Divorce Settlement with a Roth IRA
Hello, I have a client who has a Roth IRA (been opened for 10 years) and is going thru a divorce. As part of the settlement my client is giving 50% of his Roth IRA to his ex-spouse. Once the ex-spouse receives the assets does this start a new 5 year period for taking a distribution from the Roth? Assuming the portion they received was in the other account for 5 years. Thank you.
Permalink Submitted by Alan - IRA critic on Thu, 2019-06-13 21:50
All the Regs say is that the transferred IRA is treated as an IRA of the receiving spouse. That should mean that the receiving spouse is treated as making their first contribution on the same date as the transferor spouse. Each spouse will have 50% of regular or conversion basis in the Roth IRA. Age 59.5 will be attained separately for each spouse.
Permalink Submitted by Eddie Ngo on Tue, 2019-06-18 23:43
If one was in the 37% bracket during their working years and dropping to a 35% bracket at retirement, why is it advantageous to pay the 37% tax up front. Wouldn’t the IRA continue to grow tax differed, and the Roth IRA less the side fund that paid the taxes have a difficult time to catch up?
Permalink Submitted by Alan - IRA critic on Tue, 2019-06-18 23:55
The Roth does not have to catch up. When RMDs begin for the TIRA, the taxes due will reduce the taxes saved earlier by not converting. But if you paying 2% more now vs in retirement, a conversion will probably not be beneficial. That said for only a 2% difference, you should also consider tax diversification because having a Roth in addition to your TIRA give you a choice where to take the distributions from (after TIRA RMDs has been completed). Tax diversification can somewhat protect you against future tax rate increases such as in 2026 when the current reduced rates sunset, or if your beneficiary will be filing single and pay the top rate on much less taxable income after you are gone. The challenge is that no one knows for sure what their marginal rate will be deep into retirement either due to personal financial events or changes to the tax code. It seems to be that the current low highest rate is the most vulnerable to future increases, so it may be wise to hedge your bets somewhat if you are very light on Roth assets. Of course, if your current rate was 10% higher, you probably would not convert, but 2% is within the margin of error.
Permalink Submitted by David Mertz on Wed, 2019-06-19 02:08
As long as you have even a moderately long time horizon, paying that 37% now instead of 35% later can have a substantial benefit as long as you have the money outside of a retirement account to pay the taxes. At a 35% to 37% combined state and federal marginal tax rate, roughly one-third of the taxable money in your traditional IRA already effectively belongs to the government no matter how large the balance grows. By converting to Roth and paying taxes now using non-retirement money, the amount you pay in now taxes is effectively moved from taxable investments to tax free investments. That 2% difference in marginal tax rate will generally be made up for by the additional amount that grows tax-free instead of taxably. Additionally, with no RMDs required from the Roth IRA, that money can stay invested tax-free (assuming that it is not needed for expenses).