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Estate Planning New Legal Developments

Are You Ready for Roth IRA Conversions?

By Michael J. Jones

As of January 1, 2010, the well-to-do can take advantage of Roth IRA conversions.  The Tax Increase Prevention and Reconciliation Act of 2005 (Pub L 109-222, 120 Stat 345)  §512 eliminates the IRC §408A(c)(3)(B) provision prohibiting such conversions by taxpayers having adjusted gross income in excess of $100,000. Estate planners have a great deal to offer clients who wish to consider the move. After being funded with after-tax dollars, Roth IRAs offer tax-free, as opposed to tax-deferred, returns on investment. Further, in contrast to traditional IRAs and employer-sponsored qualified plans, there are no required minimum distributions during the Roth IRA owner’s lifetime. Although there will be required minimum distributions after the Roth IRA owner’s death, or the surviving spouse’s death if there is a rollover by the surviving spouse, postdeath distributions will be tax-free (subject to the possibility of limited income taxation of distributions occurring within 5 years of conversion).

But there’s a price to pay for making a conversion. The retirement account being converted is subject to income taxes as though the converted account had been distributed instead of rolled over. Accordingly, clients and their advisors must carefully evaluate whether payment of this price makes sense given the particular circumstances of the particular client. Factors that must be assessed in connection with a proposed Roth IRA conversion include:

  • Whether the income tax rates in the year of conversion are higher or lower than the anticipated rates in the years in which the client or the IRA beneficiary will otherwise make withdrawals. Evaluation of this factor should include the possible consequences of the client being forced into higher income tax brackets as a consequence of the obligation to take required minimum distributions from the unconverted IRA after age 70½. Effects on taxable income due to changes in Adjusted Gross Income (such as decreased itemized deductions and increased taxation of Social Security income) and the Alternative Minimum Tax should also be considered.
  • Whether the client is able to maximize the initial value of the Roth IRA by paying the conversion-triggered income taxes from assets other than assets of the IRA being converted.
  • Whether the client will be able financially to further maximize the value of the Roth IRA by taking advantage of the absence of a minimum distribution requirement during the client’s lifetime.
  • Whether paying the conversion-triggered income taxes from other assets will have undesired consequences, including gain recognition on asset sale, reduced estate liquidity, and reduced assets available for lifetime gifts.
  • Whether it is expected that the client’s estate will be subject to an estate tax, in which case estate taxes can be reduced by removing the income taxes paid on the conversion from the taxable estate.
  • Whether the beneficiary is likely to limit Roth IRA withdrawals to required minimum distributions.

Taken from the 31 CEB Estate Planning and California Probate Reporter, p. 49 (Dec. 2009) published by CEB.

© The Regents of the University of California, 2010. Unauthorized use and/or duplication of this material without express and written permission from this blog’s author and/or owner is strictly prohibited.

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