by Gregory Kolojeski
The following copyrighted article is available exclusively on the Roth IRA Web Site:
There are five financial or economic features of a Roth IRA conversions that make it so attractive. The first three are the most important. If you can take full advantage of the first three, a conversion to a Roth IRA is usually a dunk shot. If you take significant advantage of the first two features, you will usually be ahead of the game (in many cases, this will be true even if you pay the conversion taxes from the IRA itself). If you take advantage of only one of the first three, you sometimes still come out ahead, but not always. In many cases, the presence of two of the first three features will even outweigh unfavorable income tax bracket situations. Despite what many articles suggest, income tax bracket considerations are usually of little importance if you can take advantage of the most favorable aspects of the Roth IRA.
1. Post-70½ deferral
This is the tax-free growth and compounding that occurs after the point at which required minimum distributions would have been required under an ordinary IRA. This feature is tremendously important. If either the husband and wife survive past age 70½, the additional growth offered by withdrawing little or nothing for as long as possible adds tremendous value.
2. After-death tax-free growth
After the husband and wife die, the beneficiary will often be a child or even a grandchild. It will not be unusual for such a beneficiary to have a 30 to 60 year life expectancy for required distributions. The beneficiary takes such distributions tax-free with the balance of the plan growing tax-free in the meantime. This feature is tremendously valuable if one takes advantage of it.
3. 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 the IRA itself, you are effectively grossing up the value of the Roth IRA. You are effectively converting taxable assets to tax-free assets.
4. Four-year spreadout of conversion taxes for 1998 conversions
The value of this feature is generally overrated. Nonetheless, it is another piece with significant value even if it much less important than the previous three features.
5. Prepayment of income tax temporarily lowers federal estate tax
When you pay the income tax on the conversion, you are effectively prepaying the income tax. In the short-run, this has the effect of lowering the federal estate tax. This effect ameliorates the hit of the income tax. Of course, in the long-run, the federal estate hit will go up since the Roth IRA will usually increase in value so much faster than an ordinary IRA that you will eventually have more assets that are taxable for estate tax purposes. But having more assets (for you or your beneficiary) is the goal here. Of course, this feature is only important to those who are subject to federal estate tax.
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