An IRA to Roth IRA Conversion Example
Mr. B has an IRA and will have to start mandatory withdrawals as he is 71. He doesn't need the income as he loves his work, is in good health, and will probably continue working for another five years. He'd rather keep building his account for when he actually retires. His taxable income in 2010 will put him and his wife, also 71, in the 33% tax bracket as their taxable income is just over $200,000.
Ideally, Mr. B would like to reduce his IRA (and the mandatory withdrawals) and take advantage of tax-free compounding in a Roth IRA without having to pay taxes on withdrawals or be forced to withdraw from it.
Mr. & Mrs. B have money in a CD currently paying 1.5%. Mr. & Mrs. B. have a desire to benefit the Rochester community where they raised their family and have worked. They can write a $100,000 5.3% gift annuity with the Rochester Area Foundation, which will pay them $5,300 a year for life. Over the first 19.7 years, $3,503.30 of the $5,300 will be tax free, which means the annual annuity is equivalent to $7,049.07 in fully taxable income. This is an increase in annual income of $5,549.07 compared to the current CD.
In addition, they receive a charitable deduction for making the gift of $30,946, which will reduce the conversion tax. All told, with two years of higher income and the charitable tax deduction, they have reduced the $33,000 in taxes to $11,098. Now moving $100,000 into a Roth IRA and spreading the tax due over two years starts looking very attractive. Plus, in addition to the potential of continuing higher income, Mr. & Mrs. B have the satisfaction of creating their legacy through a significant gift to the Rochester Area Foundation that will benefit the community into perpetuity …. just about a "have your cake and eat it, too"!