Last week’s column generated a couple of follow up questions from a couple of savvy readers!
Reader Follow Up Question #1: This question had to do with the advisability of a sixty-five-year old doing a Roth conversion. I intimated that it made sense if the conversion could be done at lower tax brackets, say 15%, and you didn’t expect to need the funds and it makes even more sense if your children who inherit your Roth took the money out as slow as the law allowed.
The reader had this to say, “In your article about Roth IRAs you stated, ‘If your children would have the good sense to take only minimum required distributions from the Roth, this is a significant fact in favor of a Roth conversion.’
Say what? Please read that carefully and tell me that is not what you meant to say! Or maybe my brain is fried? It is my understanding of the law that there are NO required minimum distributions from Roth IRA, one of the greatest benefits of the conversion to them.” E.C.
Answer: I wish I could say, “It ain’t so”, but it is so! Let me explain. If you establish a Roth IRA or convert a traditional IRA to a Roth, two big advantages are:
- Future distributions at retirement will never be subject to income taxes (some early withdrawal penalties may apply).
- You are never required to take Required Minimum Distributions (RMDs) during your lifetime. This is also true of your spouse if he or she is your beneficiary.
So far so good. Unfortunately, when a non-spouse, presumably children, ‘inherit’ a Roth, they must begin taking RMDs no later than December 31st of the year following the year of death of the Roth owner. If you miss this deadline, then all of the Roth must be withdrawn by December 31st of the fifth year following the year the owner died. There is some good news in that the required distributions will be based on the child’s life expectancy. For example, say you inherited your father’s $100,000 Roth IRA at your age 55. Based on the IRS single life expectancy tables, you are expected to live 29.6 years. To calculate your RMD, divide $100,000 by 29.6 and you get your RMD of $3,378. You must recalculate the RMD each year. The best news is that all of the distributions will be tax free! It seems that the government doesn’t want the money locked up forever. They want to get it circulating so it can eventually be taxed!
Reader Follow Up Question #2: In another topic, I discussed a case where the mother made sure her child’s name was on all of her assets so as to avoid probate at her death. I noted that the child, in addition to avoiding the time and expense of probate, would receive a ‘step-up’ in cost basis on appreciated stocks and real estate at her mom’s death. This reader asked for clarification:
“In today’s column, you indicated that a man would avoid tax on the stepped up value of his mom’s stock when she passes. But if his name is on that stock (as implied in the column) does that rule apply, since he is already listed as co-owner? We have a similar situation as my wife is listed as one of the owners of some vacant land (along with her father). I fear that the original value would still apply. F.I.
Answer: This reader is correct in that you must be careful that when adding a child’s name to assets that the father doesn’t actually create a change of ownership to the child. For bank accounts and brokerage statements, the father could sign a ‘Pay on Death (POD) Agreement’. For property, the father should be careful to pay the property taxes himself and always use his Social Security number as identification of the property or accounts. Proper record-keeping is the key to maintaining ownership in the father’s name and therefore preserving the step-up in cost basis. I strongly recommend that you consult with an attorney or tax advisor for these types of transactions.