Ask the CFP (Roth IRA Conversion)

Consider the Roth IRA conversion

As you probably know, at age 70 ½ the Internal Revenue Service requires IRA owners begin taking distributions from their IRA and pay taxes on the money. The IRS doesn’t care if the money is needed or not.  When the money is distributed out, federal income tax and state income tax is paid on the amount distributed.  If the money isn’t needed the IRA owner can invest the money again outside of the IRA.

But since this money is no longer “shielded” from tax inside the IRA, taxes will be due on the interest, dividends, or capital gains on this money. That’s right, federal and state income taxes must be paid on money that may not be needed and then taxes will be due on any of the interest, dividends, or capital appreciation.  And it gets worse.

The amount that must be pulled out of your IRA is based on your life expectancy. The IRS publishes age tables so that the amount of money you must pull from your IRA’s can be calculated.  So as you get older and your life expectancy on these IRS tables shortens, you will be forced to take a higher and higher percentage of your account in distribution and pay tax on this amount.  This can lead to higher and higher levels of tax as these required minimum distributions may force the IRA owner into higher and higher income tax brackets.  If you have a larger IRA balance it is important that you use distribution planning to avoid these tax problems before it is too late.

A Roth Conversion may help with this problem in some circumstances. By using a Roth Conversion you still pay federal and state income tax when you convert from the Regular IRA to the Roth IRA. However once the money is inside the Roth IRA there is no tax to be paid on the growth as long as the tax rules are obeyed.  There are no Required Minimum Distributions on the Roth IRA during your lifetime so the money can grow without current tax.

If the Roth IRA owner dies with money inside the Roth IRA, the beneficiary is required to begin withdrawals. However, this Required Minimum Distribution is based on the beneficiaries’ life expectancy.  This can be an effective planning tool if leaving Roth IRA monies to children, grandchildren or even great-grandchildren.  And as long as the distributions are taken correctly, the money that is distributed from the inherited Roth is completely tax-free!  That’s powerful.

The decision making process for Roth IRA Conversions can be complicated. It is important that you seek professional advice before deciding to implement such a strategy. We have a great amount of experience and success in implementing this strategy.

Please call if you have any questions about how to avoid the Required Minimum Distribution tax trap or want more details on the Roth Conversion.