This is the fourth article in a series dealing with the topic of converting your traditional IRA to a Roth IRA. For other articles, see:
Part 1 – Reasons to Consider the Roth Conversion
Part 2 – The Recharacterization Option
Part 3 – The Impact of Income Tax Rates
Part 5 – The Impact of Investment Returns During the First 21 Months
Part 6 – The Impact of Estate Taxes
Part 7 – Ramifications of Charitable Giving
Part 8 – Putting It All Together
If you convert to a Roth IRA, you are betting that the present value of incremental withdrawals by you and your family in the future are greater than the taxes you will pay at the time of the conversion. Future withdrawals will be maximized when you and your heirs keep the Roth IRA intact for a long time.
The first and most important hurdle for keeping the Roth IRA intact is whether you can pay the tax on the conversion from other assets. If you must use funds from the IRA to pay the tax, my advice is to not make the conversion.
The next hurdle is whether you and your spouse will need to take withdrawals from the Roth IRA. One benefit of Roth IRAs is that you do not have to take required minimum distributions during your lifetime. If you designate your spouse as the beneficiary following your death, your spouse can rollover the Roth IRA to his or her own Roth IRA. Your spouse will not have to take any distributions during his or her lifetime. Thus, if you and your spouse can meet your living expenses from other sources, you will never have to take a distribution during your remaining lifetimes.
The final hurdle is the time period over which your children (and/or grandchildren) will take withdrawals from the Roth IRA after you and your spouse die. They will be required to take distributions over their remaining life expectancy, determined under IRS tables at the death of the survivor of you and your spouse. For example, if the beneficiary is age 45, his or her life expectancy is 38 years.
Your beneficiaries will be eligible to leave the Roth IRA intact for a long time. However, imagine the temptation for the beneficiaries to make tax-free withdrawals to buy new cars or to take vacations. If you are concerned that your beneficiaries might take distributions for wants rather than needs, you can use a trust as the beneficiary of the Roth IRA. The Trustee would be required to withdraw the required minimum distribution and could withdraw more if the beneficiary needs more. In addition to slowing down withdrawals, the Trustee might add investment expertise that the beneficiaries lack.
Families that can meet spending needs from sources other than the Roth IRA have more to gain from converting a traditional IRA to a Roth IRA. If the Roth IRA will be liquidated relatively quickly, paying tax now is less likely to provide a benefit to your family.