Taking the Long View: ROTH conversions and non-spouse beneficiaries after the SECURE Act:

In previous installments, we discussed the tax planning benefits associated with strategic ROTH conversions, especially prior to age 72 when Required Minimum Distributions begin.  As you will remember, these conversions may be done each year to convert pretax retirement accounts that have never been taxed, to tax free ROTH accounts. The conversion creates taxable income, but can be done in the years when you are in a lower marginal tax bracket. The goal is to intentionally fill up the lower tax brackets now with ROTH conversions, rather than waiting until age 72 and beyond when your marginal tax bracket may be much higher.

But the recent SECURE Act provides another benefit of ROTH conversions, specifically to non spouse beneficiaries. The SECURE Act eliminated the very preferential stretch IRA treatment given to non-spouse beneficiaries of pretax retirement accounts. Prior to the law change, your beneficiary could receive an inherited IRA and “stretch” the distribution out over their entire lifetime, paying only a relatively small amount of tax each year.  Now the entire IRA must be distributed within a 10-year period with exceptions for the following beneficiaries:

  • Minors, until they reach the age of majority (or age 26 if still in school).
  • Disabled or chronically ill.
  • Less than 10 years younger than the IRA owner.

For individuals not covered by these exceptions and who are in their prime high earning years, inheriting a large, pretax IRA could be a bittersweet experience.  Their inheritance will come with a large tax bill eroding the intended transfer of wealth.

However, if the IRA is converted to a ROTH, the beneficiary will receive an inherited ROTH IRA.  While the ROTH IRA will also have to be distributed over a maximum of 10 years, the distributions are tax free to the heirs. 

To maximize this type of planning requires some real foresight spanning more than one generation.  So, if your intention is to create wealth beyond your own lifetime needs and to transfer it efficiently to the next generation, this strategy may prove helpful.

At Level Financial, we assist our clients with this type of thoughtful and proactive long term planning.  We work collaboratively with your accounting and legal advisors to implement and monitor optimal wealth management strategies over your lifetime and beyond.  Our firm’s team approach helps support continuity and your peace of mind.

Winfred Jacob, CFP®
Senior Financial Advisor

Winfred Jacob
Winfred Jacob