The Best Time for Roth IRA conversions: Before or After the Death of the Stretch IRA?

For many individuals, a series of well-timed Roth IRA conversions can be the best defense against the Death of the Stretch IRA.

The Best Time for Roth IRA conversions: Before or After the Death of the Stretch IRA?

A lot of clients ask me if I manage my own finances the way I recommend they manage theirs, and the answer is definitely “yes”.   I realized though, that I have not told you my own Roth IRA conversion story, and how my decision will affect my own family after the Death of the Stretch IRA.

Roth IRA Conversions – The Best Time is in Years of Low Income

Think back to 1998.  It was long before we ever had to worry about the Death of the Stretch IRA, and it was the first year you were permitted to make Roth IRA conversions.  Back then, if your Modified Adjusted Gross Income was more than $100,000 you were restricted from making Roth IRA conversions.  Our family’s income was over $100,000, so I thought my income restricted me and never imagined I’d be eligible to do Roth IRA conversions myself.  Then on February 16, 1998, our office was wiped out by a devastating fire that started in a pizza shop located directly below us.  Can you imagine this happening to a CPA firm in the middle of tax season?

I learned some valuable lessons from this experience.  First, never put your office above a pizza shop.  Second, I learned more about the insurance process than I ever cared to know.  We had extremely high expenses because everything needed fixed and, even though I was well insured, I didn’t get the check for the damage until 1999. That meant that 1998 was a very tough year for the business financially.   I couldn’t take a salary, and for the first time our family’s income was far less than $100,000.  Did I get upset?  No.  I said to my wonderful wife, “Cindy, I think we have an opportunity here”.

My wife and I had about $250,000 in Traditional IRAs between us.  I told her that our normal income level would restrict us from making Roth IRA conversions, but our income in 1998 was far below normal – making that year the best time for us to do Roth IRA conversions.  I told her that I thought we should convert the entire amount to Roth IRAs and voluntarily pay the tax due the $250,000 conversion amount.  After she got over her initial shock, she looked at the mathematical calculations I had done and, being an extremely intelligent woman, she immediately understood that our family would be better off by hundreds of thousands of dollars in the long run.  And so we did it – we converted every last dime of our IRAs to Roths.  And those Roth IRAs are now worth quite a lot more than they were in 1998.

The law has since changed, and there are no longer any income restrictions on Roth IRA conversions.  This means that you can do smaller Roth IRA conversions over a series of years rather than all at once like I did, and by doing so you can convert them at a lower tax rate than I was able to.  The best time for many retired individuals is the period after you’ve stopped working, but before you are required to take minimum distributions from your IRAs and retirement plans.  And with the Death of the Stretch IRA looming, there are probably even more reasons now for you to consider Roth IRA conversions than I had when my office caught fire in 1998.

Transferring my Roth IRA to My Child

Twenty years later, it is likely that Cindy and I will never spend those Roth IRAs.  Some people will argue that, if that’s the case, there was no benefit to us converting our IRAs to Roths.  Why pay tax when you didn’t have to, they ask?  Well, I guess it’s because, in the long run, I was thinking of what would happen when I die and my Roth IRA is transferred to my child.  My daughter Erica was only three years old when we did those Roth IRA conversions.  If I die tomorrow and my Roth IRA is transferred to her, she’ll be hundreds of thousands of dollars better off because I did that conversion.  And if I live for another twenty years, it’s not unreasonable to think that she’ll be more than a million dollars better off when I die.

When my Roth IRA is transferred to her after my death, Erica will still be required to take minimum distributions from the account every year.  If I die before the Death of the Stretch IRA legislation is passed, those minimum distributions can be stretched over her lifetime and the bulk of the IRA can continue to grow in a tax-free environment.  If I die after the Death of the Stretch IRA legislation is passed, she’ll be required to withdraw the entire IRA within five years.  Although the money will be forced from the tax shelter more quickly, at least the withdrawals will be tax-free to her.  And I can’t think of a better present for my little girl.

Stop back soon for more Roth IRA talk!

-Jim

For more information on this topic, please visit our Death of the Stretch IRA resource.

P.S. Did you miss a video blog post? Here are the past video blog posts in this video series.

Will New Rules for Inherited IRAs Mean the Death of the Stretch IRA?
Are There Any Exceptions to the Death of the Stretch IRA Legislation?
How will your Required Minimum Distributions Work After the Death of the Stretch IRA Legislation?
Can a Charitable Remainder Unitrust (CRUT) Protect your Heirs from the Death of the Stretch IRA?
What Should You Be Doing Now to Protect your Heirs from the Death of the Stretch IRA?
How Does The New DOL Fiduciary Rule Affect You?
Why is the Death of the Stretch IRA legislation likely to pass?
The Exclusions for the Death of the Stretch IRA
Using Gifting and Life Insurance as a Solution to the Death of the Stretch IRA
Using Roth Conversions as a Possible Solution for Death of the Stretch IRA
How Lange’s Cascading Beneficiary Plan can help protect your family against the Death of the Stretch IRA
How Flexible Estate Planning Can be a Solution for Death of the Stretch IRA
President Trump’s Tax Reform Proposal and How it Might Affect You
Getting Social Security Benefits Right with the Death of the Stretch IRA
The Best Age to Apply for Social Security Benefits after the Death of the Stretch IRA
Part II: The Best Age to Apply for Social Security Benefits after the Death of the Stretch IRA
Social Security Options After Divorce: Don’t Overlook the Possibilities Just Because You Hate Your Ex
Is Your Health the Best Reason to Wait to Apply for Social Security?
Roth IRA Conversions and the Death of the Stretch IRA
How Roth IRA Conversions can help Minimize the Effects of the Death of the Stretch IRA
How Roth IRA Conversions Can Benefit You Even if The Death of Stretch IRA Doesn’t Pass
The Death of the Stretch IRA: Will the Rich Get Richer?