Some decisions in life are easy, others are not. One factor that gives pause when making a very serious life or financial decision is the nagging fear of "not knowing what we do not know," yes? So it is with the decision to convert your traditional IRA into a Roth IRA.
It all depends.
In fact, a recent MarketWatch article, titled "When a Roth conversion is right for your estate — and when it isn’t," advises that you to consider three salient questions before taking action.
Here they are:
1. Will your Roth outlive you? In estate planning, the top two reasons for Roth conversions are to bequeath tax-free assets and to reduce your taxable estate. It is critical to project your spending lifestyle relative to your net worth to understand how your assets may be used in retirement. This allows you to better determine which assets are likely to be part of your remaining estate after retirement.
According to the original article, if you project that you will spend all of your IRA assets in retirement, the decision to convert will be based on marginal tax rates over your lifetime. If you think your Roth will outlive you, make sure the conversion tax implications outweigh the long-term savings for the person who will inherit the account. If you throw the beneficiary into a higher tax bracket with the inheritance, he or she may be better off if you take the tax hit now at your lower tax rate. But if the beneficiary’s tax rate at the time of the inheritance will be lower than your current tax rate, conversion may not be worth it. Talk with your estate planning attorney about possibly leaving the assets in a traditional IRA.
2. Is there a plan to maximize the Roth benefit? If you plan well, the benefits of a Roth conversion could span multiple lifetimes, so it is very important to communicate this to your spouse to extend the account’s tax-free growth.
3. Does your estate benefit a charity? Charities generally do not pay any income taxes on donations, so a traditional IRA—rather than a Roth—is a terrific asset to leave to charity. When you own an IRA, it is like you have a joint account with the U.S. Government, as taxes are owed on the money that is distributed. However, when the account is transferred to charity, Uncle Sam does not get anything. No, the charity gets it all! So, converting the IRA to a Roth and naming a charity as beneficiary would be a mistake by creating an unnecessary taxable event, a payable tax to the government, and would reduce the amount received by the charity.
These are just a few of the questions that can arise when talking about an IRA conversion. The more complex your circumstances, the more you will benefit from working with an experienced estate planning attorney.
Remember: “An ounce of prevention is worth a pound of cure.” When making your financial, tax and estate plans, do not go it alone. Be sure to engage competent professional counsel.
For more information about estate planning in Overland Park, KS (and throughout the rest of Kansas and Missouri) and to download free tools to help you organize your estate, visit my estate planning website.
Reference: MarketWatch (November 17, 2014) "When a Roth conversion is right for your estate — and when it isn’t"