Maximizing Legacy With Roth Conversions: A Smart Move for Inherited IRAs

In the realm of retirement planning and legacy considerations, a powerful strategy gaining traction is the Roth Individual Retirement Account (IRA) conversion.

This innovative approach involves transferring pretax or nondeductible IRA funds to a Roth IRA, unleashing the potential for future tax-free growth. Although it incurs upfront taxes on the converted balance, financial experts are increasingly utilizing Roth conversions as a key element in legacy planning for their clients.

Roth Conversions: A Legacy Planning Tool

Pexels | Roth conversions are emerging as a vital component of legacy planning.

Certified financial planner Ashton Lawrence from Mariner Wealth Advisors notes that Roth conversions are emerging as a vital component of legacy planning. In the past, heirs could stretch IRA withdrawals over their lifetime, reducing yearly income and tax liability.

However, the landscape changed with the Secure Act of 2019, leaving certain heirs with a shorter 10-year window to empty inherited IRAs, especially impacting adult children who might find themselves in peak earning years.

Benefits for Heirs

In this scenario, Roth conversions become an attractive option. Robert Dietz, National Director of Tax Research at Bernstein Private Wealth Management, emphasizes that with the 10-year withdrawal window, Roth conversions offer a strategic advantage.

While adult children are still required to deplete inherited Roth IRAs within a decade, the withdrawals are typically income tax-free, provided the account has been open for at least five years.

Why Roth Conversions Make Sense for Families

Pexels | Roth conversions can sometimes result in a lower tax burden for families.

1. Tax Burden Considerations: Roth conversions can sometimes result in a lower tax burden for families, particularly if parents pay taxes on the conversion upfront rather than their children paying taxes on IRA withdrawals. However, it’s crucial for families to engage in “legacy conversations” and conduct tax projections before making this decision.
2. Financial Consequences for Original IRA Owners: The original IRA owner needs to weigh the financial consequences, considering factors like boosted income for Roth conversion years, which can impact items such as higher Medicare Part B and D premiums.

Planning for Higher Income Tax Brackets

With potential income tax hikes on the horizon, investors may find partial Roth conversions to be a prudent strategy. Dietz suggests that without changes from Congress, lower income tax rates will sunset after 2025. Therefore, considering the current tax brackets for 2023, some investors are exploring a phased approach with Roth conversions over a three-year period.

Tax Brackets – A Snapshot

Married Filing Jointly

Pexels | Married Filing Jointly Tax Bracket – Up to $22,000: 10% of taxable income.

• Up to $22,000: 10% of the taxable income
• $22,001 to $89,450: $2,200 plus 12% of amount over $22,000
• $89,451 to $190,750: $10,294 plus 22% of amount over $89,450
• $190,751 to $364,200: $32,580 plus 24% of amount over $190,750
• $364,201 to $462,500: $74,208 plus 32% of amount over $364,200
• $462,501 to $693,750: $105,664 plus 35% of amount over $462,500
• $693,751 or more: $186,601.50 plus 37% of amount over $693,750

Single Individuals

• Up to $11,000: 10% of the taxable income
• $11,001 to $44,725: $1,100 plus 12% of amount over $11,000
• $44,726 to $95,375: $5,147 plus 22% of amount over $44,725
• $95,376 to $182,100: $16,290 plus 24% of amount over $95,375
• $182,101 to $231,250: $37,104 plus 32% of amount over $182,100
• $231,251 to $578,125: $52,832 plus 35% of amount over $231,250
• $578,126 or more: $174,238.25 plus 37% of amount over $578,125

Strategic Roth conversions can play a pivotal role in optimizing legacy planning, providing a tax-efficient approach to wealth transfer for families considering the future. As we navigate the complex landscape of taxes and retirement, understanding and leveraging these opportunities can contribute significantly to a secure financial future.