Written by Allan B. Cutrow

Unfortunately, the current health and economic crises have significantly and negatively affected asset values. However, these depressed asset values create significant planning opportunities to consider. One is the conversion of a traditional IRA into a Roth IRA.

Many investors often consider converting their traditional IRA into a Roth IRA as part of their overall retirement planning. Investments in a Roth IRA have the potential to not only grow tax-free (in the same manner as a traditional IRA), but also do not have required minimum distributions during the lifetime of the original owner and his or her spouse. In addition, distributions from a Roth IRA may be tax-free if all applicable distribution requirements are met. This differs from a traditional IRA which requires annual minimum distributions upon attaining age 72 (age 70½ for individuals who reached age 70½ before January 1, 2020). All distributions from a traditional IRA are taxable as ordinary income.  This means that Roth IRA assets may pass to your heirs with the additional benefit of not only growing income tax-free, but also being withdrawn income tax-free by your heirs at the end of the maximum period allowed by the current IRS rules (usually not more than 10 years after the second spouse’s death).

Anyone can convert their traditional IRA assets to a Roth IRA regardless of income or marital status. However, a Roth IRA may not be the preferred option for all investors. There are some important factors that you should consider before you decide if conversion is right for you. Perhaps the most important of these is that income taxes must be paid on every dollar in a regular IRA that is transferred into a Roth IRA.  These taxes can be quite substantial.

What makes this a particularly important consideration is that to maximize the benefits of the conversion to the Roth IRA, the taxes to be paid on the conversion should be paid from assets other than the assets in the traditional IRA to be converted to the Roth IRA. The combination of the amount of the taxes and having sufficient other assets to pay the taxes can be a deterrent to considering a conversion to a Roth IRA.

The conversion of a traditional IRA into a Roth IRA can be successful if the cost (the income tax to be paid on the conversion, plus the lost income earned/principal growth on the amount paid in income taxes, less the estate tax savings by removing the income tax from the estate) is less than the additional growth of the funds until they are drawn down from the Roth IRA. The longer the period of time until the funds are drawn down from the Roth IRA, the greater the benefit.

In today’s current environment, values of investments are reduced by at least 20%. This provides a unique opportunity to convert a traditional IRA into a Roth IRA. The tax cost of the conversion would be substantially reduced and the benefits of the additional growth would be enhanced by the built in gain when the value of the investments returns.

If there is available assets outside of the traditional IRA to pay the tax on conversion to the Roth IRA, then considering a conversion now may make perfect sense and offer a substantial benefit to the family estate plan.