Life and Death Planning for Retirement Benefits

Chapter 5: Roth Retirement Plans

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to estate taxes, the plan beneficiaries do get an income tax deduction for the federal estate taxes paid (the “IRD deduction”; see ¶ 4.6.04 ). However the IRD deduction often does not fully eliminate the “double tax” effect, because (1) the beneficiaries get no income tax deduction for state estate taxes and (2) as an itemized deduction, the IRD deduction may be reduced if the beneficiary has a high income (see § 68 ). For deaths in 2010, see ¶ 4.3.08 . B. Low bracket parent, high bracket children. A participant may do a Roth conversion to save income taxes for his beneficiaries: Rhonda Example: Rhonda is a widow, age 65, living happily on her Social Security payments plus $50,000 a year withdrawn from a substantial traditional IRA. Her children are all in the highest income tax bracket, and some day those high brackets will apply to distributions the children take from the traditional IRA they inherit at her death. She can convert some of the traditional IRA to a Roth IRA each year to use up her lower income tax brackets. The high-bracket children will pay no income tax on distributions from the inherited Roth IRA. C. Simplify beneficiaries’ lives. Even if the pure mathematics indicate no advantage to having the participant pay the income tax on the retirement benefits now by converting to a Roth (rather than having the beneficiaries pay it later when they inherit a traditional plan), it would be a convenience to the beneficiaries to inherit a Roth IRA (distributions from which are tax-free) rather than a traditional IRA, so they do not to have to wrestle with the valuable but complicated IRD deduction every year (see “A”). This section discusses the choice between contributing to a Roth IRA vs. contributing to a traditional IRA, and contributing to a DRAC vs. a traditional 401(k), 403(b), or governmental 457(b) account. A. Traditional vs. Roth IRA. An individual who has compensation income, and whose AGI is under the limits described at ¶ 5.3.04 (C), has the option to contribute to a Roth IRA. If he is under age 70½ (as of the end of the tax year) he also has the option to contribute to a traditional IRA instead of to a Roth IRA, or to contribute part of his maximum permitted regular contribution amount ( ¶ 5.3.03 ) to each type of IRA. Assuming he wants to contribute to an IRA, and is eligible to contribute to either type, which type should he contribute to? The decision is easy if the choice is between a Roth contribution and a nondeductible contribution to a traditional IRA. If there is no tax deduction for the IRA contribution, then the Roth option is “free.” A Roth IRA is always better than a traditional IRA if it’s free. See ¶ 5.8.02 (A). A traditional IRA contribution is either totally or partially nondeductible if the individual and/or his or her spouse participates in a workplace retirement plan and had modified adjusted gross income (AGI) in excess of certain amounts. § 219(g)(3)(B) . Similarly, the decision is easy if the individual’s taxable income is so low he is not subject to income tax, since, again, he gives up nothing by opting to contribute to the Roth IRA. If neither the individual (nor his spouse) is an active participant in an employer plan; or, if he (or his spouse) is an active participant in an employer plan, but his (or their) AGI is low enough that he can get a tax deduction for a contribution to a traditional IRA; and his (or their) tax bracket Annual contributions: Traditional vs. Roth plan