On Roth IRA Planning Opportunities

The decision to put your money in a Roth IRA in 1998 is based on how your personal income fits into the phase-out brackets (see graphic). Although reading and abiding by the brackets may be simple, there is a more complicated planning opportunity in 1998 involving the “conversion” or “rollover” of existing IRAs to a Roth.

BWFA will be reviewing the opportunity available to all management clients and all others who are interested in the Roth conversion this summer. If you are an existing management client, you will hear from us. Otherwise, please call us after April 15 and we will help you understand whether this planning technique may apply to you.

There are six key financial features that make conversion to a Roth so desirable.

  1. Tax Free Build-up without future tax liability.
    Roth IRA contributions are after-tax, but earnings are tax-free, and no tax is due on distributions. As a result, Roth IRAs may be better than 401(k) contributions for participants whose firms do not match their contributions in 1998. That’s a switch!
  2. Post-age70� deferral.
    Regular IRAs have required minimum distributions after age 70� which are designed to empty the IRA so that the tax is eventually paid. Roths do not have this feature. They don’t have to be emptied to pay taxes. The taxes are paid at the beginning.
  3. After-death tax-free growth.
    After a husband and wife die, the beneficiary of a Roth may be a child or even grandchild. It could be possible for such a beneficiary to have a 30 to 60 year life expectancy for required distributions. The beneficiary takes these small, annual distributions tax-free. And, the bulk of the plan grows tax-free in the meantime.
  4. Gross-up of IRA value by paying conversion taxes from other assets.
    If one has the financial ability to pay the conversion taxes (i.e., the income taxes) from other assets rather than from within the IRA, you are effectively grossing up the value of the Roth IRA. You are converting taxable assets to tax-free assets.
  5. Four year spread out of conversion taxes.
    Income taxes due on 1998 Roth conversions can be paid over 4 years.
  6. Prepayment of income tax temporarily lowers federal estate tax.
    When you pay the income tax on the conversion of an existing IRA, you are effectively paying the income tax, once and done. In the short-run, this has the effect of lowering the federal estate tax because it decreases the size of your estate by the amount of the tax. But, in the long-run, the federal estate tax liability may go back up since the Roth IRA can increase in value much faster in later years. Why? See 1. and 2. above.

The rules and phase outs make a Roth conversion decision quite difficult. In the real world there are a multitude of variables which will affect the outcome of the analysis we do here at BWFA: Roth conversion rules, size of the IRA, age of the owner, tax rates, growth rates, availability of non-IRA assets to pay taxes, age at death and actions of the beneficiaries. In fact, there are pending technical corrections to the Taxpayer’s Relief Act of 1997 which may affect the Roth. We are warily watching congress for technical corrections. Stay tuned.

Modified AGI: $95,000 Modified AGI: $110,000
Single Taxpayers
Can contribute Can contribute between Cannot
up to $2,000 $0 and $2,000 contribute
Married Taxpayers
Modified AGI: $150,000 Modified AGI: $160,000