Charity as the Beneficiary and Roth Conversion Penalties: Today’s Q&A Mailbag

Question:

I want to leave my IRA accounts (money) to various charities.

Should the beneficiary of these accounts be “my estate”?

Jean

Answer:

Hi Jean,

It is wonderful that you are charitably inclined. Instead of naming your estate as the beneficiary of your IRA, you may want to name the charities directly as your IRA beneficiaries on the beneficiary designation form. This is because IRAs pass to the beneficiary via the beneficiary designation form. They do not pass through probate unless the estate is named as the beneficiary. By naming the charities directly on the IRA beneficiary designation forms, you can be sure they get the intended funds and avoid the time and expense that comes with probate.

Question:

My friend owes about $60,000 to the IRS.  He can’t borrow against his 401(k) because he already has an outstanding balance.  He, unfortunately, needs to access his IRA to pay the IRS, and he will be subject to the 10% early withdrawal penalty. 

Assume he does a Roth conversion, and then withdraws the $60k to pay the IRS.  He will have to pay income tax, but I think this would avoid the 10% penalty, thus saving around $6,000.  Does this make sense to you?  Am I missing something that would make this a bad strategic move?

Much appreciated.

Isaac

Answer:

Hi Isaac,

Sorry to hear about your friend’s issues with the IRS. As you said in your email, if he withdraws funds from his traditional IRA to pay the IRA, he will owe taxes and the 10% early distribution penalty if he is under age 59½. Unfortunately, converting to a Roth IRA will not help him avoid the penalty. If he converts to a Roth IRA, any distribution of converted funds before he reaches age 59½ or five years have passed, since the conversion would be subject to the penalty. This means if he converts and then takes an immediate distribution of those funds from the Roth IRA to pay the IRS he would be hit with the penalty.