paying the income tax currently rather than over time, as with a traditional IRA. Assuming you do not need the IRA funds for your retirement due to the fact that you may have plenty of other liquid assets, the advantage of converting a traditional IRA to a Roth IRA during your lifetime will allow for the Roth IRA to grow on a tax-free basis and will not be reduced by any RMDs once you attain age 70 ½. Further, after your death, your heirs, if they wish, will be able to keep the Roth IRA as a “tax shelter” and continue to obtain tax-free growth within the IRA during their lifetime while not paying any income taxes on forced RMDs. Inheriting a Roth IRA account is far more valuable than any of your brokerage or bank accounts since it allows your heirs the opportunity to receive tax-free growth within the Roth IRA for decades to come. When an IRA owner dies, the beneficiary will be required to begin withdrawing money from the IRA over their life expectancy. A method to maximize the deferral period may be to name grandchildren, or possibly trusts for grandchildren, due to their young age. With a Roth IRA, the benefits of naming your grandchildren are compounded. As discussed above, the converting of your traditional IRA into a Roth IRA during 2010 may be an excellent wealth transfer tool to consider and take advantage of now. If you believe you may not need the income from your IRA during retirement, then converting in 2010 will offer you the following benefits: Suspending lifetime RMD rules, allowing for continued tax-free growth in your account over your lifetime; Paying income tax now will effectively reduce your overall taxable estate; Conversion allows you to stretch out the income tax due over a period of two extra years; Most importantly, converting in 2010 transfers wealth to generations below you, which will continue to compound free of income tax for many years into the future.

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