Late-in-Life Roth Conversion Opportunity Spares Your Heirs

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If you’ve read my articles or others on Roth conversions, you probably know the most obvious opportunity for Roth conversions exists in the period between retirement and when you start to tap Social Security and retirement accounts.

If you look at a tax projection for someone who is about to retire, rates are often near their peak. They fall off a cliff when wages go away, and then they pop up again once you have required minimum distributions (RMDs) and Social Security income.

If you twist your head a little farther to the right, you’ll see, in our projections, another drop. That drop in your final years of life is due to high medical expenses, which reduce taxable income.

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While your tax rates are unlikely to go higher, which is the tell-tale sign to consider a Roth conversion, it is likely that your rates at this point are lower than those of your beneficiaries, who will inherit these accounts and pay taxes on the distributions.

Higher medical expenses mean lower taxable income

Taxable income is gross income less deductions. Most people no longer itemize deductions since the Tax Cuts and Jobs Act of 2017 (TCJA), which overhauled our tax code and increased the standard deduction.

However, once medical expenses have a significant impact on income, it’s likely that your deductions get above the standard deduction. The higher your deductions, the lower your taxable income. The lower your taxable income, the more appealing Roth conversions can become.

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Medical expenses tend to increase as we age. However, entering a retirement community or nursing home can cause those partially deductible expenses to skyrocket. Under the current code, medical expenses in excess of 7.5% of modified adjusted gross income (MAGI) are deductible.

When you enter a continuing care retirement community (CCRC) with a lifecare contract or modified contract, some portion of your entry fee and monthly fee are considered to be a pre-paid medical expense. Those are deductible.

The finance office at the community should be able to tell you what percentage of the care is considered medical. IRS Publication 502 provides a much more in-depth explanation.

A Roth conversion opportunity

The period when your medical expenses peak late in life has to be one of the least likely times you would analyze your tax return to uncover the silver lining of your less-than-ideal situation.

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Often, we uncover this opportunity through conversations with clients who are handling their parents’ affairs. We rely on financial planning software to get a rough sense of what future rates will look like for the owner and for the beneficiaries.

We rely on tax planning software to run the actual conversion calculation. You can access a free version of the financial planning software we use.

Aging sucks. Paying astronomical amounts for help, medical and otherwise, sucks. Once again, a Roth conversion is probably the last thing on your mind. Try to reframe this as a tax sale.

You may be able to pay today at a lower rate than your beneficiaries will in a decade. Maybe that won’t lessen the blow, but those beneficiaries will thank me down the line.

Disclaimer

This article was written by and presents the views of our contributing adviser, not the Kiplinger editorial staff. You can check adviser records with the SEC or with FINRA.

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After graduating from the University of Delaware and Georgetown University, I pursued a career in financial planning. At age 26, I earned my CERTIFIED FINANCIAL PLANNER™ certification. I also hold the IRS Enrolled Agent license, which allows for a unique approach to planning that can be beneficial to retirees and those selling their businesses, who are eager to minimize lifetime taxes and maximize income.