Is It Time To Consider a Roth?
Ever since passage of the Setting Every Community for Retirement Enhancement (SECURE) Act by Congress, effective January 1, 2020, financial and estate planners have been struggling with alternatives to allow parents and others who earned their traditional IRA’s and retirement tax qualified funds to pass them on to beneficiaries while mitigating the tax effect. The most serious impact of the new law is a requirement for most new recipient beneficiaries to cash out their newly acquired IRA’s within ten years. That might sound harmless enough but the catch is that, in receiving distributions, the new beneficiary must pay those taxes that were deferred in the traditional IRA. The “old” law, that is prior to 2020, essentially allowed RMD’s to be based on the life expectancy of the new beneficiary and spread them out over that time. Not now. The anticipated tax bill for those who inherit large traditional IRA’s is substantial. One possibility in planning is to take a closer look at other alternatives both when setting up an IRA and in what is known as a “traditional IRA to Roth IRA conversion.” Roths might begin to make more sense over time.
There are exceptions to the ten year cash out. Spouses inheriting from their deceased wife or husband still are able to inherit as though the traditional IRA were his or her own and take RMD’s based on his or her life own expectancy. Minors have special rules. Disabled and chronically ill individuals should also receive an exclusion although the definition of disabled and of chronically ill could be strict. Also, often for those individuals, inheritance may be in Trust. This factor generated discussion what kind of Trust with clear preference for what are known as accumulation trusts vs. conduit trusts. The reasons why would take more print than is available in this column. However, for your average adult son or daughter or grandson or granddaughter who is not disabled or chronically ill inheriting a very large traditional IRA can have catastrophic tax effect not only for the taxes on the fund itself but because it can bump their income into a higher tax bracket.
Why or how might Roth IRA’s be more involved in the planning process for retirement funds going forward? Again, this also involves more discussion than can be available in print but there are three issues that can be considered. REMEMBER this is a generalized discussion only. Specific actions should only be taken under the advice of a knowledgeable financial professional who knows your individual needs and goals. Here goes.
- Why you might consider a Roth for yourself. If you are bumping up on your retirement years but also still working or if you are just starting out, taking out a Roth vs. a traditional IRA means that you are paying taxes on the funds you invest. However, assuming you fit the criteria (e.g. keep the funds in the account for at least 5 years, withdraw at the appropriate age, etc.) at the back end you do not need to pay taxes on the accumulated income on the fund when you make withdrawals. Also you do not need to take RMD’s – the bane of many seniors who just want their account to continue to grow.
- Why your heirs might like inheriting a Roth vs. a traditional IRA. If your adult non-disabled, non-chronically ill son or daughter or grandson or granddaughter or person other than a spouse inherits a Roth IRA he or she also needs to cash out the fund within 10 years but the funds they receive do not come with the burden of paying deferred taxes. They carry through the benefit themselves. The choice – traditional vs. Roth – was clear from the beginning. You could pay taxes up front on the Roth without a tax benefit or defer taxes in the IRA that would need to be paid by your child/grandchild beneficiary over ten years.
- If you already have a traditional IRA or an employer plan that would be converted to a traditional IRA (rollover), do you have any options? Ok. So you are already well along and have a traditional IRA or rollover IRA, is there anything you can do? This is where IRA to Roth IRA conversations come into play. The idea is simple. The execution not so. If you are interested get very knowledgeable advice. This column is just an idea. Not the advice.
About the Author Janet Colliton
Esquire, Colliton Law Associates, P.C. Janet Colliton has practiced law for over 38 years, 37 of them in Chester County, Pennsylvania, a suburb of Philadelphia. Her practice, Colliton Law Associates, PC, is limited to elder law, Medicaid, including advice, applications and appeals, and other benefits planning including Veterans benefits, life care and special needs planning, guardianships, retirement, and estate planning and administration.