Life and Death Planning for Retirement Benefits

Chapter 5: Roth Retirement Plans

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bankruptcy exemption laws) he concludes that assets inside an IRA are better protected than “outside” assets, he can convert his IRA to a Roth IRA, thereby spending down the outside assets, and using them to beef up the relative value of the “inside” assets, by prepaying the income taxes on the IRA. A person who is concerned about his own tendency to (wastefully?) spend “outside” assets could use a Roth conversion to decrease those outside assets in a productive way. E. Diversification of tax risk. The Code changes constantly. Recent decades have seen changes that discriminated against retirement plan assets (such as the 15% excise tax on “excess” plan accumulations and distributions that applied, under § 4980A, from 1987– 1996, and the low 15 percent tax rate applicable through 2010 to certain dividends and capital gains earned outside a plan); as well as changes that favor retirement benefits (for example, the 3.8% investment income surtax ( ¶ 2.1.02 ) will not apply to retirement plan distributions). A client can diversify his tax risk by placing some bets on every “box”: traditional plan, Roth IRA, and outside investments. F. Control of taxable income levels. To control levels of taxable income, ideally, a retiree would have a combination of traditional and Roth retirement plans and outside investments. That way, taxable income can be increased (to use up deductions or take advantage of lower tax brackets) by taking more from the traditional plans, or spending can be financed without increasing taxes by withdrawing from a Roth IRA or outside investments. A large slug of income in the conversion year could result in many later years of lower income for purposes of graduated income tax brackets, Medicare premiums, and the taxability of Social Security benefits (§ 86). G. Longevity insurance. Roth IRAs have appeal for retirees who expect to live beyond the average life expectancy due to their genetic heritage and/or health. A traditional IRA participant approaching age 70½ faces forced distributions that may substantially diminish the account over a long life span. With a traditional IRA, the way to maximize tax deferral is to die prematurely, leaving benefits to a young beneficiary. By converting the traditional IRA to a Roth IRA, this person can eliminate the forced lifetime distributions and reverse the usual rule of thumb: The way to minimize taxes with a Roth IRA is to live as long as humanly possible, deferring the commencement of ANY distributions until that way-later- than-normal death (and then leave the benefits to a young beneficiary to get the long life expectancy payout). Here are factors that tilt in favor of not spending money to convert existing traditional plans to a Roth IRA. A. Investment risk. If the client’s investments decline in value, that is a “bad thing” regardless of whether the investments were held in a traditional or a Roth plan. Nevertheless, it is financially worse when the decline occurs inside a Roth plan, because the client has also lost the income tax money he paid for the conversion. At least when investments tank inside a traditional plan, Uncle Sam is sharing the loss. (This factor would Factors that incline against a Roth conversion