Roth IRAs can be a great planning strategy: advanced

This is the second part of a two-part series on Roth IRAs. The first part reviewed the basics of Roth IRAs. (Click here for the first article in the series.) This second part looks at two advanced planning strategies.

The first advanced planning strategy is to use a Roth IRA to maximize deferment on an inherited IRA. Prior to the SECURE Act, beneficiaries could receive distributions on life expectancy. For those who die after 2019 with IRAs, the Security Act applies. By law, most beneficiaries must withdraw assets from the inherited IRA by the end of the year-end period that includes 10NS Death Anniversary of the IRA Participant, in another meaning, The so-called “ten-year rule”. With a traditional IRA account, the problem is that if a beneficiary waited until last year to get the maximum deferment, they would have a huge income bump that would push them into higher tax brackets. For example, let’s say Mary inherited a traditional IRA of $1 million. If you wait until last year, most IRAs will be taxed at the highest marginal income tax rate. Conversely, if Mary inherits a Roth IRA, she can allow it to become tax-exempt until the end of the “ten-year rule.” Mary can withdraw her entire IRA account in the last month of the period because distributions from a Roth IRA are not included in taxable income.

Another advanced planning strategy is to use a Roth IRA to reduce property taxes. The IRA value is included in the taxable property of the IRA owner. However, with a traditional IRA, income taxes will be due on the balance upon withdrawal. But this does not reduce the value for estate tax purposes.

Let’s look at an example: Tom Taxpayer falls within the maximum income tax bracket of 37% and lives in a state without state income tax. Tom owns taxable property and has a $1 million IRA. If Tom transferred the $1 million to a Roth IRA, he would pay $370,000 in income taxes, reducing his taxable property by that amount. This reduction in his taxable property would save him estate tax on the $370,000 income tax payable upon conversion, or $148,000 with a 40% estate tax. Of course, paying income tax upon transfer to a Roth IRA also means that the beneficiary who receives an IRA will not have to pay income tax upon withdrawal.

Thus, a transfer to a Roth IRA can allow full use of the ten-year rule and can serve to reduce taxable estate while providing an income tax benefit to the recipient.

Stephen C. Hartnett, JD, LLM
Education Manager
American Academy of Estate Planning Lawyers, Inc.
9444 Balboa Street, Suite 300
San Diego, CA 92123
Phone: (858) 453-2128

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