Life and Death Planning for Retirement Benefits

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Life and Death Planning for Retirement Benefits

Roth plan or traditional? It’s all about the price tag

A Roth IRA is a nice asset to own. It offers the ability to generate income tax-free investment accumulations that can be spent in retirement or left to heirs, and the additional advantage of no required distributions during the participant’s life. And unlike with a traditional IRA, the participant can withdraw his own contributions income tax-free anytime he wants to. There theoretically could be some drawbacks that would make a Roth IRA “worse” to own than a traditional IRA: For example, it’s possible that some states’ laws haven’t caught up with the Roth idea yet, so that a Roth in such a state would be more vulnerable to state taxes and/or creditors’ claims. Also, some planners speculate that a Roth is an “inferior” inheritance vehicle because beneficiaries are more likely to cash it out quickly because it’s tax free, whereas they might go along with deferring distribution of a traditional plan that they would have to pay income tax on if they cashed it out. And (even aside from the income tax cost) the bump in taxable income generated by a Roth IRA conversion could “look bad” on an application for college financial aid or other means-tested benefit. But these drawbacks are speculative or applicable to few people. The only significant widely-applicable drawback of a Roth plan is the cost. Generally, the price is payment of income taxes on the amount going in to the Roth retirement plan—taxes that could have been deferred (via a traditional retirement plan) until the money was taken out of the retirement plan. The debate is not whether a Roth IRA is a good type of retirement plan to own. The debate is about the price tag: Is it worth it, and can you afford it? Which is better: to pay the taxes up front and get tax-free distributions later or to defer the taxes? A. Analyzing the cost and benefits of a Roth conversion. Professionals who have crunched the numbers for many clients generally conclude that the following factors will result in a Roth conversion’s being profitable for the converting participant and/or his beneficiaries: 1. The income tax payable on the conversion will be less than would otherwise apply to withdrawals from the account if it stayed in traditional form. 2. The funds stay in the Roth account for some number of years, the longer the better. This factor could mean (depending on the planner) that the money stays in the Roth IRA for some absolute certain number of years to achieve a “break even point,” or simply that it stays in the Roth account longer than it would have been allowed (under the minimum distribution rules) to stay in a traditional plan. 3. The income tax resulting from the conversion is paid with assets that are not inside any retirement account. Not all professionals agree on the relative weight of these factors, and or even that all these factors are relevant to the decision. Also, if one factor is positive enough, that factor alone may make the Roth approach profitable even if the other factors are not present. For example, work done by IRA expert Bob Keebler, CPA, and his firm has shown that prepaying a 35 percent tax (via a 2010 Roth conversion) on retirement assets that would otherwise be taxed at 43.6 percent (see ¶ 2.1.02 ) can produce a profit for the client in just 10 years (compared with leaving all the 4. The Roth investments do not decline in value.