Kitces: When NOT to Convert a Roth

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The tax-free nature of growth on a Roth IRA makes it a highly appealing investment account to hold, and a similarly appealing type of account to inherit. All else being equal, it’s clearly better to be the beneficiary of an account that will never be taxed than of one that will be taxed over time.

Yet there’s a caveat. A client who leaves a Roth IRA as an asset to inherit will have paid taxes to get money into the account — either through systematic after-tax Roth contributions spanning many years or through Roth conversions. Which means the benefit of inheriting a Roth IRA is actually more nuanced. If the original IRA owner has paid too much in taxes to create the Roth, the beneficiaries might be better off inheriting a traditional IRA and paying the taxes themselves.

Ultimately the decision of whether to bequest a Roth or traditional IRA should be driven by a comparison of the original IRA owner’s marginal tax rate and the expected marginal tax rate of the beneficiary in the future. If the beneficiary’s tax rates will be higher, it’s better for the current IRA owner to go ahead and convert the IRA, paying the taxes now at current rates and leaving the higher-income beneficiary a tax-free account.

But if the beneficiary’s tax rates will be lower — for any number of reasons — then the best thing a wealthy IRA owner can do is leave a traditional IRA, and let the beneficiary pay the taxes at his own lower tax rate.


Although there are several factors that determine whether a Roth or traditional IRA will be best, the dominating factor is a comparison of an individual’s current vs. future marginal tax rates. If rates will be higher in the future, it’s better to convert now to a Roth; if rates will be lower, it’s better to keep the traditional IRA, wait, and pay the taxes later at the lower rates.

For those who are working, the decision about whether to contribute to a traditional or Roth IRA often becomes an evaluation of current marginal tax rates (on wages and other income) versus what that marginal rate will likely be in retirement, when but clients may have a pension, Social Security or other income. Also consider the impact of retiring to a state with a different tax rate.

For those already in retirement, the decision-making process is similar, although the factors may be slightly different. For those who retire in their 50s or early 60s, there may be an opportunity to make Roth conversions while rates are especially low, before Social Security benefits begin — because the phase-in of taxation on Social Security benefits can dramatically increase the marginal tax rate. Even those in their 60s may wish to do significant ongoing Roth conversions to mitigate the tax impact of higher income in their 70s once RMDs begin.

The key point: Make sure movement of money to a Roth occurs when tax rates are lower.
Even in situations where an IRA will not be fully used by the original owner and will instead be left to a beneficiary, the traditional vs. Roth decision still follows the same formula. Calculate what the marginal tax rate would be now on the current IRA owner, and forecast what the tax rate will be when the beneficiary would ultimately withdraw the funds.

If the beneficiary’s marginal tax rate will be higher than that of the current IRA owner, it’s better to convert to a Roth now. If the beneficiary’s tax rate will likely be lower, it’s better to leave the beneficiary a traditional IRA (along with the dollars that weren’t used to pay the taxes on a Roth conversion), and let the beneficiary liquidate at the lower tax rate.

Let’s take an elderly, single father with $2 million in assets, including a $1 million IRA and a $1 million investment account. Due to Social Security benefits and an ongoing pension, he is already in the 28% tax bracket, and he hardly touches his assets because the Social Security and pension benefits are sufficient to cover expenses.

To leave a tax-free Roth to his daughter, he converts the $1 million IRA. The large conversion fills up all the tax brackets, so he pays about 28% in taxes on the first $100,000, 33% on the next $220,000 and 39.6% on the remaining $680,000. Because he lives in Colorado, he also faces a 4.63% state tax rate.

The total tax bill is over $416,000, for a marginal tax rate of 41.6% across the blended tax brackets. He pays the taxes from his brokerage account; if he dies shortly thereafter, his daughter would inherit a $1 million Roth IRA and $584,000 in the brokerage account.

Here’s the problem. His daughter is 28 and a teacher in Texas; her modest income puts her in the 25% tax bracket — and Texas has no state income tax. If she simply inherited the $1 million IRA and the $1 million investment account, the IRA would be taxed at an average rate of only 25%, stretched out over time, because RMDs for a 28-year-old start at less than 2% of the account balance.

By inheriting the $1 million traditional IRA, the daughter would ultimately face only about $250,000 of taxes, for $1.75 million net — compared with the $416,000 in taxes her father would have paid to convert it (leaving only $1.58 million net).

In situations where a beneficiary inherits a traditional IRA and not a Roth, the beneficiary will face taxes on both the traditional IRA itself and on any future growth, but will also have more money available to pay those taxes. In the above example, the $166,000 difference in taxes would provide a significant amount of “excess” inheritance (which itself can grow over time) to cover future tax liabilities of the inherited IRA, beyond taxes on the balance itself.


Evaluating the marginal tax rate of the current IRA owner is relatively straightforward: Look at what income is already coming in, and determine the marginal tax rate for additional income beyond that point. But there are a number of additional issues to consider when forecasting the beneficiary’s future tax rates.

Among them:

  • State of residence of the beneficiary and its state tax rate, especially if different from the IRA owner’s state.
  • Employment income of the beneficiary, if of working age.
  • Passive investment income.
  • Increase in potential income due to other inherited assets.
  • Number of beneficiaries, which could affect the dissipation of assets and RMDs. (For instance: A $2 million IRA for an individual has sizable RMDs, but leaving four $500,000 IRAs to four separate beneficiaries can slash the magnitude and impact of after-death RMDs.)

There are a few other issues. In the case of multiple beneficiaries, an IRA owner may have to balance the beneficiaries’ needs with some very different tax situations. Converting to a Roth IRA when at least some beneficiaries will be in lower tax brackets may still reduce overall family wealth, however.
If the IRA owner has charitable intent, it may be even more appealing to avoid converting, leave the IRA to charity and use other taxable assets to satisfy beneficiary bequests — especially if both the IRA owner and the beneficiaries are in a high tax bracket — because the charity has an effective tax rate of 0%.

If the beneficiary of the IRA will be a trust, it may be preferable to convert to a Roth. While trusts can qualify as “see-through” beneficiaries eligible to stretch the IRA, trusts that accumulate the IRA distributions inside the trust face the unfavorable trust tax brackets, with the 39.6% rate kicking in at just $12,150.

If IRA distributions to the trust will subsequently be distributed to the underlying beneficiaries, however, the trust will receive a distributable net income deduction and the income will flow through to the beneficiaries and their own individual tax returns — so if the eventual beneficiaries will have low tax rates, again, you may want to leave the trust a traditional IRA.


This analysis has one key caveat: It doesn’t necessarily apply if you know that the beneficiary will liquidate the entire IRA quickly upon inheriting it, potentially triggering top tax brackets, instead of stretching the traditional IRA.

There have also been proposals from lawmakers to do away with the IRA stretch rules and require most beneficiaries to use the five-year rule. If this happens, future IRA beneficiaries may be unable to avoid rapid liquidation, which could drive up their tax rate and make it preferable to convert the IRA in a more controlled manner before death.

With all else equal, there are a few other factors that can provide a slight tailwind benefit for converting to a Roth.

  • Avoiding RMDs during the owner’s life: The original IRA owner faces RMDs for a traditional IRA, but not a Roth. So if you expect the original IRA owner to live materially beyond age 70½, there is a slight benefit to having a Roth, allowing more tax-preferenced dollars to remain in the account.
  • Tax-efficient asset growth: If the Roth conversion can be paid for with funds from a taxable account, it is slightly more efficient in the long run to bequest the Roth — because while the traditional IRA will grow efficiently and tax-deferred, any side account left to cover taxes would itself be taxable and would face the ongoing drag of taxation on interest, dividends and capital gains.
  • State estate-tax protection: By doing a Roth conversion, the owner pays the income tax liability for the IRA and effectively reduces the size of the estate itself and potential estate-tax exposure — particularly important in states with significant estate taxes. (This is not necessary for those subject to federal estate taxes, but it is usually beneficial at the state level.)

Even so, in most cases these factors will still be trumped by a material difference in tax rates between the IRA owner and subsequent beneficiaries.

While there may be an intuitive appeal to inheriting (or bequesting) a Roth IRA, it can actually be destructive to family wealth if doing so comes at a cost of paying higher tax rates now than the beneficiaries would pay in the future on an inherited traditional IRA.

The final decision should be made by looking at who can ultimately extract the IRA dollars at the lowest possible tax rate for the family — the IRA owner or the beneficiary.

Michael Kitces, CFP, a Financial Planning contributing writer, is a partner and director of research at Pinnacle Advisory Group in Columbia, Md., and publisher of the planning industry blog Nerd’s Eye View. Follow him on Twitter at @MichaelKitces.

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Tax planning Retirement planning Financial planning