Utilizing Roth conversions for generational wealth preservation

Allworth financial advisor Dan Rausch, CFP^®, explores how Roth conversions can help high-net-worth families preserve generational wealth by reducing future tax burdens, maximizing tax-free growth, and leaving a legacy for heirs.

When it comes to passing wealth to the next generation, high-net-worth families often face a tricky balancing act: how do you ensure your heirs receive the most benefit from your hard-earned wealth while minimizing tax burdens? One powerful, yet often underutilized strategy is the Roth conversion. Done thoughtfully, it can be a cornerstone of generational wealth preservation.

In this article, I’ll break down what Roth conversions are, why they matter, and how they can set your family up for long-term financial success.

What Is a Roth Conversion?

Simply put, a Roth conversion allows you to move funds from a traditional, tax-deferred retirement account (like an IRA or 401(k)) into a Roth IRA. While this move requires paying taxes upfront on the amount converted, the funds in the Roth IRA then grow tax-free. And here’s the real kicker: qualified withdrawals—both the contributions and the growth—are tax-free for life.

For families focused on preserving wealth, the appeal of a Roth IRA lies in its ability to provide tax-free income to heirs while sidestepping some of the tax hurdles associated with traditional IRAs.

Why Consider a Roth Conversion?

Tax planning is at the heart of any good wealth preservation strategy, and Roth conversions offer some compelling advantages:

1. Tax-Free Growth: Assets in a Roth IRA grow tax-free. Over decades, this can result in significant savings compared to a traditional IRA, where withdrawals are taxed as income. For younger heirs, this tax-free growth can compound into a sizable financial advantage.
2. Eliminating Required Minimum Distributions (RMDs): Traditional IRAs require you to take RMDs starting at age 73 (thanks to the SECURE 2.0 Act). These distributions can bump you into a higher tax bracket, creating unnecessary tax drag. With a Roth IRA, there are no RMDs during your lifetime, giving you more control over how and when to use those funds.
3. Tax-Free Inheritance for Heirs: When your heirs inherit a Roth IRA, they’ll still need to withdraw the funds within 10 years (per the SECURE Act), but every dollar they withdraw will be tax-free. This ensures that your legacy remains intact and unencumbered by tax burdens.
4. Taking Advantage of Lower Tax Brackets: If you’re in a lower tax bracket now—for example, in early retirement or after selling a business—converting to a Roth IRA can allow you to pay taxes at a lower rate. This is particularly valuable if you expect your tax rate (or your heirs’ tax rate) to increase in the future.

When Does a Roth Conversion Make Sense?

While the benefits of a Roth conversion are clear, it’s not the right fit for every situation. Here are a few scenarios where it could work well:

1. You Anticipate Higher Future Tax Rates: If tax rates increase in the future (either due to personal income growth or legislative changes), paying taxes now at today’s rates could save your family significant money in the long run.
2. You’re in a Low-Income Year: During a year when your income is lower—such as the first few years of retirement—you may find it advantageous to do a Roth conversion while staying in a lower tax bracket.
3. You Want to Maximize Wealth for Heirs: If leaving a tax-free inheritance is a priority, a Roth IRA is a fantastic tool. The tax-free withdrawals provide a financial cushion for heirs without increasing their tax obligations.
4. You Have Non-Retirement Funds to Pay Taxes: Roth conversions require you to pay taxes on the converted amount. If you have sufficient non-retirement funds to cover this tax bill, a conversion becomes even more attractive, as you won’t be diminishing your retirement savings to pay Uncle Sam.

The Process: How to Execute a Roth Conversion

1. Work with Your Advisor: Roth conversions require careful planning to avoid bumping into higher tax brackets. Your advisor can help you determine the optimal amount to convert each year to balance tax efficiency and long-term growth.
2. Plan for Taxes: You’ll need to pay taxes on the converted amount so having a plan for covering this bill (ideally with non-retirement funds) is key to maximizing the benefits of the strategy.
3. Consider a Multi-Year Approach: Instead of converting all at once, many families choose a multi-year approach, spreading out conversions to avoid higher tax brackets.
4. Coordinate Your Estate Plan: If preserving generational wealth is your goal, consider how Roth conversions align with your estate planning strategies, including trusts or gifting plans.

Is a Roth Conversion Right for You?

Roth conversions are a powerful tool, but they’re not one-size-fits-all. The decision depends on factors like your current income, expected future tax rates, and your long-term legacy goals. This is why personalized planning is so important. By taking the time to analyze your unique financial situation, you can determine whether this strategy aligns with your goals.

Final Thoughts

When it comes to generational wealth preservation, Roth conversions offer a unique opportunity to take control of your financial future. By paying taxes today, you can set up your family for decades of tax-free growth and income, leaving a legacy that truly lasts.

If you’re curious about how Roth conversions could fit into your overall financial plan, let’s connect. Together, we can explore your options and develop a strategy that reflects your priorities—both now and for generations to come.

Dan Rausch, CFP®

Financial Advisor

As a certified financial planner with both tax planning and CFO experience, I understand how complex financial situations require an intentional approach. I’m passionate about educating you to make sound decisions because I understand what’s at stake for you. Wealth management is more than choosing the right investments. It also involves deliberately preserving your wealth, so you feel confident in your tax strategy and family estate plan.

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