complex question re should elderly parents convert IRAs

Submitted by robert axelrod on Thu, 2017-01-19 17:56

My parents are elderly and in poor health and at least one certainly will not survive 2017; the other very likely won’t.

They are 72 and 81 and have TIRA assets approx. $2million; cash approx. $2million; and some other investments which aren’t relevant. They are in the 33% tax bracket plus a state tax of 5%. Their beneficiaries are 2 adult children, both financially successful.

The questions are whether they should convert their IRAs to Roths; and whether they should make 4 grandchildren (2 of each adult child), all minors, the beneficiaries of the IRAs. The adult children do not need the IRA money. Currently the estate plan is to leave the TIRAs to the adult children, 50:50, without a trust.

There are several issues here. The adult children are physicians so asset protection is relevant. That might make a trust attractive. However, trusts have high income tax rates, higher than either adult child currently pays. So having to take RMDs out of inherited TIRAs in trust is unattractive. My thinking is that if my parents convert IRAs to Roths, using the cash to pay the taxes at a maximal rate (39.6% plus state), then leaves the Roths to the grandchildren in trust, all RMDs can be distributed from the trust without paying the onerous trust income tax rate; in addition the RMDs will be based on the life expectancy tables for them (ages 0-9) rather than us (ages 39-43). That grants an additional 30-40 years of withdrawals, a very attractive option. The downside is paying the taxes on a $2 million conversion, however some amount of that is done at less than the top rate, so net-net it is still better than having the heirs pay the maximal rate on all but the first ~$12,000 of TIRA distributions each year. On the other hand, the grandchildren will each be in low tax brackets for 20 or more years, so if distributions from a TIRA are kept low (ie, at RMDs only), they may pay low tax rates for a number of years going forward. Only as the assets grow, and RMDs increase, will the trust income eventually surpass the ~$12,000 figure and incur the highest trust tax rate.

In addition to all that, one of the adult children lives in a state with an onerous estate tax, so keeping that money out of his (my) estate is attractive.

Finally, there is the question of future tax law change. Given our new president, trust taxation levels, income tax rates generally, and estate taxes all seem ripe for change to the lower.

What do you think about this hot mess?



Submitted by Bruce Steiner on Sun, 2017-01-22 00:11

  • Since the children are physicians, they would leave their non-IRA assets to the children in separate trusts for their benefit.  That would keep the children’s inheritances out of their estates for estate tax purposes, and would provide protection against the children’s creditors and spouses.  Each child could effectively control his/her trust.  (Our clients would almost always do this even if the children weren’t physicians, since you never know what the future will bring.)
  • The next issue is whether to leave the IRAs to or in trust for the children, or to or in trust for the grandchildren.  If the younger parent is 71, the children are probably still relatively young, and would still get a reasonable stretch.  However, since the children are physicians, and since the non-IRA assets will still be available for the children, they might want to leave the IRAs in trust for the grandchildren, so as to get a much longer stretch.  
  • If they’re not sure whether to leave the IRAs in trust for the children or in trust for the grandchildren, they could leave the IRAs in trust for the children, and provide that if a child disclaims his/her interest in the IRAs, his/her share goes in trust for his/her children.  
  • There’s no way to predict future changes in the tax law over the life expectancy of the children, or over the life expectancy of the grandchildren.  In that regard, you should keep in mind that most of the required distributions will be in the later years.  
  • It might be worth spending a few hours running some numbers (or having the lawyer run some numbers) on Excel with regard to the Roth conversion, making some reasonable assumptions as to investment returns and tax rates.  I think the Roth conversion is likely to add substantial value, especially if they leave the IRAs in trust for the grandchildren.  If time is short, it may be better to convert, since if they convert, they or their executors can undo the conversion (recharacterize), but if they don’t convert, the opportunity to convert is lost forever after the surviving parent’s death.
  • Note that with a traditional IRA, the trustees have to choose between retaining the IRA distributions in the trust (which preserves the asset protection but incurs income tax at the trust’s rates) and distributing them to the beneficiaries (which may save some income taxes, but destroys the asset protection).  The Roth conversion avoids that tradeoff.  That’s another advantage of the Roth conversion.
  • The drafting for trusts that receive IRA benefits can be tricky the first few times you do it, though after you do it a few times, it becomes routine.  None of the IRA benefits can ever go to anyone older than the person whose life expectancy you want to use to measure the required distributions (the oldest grandchild unless there’s a large age difference), or to anyone other than an individual or another trust subject to the same restrictions.  See my article on this subject in the March 2004 issue of BNA Tax Management’s Estates, Gifts & Trusts Journal:  http://www.elderlawanswers.com/Documents/Trusts%20as%20Beneficiaries%20of%20Retirement%20Benefits.pdf .


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