Offsetting Your Roth IRA Conversion by Giving

Roth IRAs are attractive to retirees because they offer tax-free withdrawals for account holders and their heirs. Before 2010, your ability to convert a traditional IRA to a Roth IRA was limited to those with income below $100,000. But as of January 1, 2010, the income ceiling for Roth IRA conversions has been lifted, which has led to a surge in conversions from traditional IRAs. However, a conversion results in the recognition of taxable income. As you consider with your financial and tax advisors whether a conversion to a Roth IRA makes sense for you, please also consider that you may be able to mitigate this tax bite by setting up an Servant Giving Fund (donor-advised fund) and making a charitable contribution to offset the conversion income.

This new Roth conversion change represents a potentially substantial tax savings opportunity depending upon your personal circumstances. Here’s a quick look at the differences between a Roth and a traditional IRA:

IRA/401K Roth
Plan contributions income tax deduction/exclusion no income tax deduction
Plan gains and income Taxes on growth deferred until distribution balances grow tax free
Distributions from plan taxable when distributed to you or beneficiaries* 

*can avoid tax if you give to charity at death

non taxable when distributed to you or your beneficiaries
Mandatory distributions at age 70 1/2 none
Effect on your estate taxable as part of your estate taxable as part of your estate

Is a conversion right for you? How can you make the most of it?

So, how do you know if a conversion is right for you and how can you make the most of this strategy?

Consider with your advisors six questions to help you evaluate this opportunity (they may raise others for your particular situation):

  • Future Personal Taxable Income: When you begin to take distributions from your IRA, will you likely be in a higher tax bracket than you are currently? If you anticipate a higher personal tax rate when distributions begin, you may want to consider converting to a Roth. Don’t forget to consider your state tax – will you live in a state that taxes the distributions?
  • Mandatory Distributions: Will you want to take distributions at 70 ½, or would you prefer to be in a situation where you are not required to add these amounts to your taxable income? Conversion to a Roth will allow you to avoid mandatory distributions.
  • Anticipated Growth Rate: Is your IRA invested in such a way that the growth inside the IRA will be substantial? You may want to convert to a Roth so as to avoid the ultimate tax on the growth.
  • Charitable Intentions: If you plan to leave your IRA or qualified plan to charity in [a testamentary capacity; or at the time of you death] and you have named a charity as a beneficiary, it may be inappropriate to make a Roth conversion.  The bequest of an IRA to charity completely avoids income (and estate) taxation.  Therefore, why pay ANY tax on a conversion when the assets will eventually pass to charity completely tax free?
  • Ability to Pay Conversion Tax: When you convert to a Roth, you will include the conversion amount in your 2010 taxable income. You also have the option to spread this out over the 2011 and 2012 tax years. Do you have adequate resources to pay this additional income tax? This tax can be offset by charitable giving (see below for a sample scenario).
  • Future Tax Laws and Tax Rates: This is the big unknown. To the extent that tax rates applicable to IRA distributions will be higher in the future than today (at conversion time), then a Roth conversion would likely be advantageous. Another unknown is the possibility that Congress could decide someday to tax Roth distributions – in effect, changing their earlier commitment to hold these distributions as tax free.

Charitable Giving to reduce the Cost of a Roth IRA Conversion

If you do convert your traditional IRA to a Roth IRA, it will be a taxable event. In order to minimize this tax, you may consider making a charitable gift to offset all or a portion of the conversion income, in effect saving tax dollars in favor of charitable dollars. You might even consider accelerating future planned charitable contributions, donating them in the same year as the conversion to maximize the use of your donations against income. Here’s how this might look:

  • No charitable giving: You convert $100,000 from your traditional IRA into a Roth. The tax due in the year of the conversion (assuming a personal income rate of 30%) is $30,000.
  • With charitable giving: You convert $100,000 from your traditional IRA into a Roth but you also make a charitable contribution of $40,000 into your NCF Giving Fund. Your tax declines to $18,000, in effect converting $12,000 from tax dollars into charitable dollars. Consider making the $40,000 gift with an appreciated asset like securities, and you can experience even greater savings by avoiding capital gain tax on the security’s built-in gain.

To learn more about charitable giving in connection with retirement plans call us at 913-310-0219.

©2010 Republished with permission from The National Christian Foundation – DISCLAIMER: This information is designed to provide accurate and authoritative information in regard to the subject matters covered. It is published with the understanding that in this information, the authors are not engaged in rendering legal, accounting or other professional services. If legal advice or other expert assistance is required, the services of a competent professional should be sought. (From a Declaration of Principles jointly adopted by a committee of the American Bar Association and a committee of Publishers and Associations)

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