Rethinking Roth Conversions Under the Secure Act

By Ben Dolan, CFP®

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Early fall is always a busy time of year. Young families (like mine) are trying to get into a new routine with school and activities. Retirees are looking for ways to help their children and grandchildren while also sneaking away for a last-minute beach trip or to the mountains for peak leaf season. Whatever your goals, one of them was probably not perusing IRS Federal Regulation 58886 which dropped on July 19^th and provided updated rules regarding the SECURE Act. 

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In a July 26^th post, I outlined how the new regulations impact non-spouse beneficiaries of pre-tax assets (e.g Traditional IRAs). In short, the new regulations confirm that non-spouse beneficiaries of a decedent that passed away on or after their Required Beginning Date (the date by which they were supposed to start Required Minimum Distributions) must take from the pre-tax account annual Required Minimum Distributions each year for 10 years until the account is depleted.

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This is a BIG change to tax law. Prior to the SECURE Act, a beneficiary could “stretch” the distributions over their lifetime. The ability to stretch the account meant that a relatively small portion of the account total was distributed each year, minimizing the tax owed on the distribution. Going forward, beneficiaries will have to take a much larger percentage per year and pay the tax associated with doing so, until the account is fully depleted in year 10!

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This could be quite the tax trap, when you consider that parents often pass when their children are in peak earning years. Also, retirees with assets spread across after-tax and pre-tax categories may take only the Required Minimum Distribution per the IRS, which means the pre-tax accounts could grow as the owner ages, driving up the future tax liability for heirs.

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One way to avoid this tax trap is to consider Roth Conversions at a lower tax rate than your children may pay at the time of inheritance. Doing so requires making assumptions about future tax rates (like the sunsetting of the Tax Cuts and Jobs Act at the end of 2025) and the future earnings of your children. While making these types of assumptions can be a challenge, reviewing the calculations and various “what if” scenarios can prompt a healthy discussion about leaving your heirs in the best position possible to keep the most of what you’ve worked so hard to earn.