Do I Help My Kids Convert?
The financial literature is full of articles about Roth IRA’s. Most of the articles revolve around whether to convert a traditional IRA to a Roth IRA. This article attempts to start a conversation about a unique way you and your adult children might execute a Roth conversion, especially if you expect your IRA to be part of the legacy you leave behind for those children. The question then is:
I’m later in life with a substantial amount (let’s say $200,000+) in a traditional IRA. My children will inherit. Is there a strategy to convert to a Roth IRA to lower the family tax bill?
In 2019, a bill passed that changed the way inherited IRA’s are managed. Beginning in 2020, if a person inherits an IRA, and that person is not a surviving spouse, the beneficiary must liquidate the contents of an IRA in 10 years. Practically this means the beneficiary must liquidate the IRA in a finite number of years. This will raise his/her taxable income, thus incurring tax at the marginal tax rate. Let’s use an example. If Jim is married and he and his wife earn $201,000 in 2024, they are in the 24% marginal tax bracket. This means that every additional dollar of income costs them 24 cents in taxes. Let’s continue the example and assume Jim inherited an IRA from his mother and that this is year 10. This means he needs to liquidate the remainder of the IRA. If we say in the example that the IRA contained $32,000, then Jim’s income jumps from $201,000 to $233,000. He owes $7,680 in taxes upon liquidation of the IRA. Jim and his wife have incurred significant tax by having to liquidate the IRA.
Enter an interesting strategy. If adult children knew they were going to inherit an IRA from a parent, in order to pre-emptively lower their tax bill through planning, they could have their parent convert the IRA to a Roth while living. The children can pay that parent the tax bill. Let’s continue our example with Jim from above. Instead of Jim inheriting the IRA, let’s assume his mom Ruth decides to convert the $32,000 from a traditional IRA to a Roth IRA while she’s still living. Ruth and her husband are retired and their taxable income is only $60,000. They could convert the entire $32,000 to a Roth and the tax bill would only be $3,840 (the 12% tax bracket). Since Jim agreed to pay the tax, he pays his mom the $3,840 in tax, saving himself $3,840 in tax later.
When Ruth passes, Jim inherits a Roth IRA which has no rules about how quickly Jim needs to liquidate, and he incurs no additional tax.
Ruth does need to do some planning herself before she agrees to the strategy. She needs to understand her own tax brackets and where her income lies compared to the Medicare earning tables. If Ruth and her husband’s income exceeds $206,000 in 2024, their Medicare premiums go up. Therefore, Ruth should understand her estimated taxable income when considering whether to convert a traditional IRA to a Roth IRA. That’s where planning comes in. Feel free to give us a call and we can set up time to do a tax planning session.
Jared
Brian Kellett, brian@kellettwealth.com. Phone 513-312-6067
Dave Bodnar, david@kellettwealth.com. Phone 513-258-6973
Jared Kline, jared@kellettwealth.com. Phone 513-768-2238
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