Roth conversions can give clients, heirs tax flexibility

March 13, 2019


Key highlights

When planning estates, evaluate current and potential future income tax rates for clients and their beneficiaries.
The tax diversification benefits of a partial Roth conversion can help hedge tax uncertainty.
For clients who are charitably inclined, be sure that charitable contributions come from traditional IRAs.

Note: This article is the second in a three-part series on using Roth IRAs to maximize wealth transfers. The first article can be accessed here.

A partial conversion of retirement funds to a Roth account can give advisors flexibility in planning for clients' retirement and estate.

So says Garrett Harbron, senior manager, Vanguard Wealth Planning Research. For clients on the cusp of entering retirement, whose accounts consist mainly of tax-deferred retirement assets, a partial Roth conversion can build tax diversification. This can not only help manage the annual tax bite of withdrawals during retirement but also be a valuable part of an overall wealth-transfer plan.

"Life situations and future tax rates are uncertain, but you can help clients be prepared for that uncertainty by holding wealth in all three account types: taxable as well as tax-deferred and Roth retirement accounts," Harbron said. "Not only does having a Roth provide extra flexibility, but it also offers that benefit of tax-free growth and distributions for the future, which can help in so many ways."

Rule of thumb

The potential benefits of a Roth conversion hinge greatly on tax expectations—the current marginal income tax rate versus the rate when withdrawals from the traditional tax-deferred retirement account will be made. A common rule of thumb is that if a client anticipates similar or higher tax rates in the future, then a Roth conversion will likely be advantageous. If the marginal rate will most likely decline in the future, then maintaining the traditional tax-deferred account may be a sound choice.

The decision becomes more complex when planning across generations, but understanding clients' goals for their retirement accounts can help (see figure below). When considering how much to convert to a Roth, advisors might also reflect on the following:

  • For clients who intend to make significant withdrawals from the account for retirement spending, advisors should weigh their clients' current marginal income tax rate relative to their expected rate in retirement and factor in required minimum distributions (RMDs) and decisions about when and how best to claim Social Security benefits.
  • For clients intending to transfer the account to their beneficiaries, advisors should consider the beneficiaries' potential future marginal income tax rate. If the beneficiaries will likely be in a similar or higher bracket than that of the client, converting may be the better option because the conversion taxes will be paid at the clients' tax rate, and the appreciation of the Roth assets will be sheltered from future income taxation.

This "current versus potential future marginal income tax bracket" guideline should be viewed only as a starting point, Harbron added.

Regardless of an individual's income tax outlook, with good financial planning, a Roth conversion could be useful because of other considerations. "Roth accounts shield future growth from income taxes, so heirs would never have to worry about those,1 and it would keep the heirs' tax planning much simpler,' Harbron said.

As with any financial plan, it is important to understand clients' goals and time horizons. Weighing these factors holistically offers the best chance to meet financial goals while minimizing implementation costs, such as taxes, she said.

Tax rate considerations depend on account goals

Tax rate considerations depend on account goals

Source: Vanguard.

Stick with a traditional IRA for charitable bequests

Clients intending to leave a portion of their estate to a charity may find it advantageous to make the charitable bequest from a traditional IRA and leave taxable assets to their noncharity heirs. Because charities are tax-exempt, they do not have to pay income tax on the IRA and will receive the full value of the assets at the time of the bequest.

Furthermore, noncharity heirs can benefit from a step up in basis on taxable assets. This will reduce, if not eliminate, any capital gains tax that otherwise would have been due.

Click to read the next story in the series.

1 Inheritors may receive distributions exempt from taxation as long as the original account owner held the IRA for at least five years.


  • All investing is subject to risk, including the possible loss of the money you invest. We recommend that you consult a tax or financial advisor about your individual situation.
  • Withdrawals from a Roth IRA are tax free if you are over age 59½ and have held the account for at least five years; withdrawals taken prior to age 59½ or five years may be subject to ordinary income tax or a 10% federal penalty tax, or both. (A separate five-year period applies for each conversion and begins on the first day of the year in which the conversion contribution is made.)


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