Roth Conversion as an Estate Planning Tool

//Roth Conversion as an Estate Planning Tool

Roth Conversion as an Estate Planning Tool

By |2022-07-01T10:40:36-05:00January 14th, 2022|Financial Planning|

A Roth conversion allows an investor to convert a portion of a pre-tax Individual Retirement Account (IRA) into a Roth IRA. Income taxes are due on the conversion amount. However, all future growth in that account is tax free. In addition to Roth conversions with IRAs, some 401(k) plans allow for after-tax contributions inside the retirement plan. If permitted by the plan, employees can immediately convert after-tax contributions into a Roth account. This is also known as a “Back Door Roth Conversion.”

Roth conversions can make sense for many individuals. They allow an investor to shield a portion of their retirement assets from any future taxes. While we cannot predict the future of taxes, this strategy provides protection against future tax increases. Additionally, unlike traditional retirement accounts, Roth IRA’s are not required to pay Required Minimum Distributions (RMD’s) when the owner reaches the age of 72. Reducing RMD’s from traditional retirement accounts, which are considered taxable income to the recipient, can help to lower reported income to a retiree. Lower taxable income can also lower Medicare expenses.

Perhaps the most underappreciated aspect of Roth accounts comes in the advantages they provide for estate planning. If a client expects to leave assets to children or grandchildren, a retirement account is a nice gift to leave. However, current rules require most non-spouse beneficiaries to distribute all assets from the account within 10 years. Distributions from tax-deferred accounts will be reported as taxable income to the beneficiary. To avoid a large, one-time tax hit, the beneficiary will need to do some tax planning to determine the most effective distribution strategy, likely over a period of years. A Roth account would still need to be distributed within 10 years, but with no tax due to the beneficiary. The tax paid on a Roth conversion during the life of the owner can lower the owner’s taxable estate while also leaving a significant tax-free gift to future beneficiaries.

In the Build Back Better Act of 2021, the House of Representatives sought to restrict and eventually end Roth conversions. The bill did not pass the Senate. We continue to evaluate this strategy for clients on a case-by-case basis, and expect that the window on this strategy will be closing in the future.

If you have any questions, please feel free to contact us or schedule a conversation.

Thomas Burleigh, CFP®, CTFA
Wealth Manager
Tom Burleigh, CFP, Wealth Manager


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