Having worked hard and planned well, an IRA owner may find that the accumulated funds of the IRA are not needed for retirement. The IRA likely has considerable value, however, and since a traditional IRA is subject to both estate and income taxes, over half of its value may be depleted by the time the beneficiaries receive any benefit.
The Roth IRA advantage
A Roth IRA has several important advantages over a traditional IRA. A Roth IRA is not subject to required minimum distributions (RMDs), income tax upon distribution, or income in respect of a decedent (IRD) upon receipt by beneficiaries after the IRA owner’s death.
When converting a traditional IRA to a Roth, income tax must be paid on the IRA assets. By using life insurance to fund the income tax that must be paid upon the conversion, the full value of the IRA can be preserved. To maximize the value of a Roth IRA to the named beneficiaries upon the owner’s death, an additional insurance policy may be obtained to pay for the estate tax that will be attributable to the Roth IRA upon the owner’s death.
The following is a strategy to help maximize the value of the IRA when the spouse is the IRA beneficiary named on the traditional IRA.
Maximizing the IRA’s value for the beneficiaries
Consider preparing for the future by converting a traditional IRA to a Roth IRA upon the IRA owner’s death. Anytime after the IRA owner reaches the age of 59 1/2 , when there is no penalty for the withdrawal of funds from the IRA, he/she withdraws an amount sufficient to purchase a life insurance policy.
Because a Roth conversion is subject to income taxation, this solution provides a source of liquidity to pay the taxes. At the IRA owner’s death, the traditional IRA is passed to the spouse (without estate taxes under the unlimited marital deduction). The spouse converts the traditional IRA to a Roth IRA, (provided he/she meets the $100,000 income cap for Roth conversions, which no longer applies after 2009). The major benefits of the Roth IRA are that there are no distribution requirements and any distributions taken are income tax-free.