I recently met with a tax planning strategy prospect. This husband-and-wife are both age 60 and have accumulated $2,000,000 in IRA assets and $1,000,000 in a taxable brokerage account. They also will be receiving a pension and Social Security income sufficient for all of their lifestyle needs; therefore these assets will likely be accumulated for the next generations.

 

When RMD’s (Required Minimum Distributions) are set to kick in at the new age of 72, at a very modest 6% rate of return the IRA account value would double to $4,000,000. The taxable account would also double, except it would suffer from an annual tax erosion for interest, dividends, and capital gains earned along the way. 

 

Assuming half the gain is taxable interest and dividends and the other half of the gains are unrealized long-term capital gains, the taxable account doubled but net of taxes would be worth $1,800,000 respectively (Case 1). After those twelve years, if they completed a Roth conversion in year one, [although that is NOT in my opinion the best strategy available] the ROTH IRA would be worth $4,000,000, and net of the tax bill paid for the conversion, the taxable brokerage account would be worth $603,000 (Case 2).

 

Twelve years from now, if something happened to this couple and you are the heir, which set of numbers would you rather be inheriting? To help answer that question, I’ve done some additional calculations.

 

Both of those accounts would be able to grow for another 10 years, the IRA or Roth IRA with the tax preference intact and no required distributions. Assuming further growth over those 10 years of 7%, the account values would once again double. Without the conversion taking place, respective values are assumed to be $8,000,000 and $3,345,000 (Case 1). Expected values should the Roth conversion mentioned above take place, would be $8,000,000 and $1,830,000 (Case 2).

 

Twenty-two years from now, when the IRA needs to be liquidated, if the Tax Cut and Jobs Act of 2017 somehow gets extended, the federal tax for liquidating an $8,000,000 IRA would be $2,890,000. Should that TCJA bill expire, the federal tax would be $3,100,000.

 

Assuming no state income taxes, the net wealth twenty-two years from now after liquidating the IRA Case 1 is $8,455,000 ($8,000,000 [IRA] – $2,890,000 [Tax Liability on IRA] +$3,345,000 [Taxable Account]). If the conversion took place the net wealth would be $9,830,000 ($8,000,000 [Roth IRA] – $0 [Tax Liability on Roth] + $1,830,000 [Taxable Account]) . That is an additional $1,375,000 of wealth, which represents a 16% increase in total wealth.

 

The illustrated case can get even better with detailed strategic Roth conversion planning. In addition, the implementation of additional tax mitigation strategies should occur. Paying $670,000 for converting the IRA in year one is excessive. The most ideal plan differs from case to case and is dependent on many factors, but it would be extremely rare to suggest such a large conversion in one singular year.

 

At Tax Plan for Wealth, Inc our tax strategists specialize in identifying the best-case scenarios for our clients using our Advanced Financial Freedom Plan™. Book your complementary initial consultation to see if we can provide a benefit for your family.