Once the taxpayer has confirmed their total
cumulative non-deductible contributions, he or
she rolls over the remaining taxable portion of his
or her IRAs into a qualified retirement plan, such
as a 401(k) or defined benefit plan in which they
are participating. If the taxpayer is a small business
owner, this is relatively simple, since the taxpayer
controls the retirement plan. Otherwise, the
taxpayer can confirm with their human resources or
benefits department on the ability to do this.
Note, the retirement plan document must
allow the taxpayer to make the rollover into
the retirement plan – this is an elected option
that must be confirmed prior to attempting this
strategy. Accordingly, the taxpayer must contact
his retirement plan advisor to assure that his plan
allows this, or if not, is amended to allow it.
Convert the regular IRA containing only aftertax
non-deductible contributions into a Roth
IRA. Since the taxpayer’s tax basis is equal to the
cumulative amount of the contributions, there will
be no tax due on this conversion.
Thereafter, the taxpayer and spouse should make
the maximum contribution to their non-deductible
IRAs each year. So long as no taxable proceeds
are rolled into taxable IRAs from retirement
plans, the first year is the only complicated year
for shifting proceeds between accounts to avoid
triggering taxes.
Immediately thereafter, the taxpayer and spouse
should convert these amounts tax-free into their
Roth IRAs each year.
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Low Cost Roth Conversions
Following a Business Sale
We work with a significant amount of business owners who, upon
selling their business, receive all of their business sale proceeds in
cash at closing. After paying the taxes on the sale, mostly at favorable
capital gains rates, due to the goodwill treatment of the sale, we
recommend that the taxpayer live off the after-tax sales proceeds first.
This allows their retirement accounts to continue to accumulate in a
tax-deferred environment, and minimizes taxes in the post-sale years.
Even though this creates the best opportunities to generate overall
liquid assets, the taxpayer usually has very little taxable income
during these post-sale years, until they begin withdrawing mandatory
distributions from their taxable IRA beginning at age 70½. This
provides a tremendous opportunity to convert substantial amounts
from their regular taxable IRA into their Roth IRA at extremely low
income tax rates.
For example, a taxpayer recently sold her oral surgery practice at
age 55. Between after-tax investments and practice sale proceeds, we
project she will easily be able to live off of non-retirement account
assets for 15 years.
Following the practice sale, the retirement plan was terminated and
her share of the proceeds rolled over into her regular IRA. Her goal is
to accumulate a $2,000,000 Roth IRA balance by age 70, starting from
zero. Accordingly, we are targeting for her to convert around $82,116
annually ($6,843 monthly) to achieve that goal, based on a 6% return.
The $82,116 Roth conversion is fully taxable. However, a portion
of this income is offset by approximately $50,000 in itemized
deductions. As a single taxpayer, she will also be able to convert
another $38,700 in the 12% tax bracket or less. This means that she
will pay zero dollars in taxes on the first $50,000, 10% on the next
$9,525, and 12% on the final $29,175.
While the true total tax savings of what this could potentially save are
unknown, her Required Minimum Distributions will place this client
in the 35% bracket. All things being equal, the higher balance only
adds dollars to the required, taxable distributions at the top marginal
taxable rate. Without taking into consideration growth after age 70
on the $2,000,000 balance and using a pure 23% differential (12%
v. 35%), she will save $460,000 in income taxes. If we assume a 4%
growth rate in the Roth over a 15 year period, this client will have
saved over $835,000 in taxes with these strategic conversions.
Whether these conversions are right for you requires intimate
planning and precise analysis on what consequences are triggered by
making any kind of Roth conversion. However, as illustrated above,
there can be significant tax savings when done correctly by a taxtrained
advisor who understand the rules surrounding the topic.
Andrew Tucker, JD, CPA, CFP®, provides tax and business planning
predominately for the dental profession and provides financial
consulting advice on a case-by-case basis to non-dental professionals.
They publish the McGill Advisory newsletter through John K.
McGill & Company Inc., a member of the McGill & Hill Group
LLC. Contact Andrew at andrew.tucker@mcgillhillgroup.com for
more information.
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FLocal Magazine • March 2018 9
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