THE Roth IRA: A POWERFUL-ESTATE PLANNING TOOL

As you plan your client's estate, you may want to consider a new strategy involving converting your traditional IRA to a Roth IRA. A Roth IRA offers six key benefits that can help you make the most of your client's retirement-account assets and permit him leave more of your estate to your heirs.

1. Your Roth IRA earnings grow tax-deferred. Roth IRA contributions are always made with after-tax dollars, because you must pay income taxes up front when you convert. However, you don't pay taxes on the assets as you invest them, and thus your client's investments can accumulate faster than they would otherwise.

2. Qualified withdrawals from your Roth IRA are income-tax-free and penalty-free. Moreover, the rules governing when Roth IRA assets can be withdrawn tax-free are more favorable than a traditional IRA. When these new ordering rules are applied, all of your Roth IRAs are treated as one account:

The first money you withdraw is considered to come from any annual Roth IRA contributions you have made. These withdrawals will always be income-tax-free and penalty-free because paid taxes have already been paid on the contributions.

Next, any amounts you converted from traditional IRAs are withdrawn. These assets will also be tax-free and, if your client has held the money in a Roth IRA at least five years after conversion,he will avoid the 10% early-withdrawal penalty tax. Thus, he may have access to his account. Tax due prior to age 59 1/2.

Finally,there is withdrawal of investment earnings. These earnings will be tax-free and penalty-free as long as your client satisfies a five-year holding period and he is older than age 59½, dies, become totally and permanently disabled, or uses the proceeds (up to a $10,000 lifetime maximum) to purchase a first home. The five-year holding period begins on January 1 of the year for which you made your first Roth IRA contribution, whether it was a conversion or an annual contribution.

3. Roth IRA assets continue to grow tax-free as long as your lives. The Roth IRA provides flexability as how long you wish to keep retirement assets growing on a tax- advantaged basis-and when, or if, to take distributions to commence after the account. Unlike a traditional IRA, a Roth IRA doesn't force distributions after age 70½, and your client may be eligible to make annual contributions of up to $2,000 to the account after that age, as long as he has earned income. Because a Roth IRA allows your assets to continue growing tax-free without any withdrawls and undisturbed for the rest of your life, your client can pass more of your retirement-plan assets to his heirs.

4. Your heirs won't have to pay federal income taxes on the Roth assets they inherit, no matter how much the account might grow. With a traditional IRA, your heirs would owe federal, and possibly state and local, income taxes as money is withdrawn. Without proper planning, beneficiaries of traditional IRAs could lose (to taxes) up to two thirds of every dollar inherited. With a Roth IRA, any money you don't spend passes to your beneficiaries free from federal (and often state) income taxes. However, estate taxes continue to be payable.

5. Your Roth IRA assets can continue growing tax-free for your spouse. If the bene-ficiary of your Roth IRA is your spouse, he or she can roll the inherited assets into his or her own Roth IRA where they can continue to compound tax-free dur-ing the remainder of your spouse's life. This results in a deferal of any estate taxes.

6. Your Roth IRA can provide your heirs with tax-free growth and income. When the IRA owner-either you or your surviving spouse-dies, the nonspouse beneficiary, such as your child or grandchild, must start mandatory distributions. However, rather than withdrawing the entire amount, your beneficiary may be eligible to take smaller, annual distributions from the account based on his or her life expectancy. The assets remaining in the Roth IRA will continue to grow federal--income-tax-free and the distributions will be tax-free as well. Thus, the Roth IRA may allow your beneficiary to receive tax-free income for the rest of his or her life. It also provides flexability for your heirs.

Is Converting Right for You?

Many people believe a Roth IRA conversion would not be advantageous because they assume their income and tax bracket will be lower in retirement. However, this may not be the case, par-ticularly if your client is are a successful saver who has accumulated a large investment portfolio. The bull market makes it less likely that your tax bracket will necessarily decrease.

Furthermore, if your objective is to preserve IRA assets for your heirs, you may need to consider their future tax rate rather than your own. Your beneficiaries could inherit your IRA assets in their peak earning years when their tax brackets are high. Converting your traditional IRA to a Roth IRA now may be beneficial, assuming you can pay the taxes due at a lower rate, since your heirs will be able to withdraw the assets free from federal income taxes.

Eligibility to Convert

A persons is eligible to convert a traditional IRA to a Roth IRA during any tax year in which his modified adjusted gross income (MAGI) is $100,000 or less. This limit applies to both single taxpayers and married couples filing a joint return. Married individuals filing separate returns do not qualify for conversion. If you convert to a Roth IRA and later discover your MAGI that year exceeded the $100,000 ceiling because of unexpected earnings, such as a year-end bonus, you can transfer the money from the Roth IRA back to a traditional IRA without penalty until the due date of your federal tax return (including extensions).

Although you will have to report the taxable portion of the conversion as income, the size of your taxable estate will be reduced by the income taxes you pay. This results in savings of the state the maximum federal income tax rate is less than 40%, but estate tax rates can range as high as 60%. Thus, converting a traditional IRA to a Roth IRA may result in a lower tax rate for retirement-plan or non-retirement plan dollars.