Roth conversions of individual retirement accounts have been getting a lot of attention this year as more people became eligible to convert. The prospect of tax-free withdrawals in retirement has been enticing for those who earn more than $100,000 a year and who, before 2010, were not eligible to convert their IRAs. But a group that hasn't been receiving a lot of Roth attention is seniors.
For the most part, the thinking has been for seniors not to convert because the tax bill would reduce available funds. The seniors who could benefit are those that are wealthy, especially if estate taxes next year revert back to 2001 levels, in which assets more than $1 million will be subject to estate taxes. This year, no assets are subject to taxes at death, and previously $3.5 million were excluded from estate tax.
The Roth IRA conversion would let seniors with assets above these levels pay taxes now, which would reduce their assets and result in less being taxed at death at a potential rate of 55 percent. This would be most effective if the taxes paid lower assets enough to fall under the amount excluded for estate taxes.
The question is whether the remainder will be enough to live on in retirement. No one wants to give away too much now, especially when healthy in retirement.
Therefore, this strategy should only be considered by seniors who get help calculating living expenses through age 100, to be safe. Make sure enough money would be left to live on, along with a cushion for unexpected medical expenses.
Besides reducing the taxable estate, the Roth conversion would be appropriate for seniors who want to help their heirs avoid paying the tax bill on withdrawals.
When the senior pays taxes at conversion, those who inherit the IRA receive tax-free withdrawals. That could also help heirs avoid higher taxes when their income increases by annual withdrawals from inherited IRAs.
Another benefit: The conversion would eliminate the need for required minimum distributions by the senior.
The obvious disadvantages of the conversion are paying the taxes and reducing funds available for investment and expenses.
In addition, the beneficiary could potentially inherit less because the senior's estate would be smaller if the estate still had to pay estate taxes after the conversion taxes.
Until more is known about the future of estate taxes, it remains a subject to plan carefully to manage the tax implications. That's not just for seniors but for anyone subject to estate taxes.
The Roth conversion is just one tool that could help to evaluate options.