Among the things that we want to do when planning for the inevitable would be to make certain that our surviving loved ones have access to adequate monetary resources to support themselves, in the most cost-effective manner. Another thing that we hope to accomplish is to make the transition as easy as possible for our loved ones. One way to do this is to convert a good portion of your IRA or other tax-deferred funds to a Roth IRA account. Here’s why:
By converting to a Roth account, you will make the funds in that account available to your heirs totally tax free.
Granted, your estate will also be smaller by the amount of tax that you paid on the conversion. At the same time, your heirs will also not have to go through the rather painstaking process of managing the IRD deduction, if the estate is of a size that requires estate tax to be paid. This will simplify the overall process dramatically, and depending upon the size of your overall estate this could be a significant.
On the downside of this, it’s likely that if you convert your account in a single year the tax paid on the conversion would be much, much higher than if your heirs paid tax on the ordinary required distributions if the account is left as a traditional IRA.
However, if you convert your account gradually over several years in smaller amounts using a strategy like filling up the brackets, the overall tax cost of the conversion will be less, maybe even less than the cost that your heirs would experience otherwise.
Other possible downsides include –
- causing difficulties with itemized deductions, since increasing your income will increase certain deduction limitations like healthcare expenses;
- triggering IRMAA increases to your Medicare premiums due to the increase in your income;
- if under Medicare age and using ACA exchange insurance, increasing your income might result in significant overpayment of advance credits;
- other tax credit issues due to the increased income.
However in today’s tax climate, with careful tax planning there are otherwise very few reasons not to go ahead with a Roth conversion strategy, setting up your heirs with a tax-free resource upon your passing.