Most investors’ top priorities include providing for and protecting loved
ones. An important part of preparing for the future involves finding tools
that help add value to your estate, while maximizing your financial legacy.
That’s why you should consider the estate planning benefits of a Roth
IRA conversion.
Understanding estate taxes
The threat of incurring estate taxes provides incentive to reduce your taxable estate as much as
possible. Federal estate taxes are triggered upon your death if your taxable estate exceeds the
federal exemption amount. Tax laws are subject to change, so exemption amounts and tax rates
are not set in stone.1 Many states also have their own version of estate taxes.
How a Roth IRA conversion can help trim your estate
When you make a full conversion of a Traditional to a Roth IRA, ordinary income taxes are
due on the total amount converted in that tax year. Paying income taxes now on converted
assets removes them from your taxable estate, thereby reducing its size. If you’ve accumulated
considerable wealth, this can be an effective way to stay within the federal exemption amount
and possibly reduce estate tax liability.
Roth IRA conversions can help reinforce your financial legacy
Traditional IRA assets that are passed to non-spousal beneficiaries, especially during their peak
earning years, can result in a significant tax bill for these heirs. If you anticipate having a sizeable Traditional IRA account balance upon your death, consider converting now to potentially provide your designated beneficiaries with tax-free access to a substantial sum of money. Roth IRA
earnings can grow tax-free and earnings can be withdrawn tax free if you hold the conversion
contribution for at least five years and you are age 59½ or older. Earnings can also be withdrawn
tax and penalty free if they meet one of the other qualified distribution criteria (death, disability, and qualified first time homebuyer expenses (up to $10,000 limit)) and were held for at least 5 years.
Your heirs can withdraw earnings tax-free regardless of their age or the age of the deceased
account owner, as long as the Roth IRA conversion assets have existed for at least five years.2 Spousal beneficiaries can elect to treat the Roth IRA as their own, but may not be able to withdraw earnings tax or penalty-free until age 59½.
Transferring wealth after converting to a Roth IRA
The hypothetical example below illustrates how the tax-free earnings potential of a Roth IRA can be passed on to heirs over a long period of time.
Husband converts Traditional IRA to Roth IRA
- Designates his wife as sole beneficiary
- Pays taxes on conversion from a savings account
- Does not need to use money for retirement
- Full IRA value can grow
- No mandatory withdrawals
10 years later, husband dies
- Wife elects to transfer the Roth IRA into her name
- Designates her son as beneficiary
- Does not need to access money
- IRA can continue to grow
- Still no withdrawals required
After 15 years, wife dies
- 55-year old son has life expectancy of 30 years
- Son must begin RMDs by December 31 of the year following his mother’s death
- Roth IRA continues to provide tax-free growth potential and withdrawals throughout his life
Transfer and accumulation of potential tax-free wealth
- 10 years: husband’s account
- 15 years: wife’s inherited account
- + 30 years: son’s RMDs
- 55 years: from conversion till end of payout
Talking Taxes
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Many people confuse estate and gift taxes.
Estate tax: imposed upon your death when wealth is transferred.
Gift tax: imposed when you transfer wealth during your lifetime.
The Unified Gift and Estate Tax system was established in the
United States as a way to ensure that money transferred during life does not escape estate taxes. Current tax laws do provide exemptions from these taxes.
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Find out more from your advisors
Enhancing your financial legacy with a Roth IRA conversion can be a complex process. Rely on the guidance of trusted tax and financial professionals.
To learn more about strategies for retirement, including commentary from Thomas Rowley,
IRA calculators, and additional information on traditional and Roth IRAs, please visit us at here.
Invesco does not provide tax advice. The tax information contained herein is general and is not exhaustive by nature. It was not intended or written to be used, and it cannot be used by any taxpayer, for the purpose of avoiding penalties that may be imposed on the taxpayer under U.S. federal tax laws. Federal and state tax laws are complex and changes frequently. You should always consult your own legal or tax advisor for information concerning your individual situation.
The information provided is based on tax laws as of 12/31/09, which are subject to change. There is a possibility that this tax legislation will be amended or repealed in the future. In that case, the outcome of a Roth conversion may not be advantageous. Additionally, a Roth IRA conversion may not be suitable for your specific circumstances now or in the future.
You should always consult your own legal or tax professional for information concerning your individual situation. IRA owners are encouraged to seek the advice of an attorney or tax advisor that specializes in this area.
The opinions in this piece are not necessarily those of Invesco. Information in this report does not pertain to any Invesco product and is not a solicitation for any product.
