Roth IRA “Gift”

I read an interesting article about Roth IRA conversions recently, and wanted to share some highlights with you, about an almost unbelievable estate planning possibility.

In the not too distant past, a couple of tax law changes created some major estate planning opportunities. The first change was the lifting of the $100,000 income restriction on who could make a conversion from an IRA or 401(K) to a Roth IRA. In the past, if a taxpayer’s adjusted gross income (AGI) exceeded $100K, a conversion to a Roth IRA was not allowed. Since the $100K AGI limit was the same for either single or married taxpayers, many people were precluded from making a conversion. By eliminating that income restriction, IRS has opened the door for people to make Roth conversions, regardless of the amount of income showing on a tax return. Keep in mind that income tax will need to be paid on the amount of the conversion, but the tax paid could potentially be far outweighed by the future tax saved. Read on…

The second change that has enabled a greater transfer of wealth was the increase in the generation skipping tax (GST) exemption, to $5,000,000. GST is owed when amounts in excess of the exemption are passed from an individual to a grandchild (inherited), effectively skipping a generation. Before the most current increase, the exemption was $3.5M, and had been scheduled to drop to $1M, before the last tax law change. What this means is that more assets can be transferred without estate tax or GST.

The “gift” I was alluding to in the title refers to what happens when the effects of the two law changes are combined. With no income limitations, it’s possible for an individual to make a Roth conversion of any size from an IRA or 401(K) account, and then $5M can be passed by inheritance to a grandchild, without having to pay estate tax or GST. If that grandchild is young, the value of that account can grow astronomically during that person’s lifetime. Even with required annual distributions for Roth heirs, those distributions would be income tax free, which could greatly offset the tax paid on the original rollover. That’s an incredible “gift” from the IRS!

This is a great planning opportunity for many people, not just the super wealthy. Speak with your favorite CPA about more details. As always, I’d be happy to field comments and suggestions on topics for future articles.


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