Wouldn’t it be great if you did not need to take mandatory distributions from your IRA (and pay tax)? Wouldn’t it be great to have that IRA money grow tax-free (rather than tax deferred)? Although the Roth IRA offers these two benefits to IRA owners, incomplete knowledge has kept them from converting their IRA to tax free status.
Because the accumulated tax on your IRA must be paid immediately upon conversion to the tax-free Roth IRA, many investors do not convert. Even though for most, the long run advantages outweigh the immediate payment of the tax, they still avoid the tax by keeping their existing tax-deferred IRA.
But what if you could reduce this tax or even push it off until after you die?
You can reduce the tax by purchasing a fixed annuity in your IRA and then converting to a Roth IRA. The IRS rule is that you pay tax on the fair market value of assets in your IRA when you convert. But an annuity is taxed at its “surrender value,” rather than at its higher “account value” when distributed from or converted to an IRA. So just by owning the right investment, you can reduce the taxable amount of your IRA.
That still leaves the problem of an immediate tax payment, albeit smaller by using the annuity. Although the tax payment is due, here’s a way to avoid taking the money from your pocket. For those who really want to maximize the cash flow from the conversion, use a residential equity line to pay the tax. Many financial institutions offer equity lines, interest-only, at prime rate. Most people can deduct this interest and pay it with a tax-free withdrawal from the Roth IRA. As long as your investments in the Roth earn more than the prime rate, you are ahead. You potentially get a tax deduction and have your IRA grow tax-free.
When do you pay off the equity line? When your house is sold. So if you live in your current house for the rest of your life, the equity line is paid from the house proceeds, and your heirs inherit a tax-free Roth IRA after your estate is settled.
If you would like having more of your money working tax free, the Roth conversion may be for you. To have an analysis prepared, return the enclosed coupon.