If you have an individual retirement account (IRA), you probably already know about required minimum distributions (RMDs). For traditional IRAs, including Simplified Employee Pension (SEP) or a Savings Incentive Match Plan for Employees (SIMPLE), you must take your first RMD in the year you turn 70½ or by April 1st of the following year from when you reach 70½.
Converting your traditional IRA to a Roth IRA can help you avoid RMDs and significantly benefit your children and grandchildren.
The conversion is treated as a taxable distribution, meaning you'll owe income taxes on the amount converted in the year you convert. (On the bright side, the rate might be lower if you're already retired.) Still, Roth IRAs are great because the money in the account can grow tax-deferred and any future withdrawals are tax-free to you and your heirs.
Sign up for Kiplinger’s Free E-Newsletters
Profit and prosper with the best of expert advice on investing, taxes, retirement, personal finance and more - straight to your e-mail.
Profit and prosper with the best of expert advice - straight to your e-mail.
To exemplify the benefits of a Roth IRA conversion, consider this scenario: Imagine two fathers at the age of 65, both in a 28% tax bracket. Both fathers have $100,000 in each of their IRAs and $28,000 in a separate taxable account. The first father uses the balance of the taxable account to convert his IRA to a Roth IRA. The other does not convert and keeps his funds in his SIMPLE account.
Over time, the first father's Roth IRA account grows tax-free, and he does not take any RMDs. The father with the SIMPLE begins taking out his RMDs at age 70.
When both fathers die at age 90, both accounts are 25 years old, and the children must begin taking their RMDs. The child who inherited the Roth account has about $685,000, if the annual rate of return was 8%. The child with the SIMPLE has nearly $217,000.
What made such a significant difference in account value? The SIMPLE father and child paid taxes on their RMDs. The father with the Roth IRA didn't take any RMDs, and his child was able to take withdrawals tax-free.
Other benefits to converting your traditional IRA to a Roth IRA: doing so can eliminate or lower federal and state taxes, drop your estate tax bracket and allow you to make earnings from depressed market values on stocks.
Talk to Your Beneficiaries
To ensure that your Roth IRA conversion earnings continue with your beneficiaries, prepare them and encourage them to be a part of the planning process now. If you want your heirs to stretch this tax-free shelter over their lifetimes, talk with them now about the rules they must follow after you die.
IRA account beneficiaries are subject to special distribution rules. Their first RMD is due December 31st of the year after the original account holder's death, or by December 31st of the year the deceased would have reached the age of 70½ (whichever option is the latest). If the original account holder died after reaching 70½, the beneficiary must take his or her first RMD before December 31st of the year after the death.
Most laws for account beneficiaries tend to favor spouses, and they have more choices in the event that they inherit an IRA account. They can merge inherited traditional IRAs into their own Roth IRA account, whereas non-spousal beneficiaries cannot.
Non-spousal beneficiaries must set up an "inherited IRA" under the name of the original account holder. Multiple beneficiaries each need their own "inherited IRA" account so that each heir can base their RMDs on their own life expectancies; otherwise, their RMDs will be generated based on the life expectancy of the oldest beneficiary—which may cause a significant amount of the account value to be lost.
Also, before you convert, consider whether your tax bracket is higher than your child's. For instance, if you're in a 28% tax bracket, and your child is in a 10% tax bracket, it may not make sense to convert. However, most retirees are in a 0%, 15% or 25% tax bracket while their children are in a 33% tax bracket—in which case, a conversion would be beneficial.
Finally, if you decide to convert, use non-IRA funds to pay the income tax owed upon conversion to maximize IRA account value for tax-deferred earnings.
As of 2010, there are no longer income limits that prevent you from converting your traditional IRA to a Roth IRA, so now is the time to take advantage of this account and its growth potential.
This article was written by and presents the views of our contributing adviser, not the Kiplinger editorial staff. You can check adviser records with the SEC or with FINRA.
-
-
Best 5-Year CD Rates for March 2023 as Rates Rise
Here are the best 5-year CD rates as the Fed continues its campaign to raise interest rates to try to combat inflation.
-
Stock Market Today: Stocks Sink After Latest Fed Rate Hike
The major indexes sold off sharply Wednesday even amid signs the Fed's rate-hike campaign could be nearing an end.
-
I Wish I May, I Wish I Might: Estate Planning’s Gentle Nudge
Contrary to what you might expect, using precatory language such as ‘I wish’ or ‘I hope’ can play an important part in three estate planning objectives.
-
Investors Nearing Retirement Show Patience With Markets
Despite last year’s upheaval, many investors are sticking with long-term plans and tightening their budgets instead of moving money out of stocks and bonds.
-
Long-Term Care Planning vs. Taxes: Finding a Healthy Balance
Many families discover that trying to mitigate the cost of long-term care can conflict with another common retirement concern — reducing taxes for retirees and their heirs.
-
For a Concentrated Stock Position, Ask Your Adviser This
There can be advantages to having a lot of stock in one company, but ‘de-risking’ can help avoid some significant disadvantages.
-
Long-Term Care Insurance Quandary: Keep Paying or Let It Go?
As long-term care insurance premiums go up, many policyholders are struggling with what to do. Accept higher premiums, reduce benefits, let the policy lapse or take a payout?
-
In Retirement, Many Crucial Questions Start With the Word ‘When’
For a secure retirement, make sure you know the answers to all of these “when” questions.
-
Why So Many Experts Consider Annuities a Win for Retirees
Rising interest rates, pressure on Social Security, unpredictable markets and longevity risks are making annuities ever more attractive as a part of retirement planning.
-
What the Markets’ New Tailwinds Could Look Like in 2023
Historically, the markets bounce back nicely after sharp declines, so focusing on historically high-quality companies trading at today’s lower valuations could be a good recovery strategy.
