OK, let’s remember that paying taxes on tax-postponed IRAs are inevitable. The tax judgment day will come… both during and after your life. The taxes must be paid at one point – at future tax rates, tax brackets and deductions that are unknown today. The IRS is an unwanted but a very real beneficiary of your retirement savings (while you’re alive taking any distributions… and at death).
Whatever the account balance on your traditional 401K/IRA statement shows, a good chunk of that money is NOT yours – it is owed to the IRS and maybe your state! You cannot spend the IRS’s dollars. Do yourself a favor and mentally erase 20%, 30% or 45%+ of whatever the figure that the statement shows is yours. It’s not all yours.
So, ROTH conversions can save you and your heirs significant tax dollars. I believe that taxes are “on sale” for the next 5-6 years – maybe even shorter depending upon the November election results. And when markets are down, the conversion costs even less. Let’s make hay while the sun shines!
As readers of my “Get me to ZERO” book know well, I believe most everyone should seriously consider ROTH contributions and/or conversions as part of your strategy to reduce your lifetime tax burden.
Besides paying taxes at low and known rates (using tax bracket management), ROTH conversions could reduce or eliminate your own RMDs and possibly lower the taxation of your Social Security and/or Medicare Part B and D premiums. But not everyone is willing to write the checks to the IRS today to do a ROTH conversion (even using the IRA funds if necessary to get all of those above benefits without changing lifestyle today).
So here is a different and tax-savvy potential solution to pay the inevitable future income taxes on tax-deferred accounts at a whopping 35%-55% discount when the primary IRA owner passes on.
Why might it be important to convert to a ROTH at death? Well, the surviving spouse’s taxes will likely skyrocket when they begin filing as a single. Married filing jointly tax brackets are generally double those of single filers. And the surviving spouse’s income will not likely be cut in half. RMDs alone could cause a huge jump in taxes owed! I see it every month. It’s something that few plan ahead for.
Our “ROTH Conversion LATER” (RCL) strategy only makes sense for those who don’t need their 100% of their IRA balance to fund their future lifestyle. Perhaps they have pension income, real estate rental income or other assets to fund most or all of their desired retirement lifestyle.
They will begrudgingly take their RMDs — only because they have to (the IRS wants to finally tax those dollars). We call them “Uncontrolled” RMDs. Forced distributions that you have no control over. Ones that could push you into a higher tax bracket on your excess pre-tax savings.
For those unwilling/unable to do total ROTH conversions over the next few years or will still have pre-tax funds after doing some conversions, here’s a thought. How would you like your spouse (or kids) to have the money to pay the taxes due and convert your IRA to their own ROTH at your death?
Once in a ROTH, your spouse will have no RMDs, possibly lower taxes on their Social Security and/or lower Medicare Part B premiums. Any money in their new ROTH that they don’t spend will then eventually go to your heirs – totally tax-free as well — for up to another 10 years od tax-free growth (under the new SECURE Act).
In a nutshell, this strategy has you distribute part of your IRA money now and over the next 7-10 years, pay the taxes due (at historically low rates) and use the after-tax net proceeds (using tax bracket management) to pay premiums into a cash-value life insurance policy. We can project your IRA balance at your life expectancy along with the potential taxes due and have the death benefit grow to as close to that amount (to pay the taxes) at death.
Your spouse will then convert your taxable IRA to their own ROTH – using the tax-free death benefit proceeds to pay for the conversion taxes. They’ll end up with their own tax-free ROTH with all the benefits thereof.
So where does the paying taxes at a big 35%-55% discount come in to play? We all know that people buy the death benefit with premiums that are much lower than the eventual death benefit. That’s how life insurance works (at least if it was properly designed but the agent).
Depending upon one’s age, sex and health at the time of application we may need to pay “X dollars” of premiums for just 10 years only. Yes, paying premiums for just 7-10 years. The younger and healthier you are, the lower the premiums needed. The lower your current tax bracket, the less we need to take out of your IRA now to pay the premiums.
For example, here’s a 65-yr old male in standard health. Let’s say that his $1 million IRA will grow to $1,455,000 million at his death at age 85 (after growing at an average of 6% per year minus taking the annual Required Minimum Distributions (RMDs) which grow to an astounding $100,066 RMD at age 85). And let’s say taxes would be 45% (in a lump sum conversion to a ROTH) at that point. That means we’ll need about $655,000 in death benefit to pay the total ROTH conversion taxes at that point.
In his case, we’ll need 10 years of $24,500 annual premiums to make this strategy work.
In order to pay 10 annual premiums of $24,500, we’d have to withdraw about $35,000 a year from the IRA and pay the 30% taxes (marginal tax rate on the IRS dollars distributed) to net the $24.5K premium. (Married filing jointly marginal rates for 2020 on taxable income of $171,050 – $326,600 are at 24%. I added in state taxes at 6%). Of course, your premium and/or tax cost on this strategy could be much lower or higher depending upon your age, health, income and the size of your IRA to convert at death.
After just 10 years of planned premium payments, we’d let the life policy cash value and death benefit grow. The total cost of the policy was $350,000 ($35,000 annual taxable IRA distributions for a 10-year period). That’s a 46% discount to the eventual tax paid of $655,000. Not too bad. Not too bad at all.
By taking advantage of this strategy, there would be a $305,000 cash TAX SAVINGS on paying the taxes on the ROTH conversion! The end result for the spouse (or kids) is they will inherit an IRA (now a ROTH) worth $1,455,000. TAX-FREE money. No more pesky RMDs. Maybe no more taxation of Social Security, etc. Maybe lower Medicare premiums and for sure, 100% control of the monies in the ROTH.
Dozens and dozens of you have read my blogpost and have used my free retirement calculator to do a 10,000-foot view of your retirement projections. And many of you had a very large IRA balance at your life expectancy (with IRAs worth millions!). Can you imagine what the taxes on those huge IRAs are going to be for your spouse or heirs? CLICK HERE to re-read that blogpost and GET FREE ACCESS to my retirement software to do your own projections. You can do unlimited projections for yourself.
Anyway, for many of those folks with very rosy retirements, using this “ROTH Conversion LATER” strategy will save their spouses and children well over $1 million of future taxes. Planning. Planning. Planning.
We can tweak the basic RCL strategy to keep premiums and tax costs to a minimum – depending upon your own circumstances (what if you’re not so healthy?). Remember that we are only using excess IRA capital to pay for the policy – which has the secondary benefit of reducing your future RMDs and perhaps keeping you in a lower tax bracket.
We are NOT changing your current lifestyle at all. We are simply setting up the payment of a future ROTH conversion (at whatever age death may occur) for the benefit of your spouse (and kids) by using the wonders of life insurance.
And for some folks, we can even use my “Catapult” strategy to increase the already whopping discount the ROTH Conversion LATER strategy by yet a further 25%-35% or more. But even without that formidable planning twist, the plain vanilla version works wonders as you have just seen.
If you are worth $7+ million or more, we can do another RCL-like strategy that has no out-of-pocket costs at all – but now we’re getting into serious estate planning (and lots of fun!).
This (RCL) is a proven strategy. In the same manner that life insurance was used for millions of Americans when the federal estate taxes would kick in for those who passed on with over $675,000 in assets (as recently as 2001 with an estate rate topping out at 55% after income taxes were paid). Do you remember those days?
Life insurance was the answer to that estate tax problem, and it can be the answer to this problem just as easily. And our proprietary software and planning shows how well it will work for you.
There are many ways to do PROACTIVE Tax Planning (my LLC’s name). Using the 7 strategies for a tax-free retirement that I describe in my latest book is one method. Advanced Tax-Savvy Planning for successful business owners and the high-earning self-employed is another. Add this “ROTH Conversion LATER” strategy to my list.
The wealthier you are the more opportunities we have in all financial planning respects. But this “ROTH Conversion LATER” strategy will be a godsend for millions of Americans that are concerned about higher taxes – especially in the future, yet are unwilling to do total or partial ROTH conversions now.
Please don’t be a puppet to the IRS rules and be forced to pay the most lifetime taxes possible. You can legally and morally take much greater control over your taxes today and in the future. You can literally save a fortune with many forms of tax planning and the use of various proven strategies. I can help. Let’s get to work on this.
all the best… Mark