**OT**
Bill, Scot,
Thanks for sharing your knowledge on this topic.
I finally found the Wall Street Journal article that had sparked my interest. It has some interesting info on this matter.
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For Personal Use Only
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Older Investors' Switch
To Roth IRAs Helps Heirs
By KAREN HUBE
Staff Reporter of THE WALL STREET JOURNAL
Older investors are snubbing the Roth IRA, and some tax advisers say
they may be making a big mistake.
Since the Roth IRA was introduced in 1998, only a small fraction of the
conversions from regular individual retirement accounts have been made by
investors older than 60. At Charles Schwab Corp., for instance, just 0.6%
of conversions from regular IRAs to Roth IRAs have been by investors
more than 70 years old, and 5.6% were by those aged 60 to 69.
While older investors will probably never regret forgoing the Roth
conversion, "there's a good chance that their heirs will," says Donald
Speakman, a financial adviser in Pittsburgh.
The Roth IRA is primarily known for its advantages in accumulating
assets. It is a tax-free retirement savings account, while the traditional IRA
lets assets grow tax-deferred and withdrawals are subject to income taxes.
But the Roth IRA also has enormous estate-planning benefits that can
preserve assets and help them grow, far better than the traditional IRA.
True, there are immediate tax consequences to converting: You must pay
income taxes on the amount you convert to a Roth. But on money that is
intended to be left to heirs, in many cases the advantages of the Roth IRA
outweigh the tax drawback, particularly if heirs withdraw the Roth IRA
assets over their lifetimes. "If you're willing to pay the taxes, it can lead to
tremendous growth" in assets, says Erwin Hass, president of Weiser
Pension Services, an affiliate of M.R. Weiser, a New York accounting
firm.
Take Dick and Mary
Whitehouse, in Pittsburgh.
The 79-year-old Mr.
Whitehouse and his
68-year-old wife
converted $180,000 -- an
amount they figured they
wouldn't need in their
lifetimes -- to a Roth
IRA in March 1998,
vastly increasing the
potential amount that their
three children will inherit.
Although the couple's tax
bill on the conversion is
about $52,000, if their
children inherit the
account precisely at the
end of Ms. Whitehouse's
life expectancy of 87, they
would inherit $1.9 million
in the Roth. And if the
children take distributions
over their average life
expectancies, they would
each get a portion of $13
million, tax free, by the
time they are 83.
In contrast, if the $180,000 had been kept in the regular IRA, the heirs
would have inherited just over $300,000 by the end of both of their
parents' life expectancies. Then, they would owe income taxes on the
amounts they withdrew from the IRA. To be sure, the couple would have
saved $52,000 in taxes by not converting. But "the taxes didn't seem like a
whole lot to pay next to the benefits of the conversion," Mr. Whitehouse
says. The analysis assumes a healthy annual return averaging 12%.
"People don't realize the magnitude of the benefits of a Roth conversion
from an estate-planning standpoint," says Mr. Speakman, the financial
adviser for Mr. and Mrs. Whitehouse.
Some tax advisers say many older investors mistakenly believe that the
Roth is a good tool only for younger people. Indeed, for people who plan
to use their IRA money for living expenses, a Roth conversion doesn't
make much sense unless they won't need to start withdrawing IRA money
for 10 or more years. That's because it takes a while to offset the brunt of
the taxes paid on the converted amount.
But for people who expect to leave all or some of the assets in their IRA to
heirs, "even a deathbed conversion can make sense," says Ed Slott,
publisher of Ed Slott's IRA Advisor in Rockville Centre, N.Y. That's
because money in a traditional IRA will get whittled away before it ever
lands in your heirs' pockets.
Under traditional IRA rules, you will have to start drawing money from
your IRA after you turn 70 1/2, even if you don't need the money. Once
whatever is left in the IRA is inherited, estate taxes are due if the assets in
the estate exceed $675,000. The kicker: Then heirs must pay income taxes
on the money as they withdraw it from the account.
"Between income taxes and estate taxes, you could kiss 70% or more of
the account goodbye," Mr. Slott says.
In contrast, an investor in a Roth IRA isn't required to withdraw money
from the account in his or her lifetime. Even better, while the Roth is also
subject to estate taxes, heirs don't have to pay income tax on the money as
they withdraw it.
If heirs withdraw Roth assets over their lifetimes, the tax-free compounding
can lead to far more in assets than if the money stayed in the tax-deferred
IRA, says Gary Schatsky, a New York financial planner. Leaving a Roth
for grandchildren can be particularly effective, because they would get
tax-free compounding for many decades, he says.
Beware a common trap in Roth rules, however: To ensure a lifetime
income stream from a Roth, heirs must make the first withdrawal by Dec.
31 of the year following the IRA owner's death. If they don't, they must
cash out the account by the end of the fifth year following the year of death.
For people who cringe at the idea of paying taxes up front on a conversion,
"they should remember it's not all or nothing," you can convert a portion of
assets to a Roth, Mr. Hass says.
Moreover, Mr. Slott and Mr. Schatsky point out that if you have a large
estate, paying taxes up front can be viewed almost like an estate-tax
deduction. "For every dollar in taxes you're paying, you're reducing your
taxable estate," Mr. Slott says. He cautions that a Roth conversion makes
sense only if you pay taxes with money you have outside the Roth or other
tax-favored accounts.
Not everyone can convert to a Roth, however. Couples and singles can
convert to a Roth IRA only if their adjusted gross income isn't more than
$100,000.
For many people still in the work force, this can easily rule out a
conversion, but many retirees have more control over their income and can
plan to draw less than $100,000 in the year they wish to convert, Mr.
Speakman says.
While the Roth can be a winning estate-planning strategy, it should be
considered along with other strategies. For example, if your estate is over
the estate-tax exemption of $675,000, it can pay to create a second-to-die
life-insurance policy that would cover estate taxes. A second-to-die policy
would pay out to heirs after both spouses have died.
This kind of policy can be created so that it is outside of the estate and
wouldn't be subject to estate taxes and income taxes. Heirs could use that
money to pay estate taxes, without having to tap assets in an inherited IRA
or Roth IRA for tax purposes. "The whole key to parlaying wealth within
an IRA or a Roth is to keep it growing tax deferred or tax free," Mr. Slott
says. "If it has to be tapped to pay estate tax, you're killing the golden
goose." |
