Don't Overlook Post-Retirement Roth Conversion Benefits

Building a Roth account can also serve as a hedge against potentially higher future tax brackets. For example, if the client anticipates selling a business or another asset at some point during retirement, the Roth can be drawn upon to control overall taxable income during that year to potentially avoid jumping into a higher tax bracket.

Clients, however, should remember that they must wait five years before they can withdraw the amounts that have been converted — meaning that the funds converted will be locked into the Roth for at least five years, or the client will incur a 10% penalty on the amounts withdrawn. That five-year clock starts running on Jan. 1 of the year the client executes the Roth conversion.

Estate Planning Workaround

Roth accounts are also a much more valuable estate planning tool today. Post-Secure Act, most beneficiaries of traditional retirement accounts must empty the account within 10 years of the original owner’s death — and pay the associated tax bill during that period. If the original owner died after the date that RMDs began, beneficiaries will also be required to take annual RMDs during years 1-9 after death. Any remaining amounts must be distributed in year 10.

With Roth IRAs, on the other hand, beneficiaries are not required to take required minimum distributions during that 10-year period, although the account must still be emptied within 10 years of the original owner’s death. Even when beneficiaries do withdraw the funds, they won’t have to pay taxes because they also inherit the benefit of tax-free withdrawals.

Clients who have accumulated large balances in traditional IRAs before entering retirement may be attracted to this strategy because it essentially allows them to prepay beneficiaries’ taxes at a time when the owner tends to be in a much lower tax bracket than beneficiaries are expected to be in their prime working years when they inherit the account.

Conclusion

As is the case with clients who are in their working years, it’s important to evaluate their big picture to determine whether a Roth conversion strategy might make sense during retirement.

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