07 May Roth conversion strategies for your estate

 Q. I have a decent amount of money in a brokerage account as well as an IRA. Both taxable accounts. I wanted to convert some of the IRA into a Roth to have a future pot of tax free money to leave my children. I’m 60, retired and a widower. My questions: Can I transfer money from the IRA to Roth over a number of years? Can it be different amounts or does it have to be same dollar amount? Is there anything else I need to know on conversion in retirement?

A. Yes you can, but there are a lot of considerations.

First, you need to assess what you mean by “a decent amount of money.”

Assuming you do not have any health or genetic issues, you very well could be looking at a 30-year time horizon in terms of your retirement, said Michael Maye, a certified financial planner and certified public accountant with MJM Financial in Gillette.

His first suggestion is to take a step back and assess how much of your money you are likely to spend during retirement.

Maye said a Roth IRA is most valuable when the account owner won’t need to draw down the account.

Also, Maye said, you describes both accounts as taxable, which he said is not technically correct.

“While it is true both are ultimately taxed, the brokerage account is comprised of after-tax dollars which will be subject to capital gains rules as investments are sold in the account,” he said. “What is important to note about capital gains is they are typically taxed at a lower rate than ordinary income.”

So the IRA is a tax-deferred account which becomes taxable as distributions are taken, he said.

“For an IRA funded by tax-deductible IRA contributions or via a 401(k) rollover comprised of pre-tax contributions, any distribution, including a Roth IRA conversion, is subject to ordinary income tax rates,” Maye said. “To maximize the Roth IRA conversion, it is best to use after-tax dollars to pay any tax liability related to the Roth IRA conversion.”

Now on to the your specific questions.

Yes, it is possible to do partial Roth IRA conversions over a number of years and you’re not required to do it for any specific dollar amount or number of years, Maye said.

A major point you need to consider before doing any conversions is deciding in which year(s) it makes sense from a tax perspective to do a conversion, Maye said.

He said you need to ask: Does the conversion push you into a higher bracket or make more of your Social Security taxable? Will the sale of investments in the brokerage account to pay the taxes due on the Roth IRA conversion create a capital gain, increasing your income tax liability further?

“It may very well make sense to incur the tax liability to do a Roth IRA conversion,” he said. “I am merely suggesting understanding the tax impact given all the moving parts.”

If you do convert to a Roth IRA and your children inherit the money, it will still be subject to the inherited IRA distribution rules, Maye said, but the Roth will give one major advantage: the distributions are tax-free.

From an estate planning perspective, remember a Roth IRA is still part of your estate. So while the Roth conversion eliminates income taxes, it doesn’t eliminate potential estate taxes.

While you can convert the money over a period of years, that strategy has one disadvantage.

“The downside to converting over a period of years in that each conversion done in a different year starts a new five-year holding period for that conversion,” said howard Hook, a certified financial planner and certified public accountant with EKS Assoc. in Princeton. “This can make it complicated to keep track of when it comes time to start withdrawing money from the Roth IRA.”

Hook said the move may still be beneficial if by breaking up the amount into smaller portions, you stay in a lower tax bracket.

Finally, Hook said, you may convert to a Roth IRA after reaching age 70 1/2, but you have to tax your Required Minimum Distribution (RMD) first prior to any conversions.

“This is a technicality but an important one to get right,” Hook said. “Tax law treats the first distributions out of an IRA for someone age 70 1/2 as their RMD. RMDs are not allowed to be converted to Roth IRAs and are subject to penalties if someone does so.”

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This story was first posted in May 2015.