By Kevin Cotton and Steven Joshua Samuel, JD, MBA, AIF® Roth IRA accounts allow a taxpayer to contribute after tax money to an account which is never taxed again. The popularity of Roth accounts has grown and presents unique opportunities for retirement and for supercharging bequests to family or friends after the lifetime of the original owner. Converting Pre-tax Assets Eliminates Future Taxation Some people are fortunate enough to accumulate amounts of money in retirement that are more than enough for their own spending needs. For those taxpayers, converting some of the assets from a traditional IRA to a Roth IRA offers major advantages. Conversions to Roth IRAs are most commonly done with traditional IRA assets, but some 401(k) and other employer sponsored retirement plans even allow for “In-Plan” conversions. Converting money in a traditional IRA to a Roth IRA does require payment of income taxes. However, paying taxes upfront allows assets to then grow tax-free forever.  And, the Internal Revenue Code does not require minimum distributions at age 70.5 from Roth IRAs as it does from traditional pre-tax accounts. It is best to pay the tax using cash not in the traditional IRA for two reasons:

1. So that the entire pre-tax balance is converted, ultimately increasing the after-tax value.
2. To avoid the early withdrawal penalty on taxes paid from the Traditional IRA when the IRA owner is under age 59 ½ at the time of the conversion.

For taxpayers who intend to pass gifts to future generations, a Roth IRA can magnify the gift. Magnifying Gifts to Future Generations with Roth IRAs Roth accounts (or converting traditional IRAs to Roth) can be very effective as an estate planning and wealth transfer tool, especially if gifts to younger people are important goals. Since Roth IRAs do not require owners to take required minimum distributions, the account balance will continue growing and can ultimately result in a much higher balance being transferred to the named beneficiary after the original owner’s death. When a Roth is transferred to a younger beneficiary at death, the Roth becomes the beneficiary’s account. Some factors make the inherited account extremely valuable. Withdrawals from inherited Roth accounts are always free of penalty and are generally tax-free to the beneficiaries. Please note that inherited Roth IRA distributions may be subject to tax if it has been less than 5 years since the original Roth IRA owner funded his or her first Roth IRA. Although required minimum distributions do not apply to original owners of Roth accounts, they do apply to inherited accounts. However, required distributions are taken based on the heir’s life expectancy rather than the original owner’s life expectancy. For this reason, younger people will ultimately have a much higher balance inside the Roth, growing tax-free forever. Two examples of the magnifying effect of gifting a Roth IRA to a younger person follow below. Real Life Scenarios Bob, age 65, is considering leaving his $50,000 traditional IRA to his daughter, Jane, or grandson, Jack. He wants to know whether converting his traditional IRA to a Roth and paying the taxes on the conversion is a better idea. If Bob chooses the Roth conversion, he will pay the necessary tax with money outside of the IRA so that the full $50,000 balance is converted. This will cost Bob anywhere from $5-15,000 depending on his tax bracket, but see below for how well the Roth rewards that sacrifice. Scenario 1:

• Assuming a 6% annual growth rate, the $50,000 Roth account balance grows tax-free (without required distributions) to approximately $127,021 at the time of Bob’s death at age 80.

• Compare the Roth total of $127,021 with what would happen without the Roth conversion. The traditional IRA requires distributions starting in the year Bob turns 70.5 and would grow to only approximately $79,500 at the time of Bob’s death at age 80.

• Jane inherits the $127,021 Roth account at age 45. Jane now enjoys tax-free growth and is only required to take out small annual required distributions based on her longer life expectancy.

• Jane sees the inherited assets as additional retirement savings and lets the balance grow. At age 65, the Roth account grows to approximately $200,909, compared to only $125,746 if Jane had inherited a traditional IRA.

Scenario 2:

• Assuming a 6% annual growth rate, the Roth account balance grows tax-free (without required distributions) to approximately $94,917 at the time of Bob’s death at age 75. The similar traditional IRA requires distributions starting in the year that Bob turns 70.5 and grows to approximately $75,392 at the time of Bob’s death at age 75.

• Jack inherits the $94,917 Roth account at age 10. Jack now enjoys tax-free growth and is only required to take out small annual required distributions based on his longer life expectancy.

• Jack sees two possible uses for the inherited assets: college expenses and the purchase of a home:

• At age 18 and assuming a 6% annual growth rate, the Roth account grows to approximately $129,373, compared to only $102,763 for the similar inherited traditional IRA

• At age 40 and assuming a 6% annual growth rate, the Roth account grows to approximately $312,907, compared to only $248,541 for the similar inherited traditional IRA

Notes: The above estimates assume 6% annual growth, 25% total taxation on all withdrawals, 15% total taxation on investments, and that RMDs are taken at the end of each year. These are hypothetical examples and are for illustrative purposes only.  Actual performance and results will vary. As the figures show, using Roth assets as a wealth transfer tool can be a very effective way to increase the value of a gift over time to a younger beneficiary. Since the inherited account does not have restrictions on withdrawals, the increased value can be a useful source of funds for various important goals in a beneficiary’s life. As always, consult a trusted financial advisor before implementing investment strategies. Samuel Financial LLC is located at 858 Washington Street, Dedham, MA 02026 and can be reached at 781.461.6886.  Securities and advisory services offered through Commonwealth Financial Network, member FINRA/SIPC, a registered investment adviser. Fixed Insurance products and services offered through CES Insurance Agency.