Roth Money/Roth Conversions if Goal is Estate Planning

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Topic Author
mbt863
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Roth Money/Roth Conversions if Goal is Estate Planning

Post by mbt863 »

Hello....DW and I are in our early 50s and have a fairly significant (to me) amount in Roth IRAs. There is a very good chance we will not need this money during our lifetime so my goal is to earmark Roth $ for inheritance to my three children (currently aged 17-22—no disabilities).

I will likely early retire although DW may work a bit longer—we will see. In either scenario, we will have many years to do Roth conversions before 72—my current thought is up to the top of the 12% bracket with DW taking SS at 62 and me at 70 (neither of us have a pension). We will need ACA health insurance before 65 so know conversions may impact a subsidy but I’m ok with that so long as inheriting Roth dollars is as good as I think it is—thus the reason for this post.

Consider my questions below based upon the following assumptions: (1) we can pay tax on conversions from outside funds; (2) I live to 80 and my DW lives to 85—we invest Roth money aggressively (no RMDs—a big plus to Roth) and when DW dies Roth IRA has value of $3M; and (3) by the time DW dies tax rates are higher than now.

I would appreciate any input on my questions and would also be curious if others in my age/stage are planning Roth for estate purposes and how you are planning conversions. I know rules/laws will be different decades from now but just want to make sure I know the benefits or drawbacks under the current landscape before I make Roth conversions a priority in retirement. Thanks.

--Brian

Questions:
1. When I die my wife will inherit my Roth IRA. When she dies, it is my understanding that the $3M must be fully distributed within 10 years of her death to our children (the beneficiaries) under the SECURE act. Correct?
2. If my DW elects to equally distribute the $3M to three children as a lump sum on her death—it is a federal/state tax free $1M gift—correct?
3. Same assumptions as above but with one change and one new fact: DW dies later and Roth IRA has value of $9M and estate tax has dropped down to tax estates valued over $5M. DW’s only asset is the $9M Roth IRA. Even though this is after tax Roth dollars, the estate would be still be subject to estate tax (i.e. while distributions from DW’s Roth IRA up to $5M are tax free, $4M of the Roth IRA—or the amount above the $5M estate tax limit in my example—would still be subject to estate tax).

Now three practical/planning questions:

4. I agree with the advice of not trying to “rule from the grave” by setting up rigid distribution rules in an estate plan as impossible to know when/how my adult children will need the Roth IRA amounts after DW dies. However, would be interested on how others have addressed distributions on Roth IRAs if done for estate planning. That last decade of compounding after death—depending upon how the market performs—could be a powerful wealth building tool if my children are not in immediate need of that money. Just interested if anyone has tried to address this in a trust to provide flexibility if $ is needed earlier but keep Roth $ compounding as long as possible.
5. If the intent of my DW is just to equally distribute the full value of the Roth IRA as a lump sum to our children, should the children just be added as beneficiaries to the Roth IRA after I die or is it a better practice that a trust be established as the primary beneficiary of the Roth IRA.
6. I follow Roth conversion threads on BH but understandably the topic is focused on the original account owner. However, if the goal of conversions is estate planning it seems like a totally different analysis and more driven by benefit of additional uninterrupted compounding assuming you live into your 80s or beyond…i.e. if I/DW don’t need the $ during our lifetime, Roth conversions for estate planning is almost a no brainer as no RMDs with potentially an extra 10 years of compounding after death of DW with ultimate gift to children being tax free. The only exceptions that I can think of is if future tax rates are substantially lower than today or if taxable estate limits are much lower but feel free to poke holes in my general statement!
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Wiggums
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Re: Roth Money/Roth Conversions if Goal is Estate Planning

Post by Wiggums »

Yes, non spouse is subject to 10 year withdrawal.

Our children are named as secondary beneficiaries and divided equally.

The federal estate tax exemption for 2021 is $11.7 million and is adjusted for inflation every year.

We are slowly doing Roth conversions even if the end result is a wash. We won’t be able to convert everything, but a mixture of pre and after tax makes sense for us.
Investors need to be better informed about the costs they pay. “High fund fees can be hazardous to your wealth in the same way that high calories can be hazardous for your health.”
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mbt863
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Re: Roth Money/Roth Conversions if Goal is Estate Planning

Post by mbt863 »

Thanks. Agree on tax diversification. However, as noted, roth conversions seem highly unlikely to have an end result of a wash if done in your 50s and you live until your 80s with idea that they will be used for estate planning purposes. Any other thoughts/insight welcome.
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FiveK
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Re: Roth Money/Roth Conversions if Goal is Estate Planning

Post by FiveK »

mbt863 wrote: Mon Sep 13, 2021 4:58 pm Thanks. Agree on tax diversification. However, as noted, roth conversions seem highly unlikely to have an end result of a wash if done in your 50s and you live until your 80s with idea that they will be used for estate planning purposes. Any other thoughts/insight welcome.
When estate planning (i.e., investing, not spending) is the intent, avoiding the tax drag due to RMDs from the traditional account, by doing Roth conversions, may have a significant effect.

There has been recent discussion of this, e.g., in Roth Conversions - McQuarrie study - Bogleheads.org.

It's not a new concept, as it was discussed over 10 years ago by Kitces in https://www.kitces.com/wp-content/uploa ... y-2009.pdf, although the effect was downplayed in that paper. But, laws have changed.

Also, there was a post in another forum, How do RMDs affect Roth conversion choices? that suggests the Kitces calculations incorrectly favored not converting. I haven't looked closely enough to say.

Anyway, no good answer immediately available but you ask a good question. :)
SnowBog
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Re: Roth Money/Roth Conversions if Goal is Estate Planning

Post by SnowBog »

As a counter consideration (assuming current laws remain)...

While Roths won't have taxes for heirs...

Neither will funds left in taxable that get step-up in basis...

So if you end up spending down a large sum of taxable paying taxes on Roth conversions, you might have inadvertently paid more in taxes and thus passed down less to heirs by doing so.

Obviously, your specifics would determine what's "optimal".
sc9182
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Re: Roth Money/Roth Conversions if Goal is Estate Planning

Post by sc9182 »

SnowBog wrote: Mon Sep 13, 2021 11:45 pm As a counter consideration (assuming current laws remain)...

While Roths won't have taxes for heirs...

Neither will funds left in taxable that get step-up in basis...

So if you end up spending down a large sum of taxable paying taxes on Roth conversions, you might have inadvertently paid more in taxes and thus passed down less to heirs by doing so.

Obviously, your specifics would determine what's "optimal".
good point and great explanation!

[OT comment removed by admin LadyGeek]

There is surprisingly low amount of knowledge about step-up basis. Many of marital assets which grew LTCG — if one spouse dies., the surviving spouse almost-always gets either 100% step-up in cost basis to time of death — ie., all those LTCG gains now are now tax-free avail to surviving spouse (this 100/% is applicable to Community property tax states; whereas common-law property tax states could get 50% LTCG tax-free; there are some exceptions and guidelines., refer to applicable laws with right resources). Then, the step-up of cost-basis for heirs as well.

In addition - Rental accumulated Depreciation that has on their rental portfolio disappears as of the date of death of the former owner because the property gets a step up in basis AS OF the date of death, (yeah this is not direct tax saved, but this is tax-avoided., this point doesn’t show up in any of their calculators— but such is the state of affairs)

Many a times someone raises tax rate upon become widowed/single ., I raise this point — and the fact that they already received some/most tax free monies to absorb single-status tax hit — there is NOT one taker thus far!! (Step-up basis, and some insurance payout at demise of one spouse— the surviving spouse already enjoying a decent sized tax-free kitty ; but they come back to complain - hey, my now-single tax brackets are worse., but promptly fails to ack the above tax-free dollars made available to them earlier..) But, life and complaining must go on ..
SnowBog
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Re: Roth Money/Roth Conversions if Goal is Estate Planning

Post by SnowBog »

sc9182 wrote: Tue Sep 14, 2021 12:57 am
SnowBog wrote: Mon Sep 13, 2021 11:45 pm As a counter consideration (assuming current laws remain)...

While Roths won't have taxes for heirs...

Neither will funds left in taxable that get step-up in basis...

So if you end up spending down a large sum of taxable paying taxes on Roth conversions, you might have inadvertently paid more in taxes and thus passed down less to heirs by doing so.

Obviously, your specifics would determine what's "optimal".
good point and great explanation!

[OT comment removed by admin LadyGeek]

There is surprisingly low amount of knowledge about step-up basis. Many of marital assets which grew LTCG — if one spouse dies., the surviving spouse almost-always gets either 100% step-up in cost basis to time of death — ie., all those LTCG gains now are now tax-free avail to surviving spouse (this 100/% is applicable to Community property tax states; whereas common-law property tax states could get 50% LTCG tax-free; there are some exceptions and guidelines., refer to applicable laws with right resources).

Many a times someone raises tax rate upon become widowed/single ., I raise this point — and the fact that they already received some/most tax free monies to absorb single-status tax hit — there is NOT one taker thus far!! (Step-up basis, and some insurance payout at demise of one spouse— the surviving spouse already enjoying a decent sized tax-free kitty ; but they come back to complain - hey, my now-single tax brackets are worse., but promptly fails to ack the above tax-free dollars made available to them earlier..) But, life and complaining must go on ..
I have to admit, I've probably been one of those Pro-Roth people in prior threads! :oops:

But someone helped me see the light that for "estate planning", step-up basis can be a much better option.

I'm still probably more pro-Roth for the transition from MFJ to single rates, at least as it relates to RMDs. But that's probably more bias against being forced to withdraw more money than needed and thus being unnecessarily taxed on that money. Especially as our plan is to retire early, giving us many years to do Roth conversions with minimal taxes.

But my eyes have been opened, and I no longer intend to convert everything to Roth as I thought about at one point. Doing so would eat into taxable funds - which if not spent - could be great to leave to the estate. Likewise, assuming higher healthcare costs later in life, that could be very tax-efficiently covered with funds still in tax-deferred accounts. Balance and diversity can be a great thing!
smitcat
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Re: Roth Money/Roth Conversions if Goal is Estate Planning

Post by smitcat »

SnowBog wrote: Mon Sep 13, 2021 11:45 pm As a counter consideration (assuming current laws remain)...

While Roths won't have taxes for heirs...

Neither will funds left in taxable that get step-up in basis...

So if you end up spending down a large sum of taxable paying taxes on Roth conversions, you might have inadvertently paid more in taxes and thus passed down less to heirs by doing so.

Obviously, your specifics would determine what's "optimal".

"Neither will funds left in taxable that get step-up in basis..."
A valuable tool under current law for heirs up to the existing inheritance limits.

"So if you end up spending down a large sum of taxable paying taxes on Roth conversions, you might have inadvertently paid more in taxes and thus passed down less to heirs by doing so."
All funds in tax exempt will need to be removed eventually- wether you intend to donate them or earmark them for eventual heirs is one initial decision. After that any funds to heirs will incurr taxes either at your future tax rates or your future heirs tax rates, the most likely scenarions will depend on your specific details. Goals for heirs are to pass along the most spendable dolllars after tax and not to pass along the highest account value prior to taxes.
BernardShakey
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Re: Roth Money/Roth Conversions if Goal is Estate Planning

Post by BernardShakey »

mbt863 wrote: Mon Sep 13, 2021 9:12 am Hello....DW and I are in our early 50s and have a fairly significant (to me) amount in Roth IRAs. There is a very good chance we will not need this money during our lifetime so my goal is to earmark Roth $ for inheritance to my three children (currently aged 17-22—no disabilities).

I will likely early retire although DW may work a bit longer—we will see. In either scenario, we will have many years to do Roth conversions before 72—my current thought is up to the top of the 12% bracket with DW taking SS at 62 and me at 70 (neither of us have a pension). We will need ACA health insurance before 65 so know conversions may impact a subsidy but I’m ok with that so long as inheriting Roth dollars is as good as I think it is—thus the reason for this post.

Consider my questions below based upon the following assumptions: (1) we can pay tax on conversions from outside funds; (2) I live to 80 and my DW lives to 85—we invest Roth money aggressively (no RMDs—a big plus to Roth) and when DW dies Roth IRA has value of $3M; and (3) by the time DW dies tax rates are higher than now.

I would appreciate any input on my questions and would also be curious if others in my age/stage are planning Roth for estate purposes and how you are planning conversions. I know rules/laws will be different decades from now but just want to make sure I know the benefits or drawbacks under the current landscape before I make Roth conversions a priority in retirement. Thanks.

--Brian

Questions:
1. When I die my wife will inherit my Roth IRA. When she dies, it is my understanding that the $3M must be fully distributed within 10 years of her death to our children (the beneficiaries) under the SECURE act. Correct?
2. If my DW elects to equally distribute the $3M to three children as a lump sum on her death—it is a federal/state tax free $1M gift—correct?
3. Same assumptions as above but with one change and one new fact: DW dies later and Roth IRA has value of $9M and estate tax has dropped down to tax estates valued over $5M. DW’s only asset is the $9M Roth IRA. Even though this is after tax Roth dollars, the estate would be still be subject to estate tax (i.e. while distributions from DW’s Roth IRA up to $5M are tax free, $4M of the Roth IRA—or the amount above the $5M estate tax limit in my example—would still be subject to estate tax).

Now three practical/planning questions:

4. I agree with the advice of not trying to “rule from the grave” by setting up rigid distribution rules in an estate plan as impossible to know when/how my adult children will need the Roth IRA amounts after DW dies. However, would be interested on how others have addressed distributions on Roth IRAs if done for estate planning. That last decade of compounding after death—depending upon how the market performs—could be a powerful wealth building tool if my children are not in immediate need of that money. Just interested if anyone has tried to address this in a trust to provide flexibility if $ is needed earlier but keep Roth $ compounding as long as possible.
5. If the intent of my DW is just to equally distribute the full value of the Roth IRA as a lump sum to our children, should the children just be added as beneficiaries to the Roth IRA after I die or is it a better practice that a trust be established as the primary beneficiary of the Roth IRA.
6. I follow Roth conversion threads on BH but understandably the topic is focused on the original account owner. However, if the goal of conversions is estate planning it seems like a totally different analysis and more driven by benefit of additional uninterrupted compounding assuming you live into your 80s or beyond…i.e. if I/DW don’t need the $ during our lifetime, Roth conversions for estate planning is almost a no brainer as no RMDs with potentially an extra 10 years of compounding after death of DW with ultimate gift to children being tax free. The only exceptions that I can think of is if future tax rates are substantially lower than today or if taxable estate limits are much lower but feel free to poke holes in my general statement!
On #3 of your post, having to do with the federal estate tax exemption, I believe that your unused exemption can be transferred to DW upon your demise. So, in fact, your DW would have a $10M exemption in your example. Someone here can probably confirm whether I have this correct or not. I believe it is known as a "portability election."
An important key to investing is having a well-calibrated sense of your future regret.
Topic Author
mbt863
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Re: Roth Money/Roth Conversions if Goal is Estate Planning

Post by mbt863 »

Thanks for the responses. A couple of comments: (1) did not know about "portability election" so good to keep in mind so thanks for that response; (2) while I did know about step up in basis but had not made the connection in considering it in terms of roth conversions; (3) FiveK--thanks for the response and link to the McQuarrie study thread--I had read that thread before but not closely enough and think it gets to my question 6...i.e. if there is a very long time horizon (like in case of doing conversions in your 50s with goal to be used for estate planning) there is a very good chance it is a wise move.
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TomatoTomahto
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Re: Roth Money/Roth Conversions if Goal is Estate Planning

Post by TomatoTomahto »

mbt863 wrote: Wed Sep 15, 2021 6:42 am [snip…]if there is a very long time horizon (like in case of doing conversions in your 50s with goal to be used for estate planning) there is a very good chance it is a wise move.
if there’s a very long time horizon, there’s an increased likelihood of being affected by tax law changes.
I get the FI part but not the RE part of FIRE.
wrongfunds
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Re: Roth Money/Roth Conversions if Goal is Estate Planning

Post by wrongfunds »

Change that $3M and $9M to $30M and $90M just to understand the principle.

Does the estate tax now apply regardless of the asset class Traditional/Taxable/Roth ? Would the estate be paying high taxes on the Roth money?
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mbt863
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Re: Roth Money/Roth Conversions if Goal is Estate Planning

Post by mbt863 »

TomatoTomahto totally agree as who the heck knows what things will look like that far down the road but just trying to plan under the current landscape as best as I can.

Wrongfunds--I think the estate would be paying taxes on the Roth money if balances are that large and beyond the estate tax exemption but someone can correct me if I've got that wrong.
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