Life and Death Planning for Retirement Benefits

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Chapter 5: Roth Retirement Plans 273
be of less concern to someone whose IRA investments are in cash or some type of
guaranteed-return annuity product.)
Ruby Example: Ruby has a $1 million IRA and $350,000 of cash outside her IRA. She converts
the IRA to a Roth and spends the $350,000 of cash paying the income tax on that conversion. Then
the IRA’s value declines to $700,000. Ruby ends up with $700,000 of after-tax money (inside the
Roth IRA). If she had not converted, the IRA would have shrunk to $700,000 and she would still
have the outside cash; she could then have cashed out the $700,000 IRA, paid tax of only $245,000
on that distribution, and been left with $755,000 of after-tax money instead of $700,000.
B. Future tax rate lower. The Roth deal is unfavorable if the benefits would be subject to
income taxes at a lower rate when they come out than the rate the participant paid to convert
the plan to a Roth. For Americans (the majority?) who will be in a lower bracket after
retirement than they are during their working years, the Roth conversion seems unlikely to
be profitable.
C. Legislative risk. Prepaying the income tax would also presumably turn out to be a bad deal
if the income tax is replaced by a value-added tax (VAT), or if income tax rates are
substantially reduced when Congress adds a VAT. One skeptic won’t “Roth” because he
expects that retired baby boomers will use their electoral clout to cause Congress to make
all pensions wholly or largely tax-free.
A perhaps more realistic worry is that Congress, in a desperate search for revenue, will
seek ways to diminish the benefits of the Roth account, especially if there are massive conversions
by “the rich” trying to keep their taxes in check. Presumably Congress would not simply declare
that Roth distributions are taxable after all, but they could: make Roth IRAs subject to lifetime
minimum distribution rules, or faster post-death minimum distribution rules; mandate that all of a
Roth’s earnings accrued after a certain date would be taxable; subject Roth distributions to income
tax, with a credit being given for taxes previously paid; and/or count Roth IRA distributions as
income for purposes of Medicare premiums, the taxability of Social Security benefits, the
alternative minimum tax, or the “threshold” for the post-2012 surtax on investment income
.
The question is, how much weight should be given to these prospective scenarios? Should
a client bet everything on these possible outcomes and convert nothing to a Roth IRA, despite a
projection that (if these negative rule changes do NOT occur) the Roth conversion would be
favorable for him?
5.8.04 How participant’s conversion helps beneficiaries
Beneficiaries of a traditional IRA can NOT convert that inherited IRA to a Roth.
A). If the participant converts his IRA to a Roth IRA prior to death, that conversion can
benefit his beneficiaries:
A. Reduce estate taxes. Converting to a Roth IRA can reduce the participant’s estate taxes
by removing the income taxes due on the Roth conversion from the gross estate. Unlike
gift taxes payable on gifts made within three years of death, income tax paid (or due) on a
Roth conversion is NOT brought back into the estate for purposes of computing estate
taxes. If the participant dies owning a traditional retirement plan, and the estate is subject