Large Roth conversion when terminally ill

[fyre4ce]

My mom is losing a battle with stage 4 cancer. It's incredibly sad and I'm in tears as I write this. But, I am trying to deal with the financial planning aspects of this objectively. Her assets are about $850k in cash and highly appreciated stocks in a taxable account, $1.6M in a pre-tax IRA, and about $50k in several Roth accounts. My brother and I are 50% beneficiaries on all her accounts. He and I both have relatively high incomes, and both live in CA. I'm at the top of the 24% bracket MFJ + 9.3% CA (=33.3%) and he's in the 32% single bracket + 9.3% (=41.3%). She lives in NY state. I ran the numbers looking at the tax impact of that large IRA, and it looks like there is tax savings for us if my mom converts a large portion of that IRA to Roth, up to a ~$1M conversion, due to the difference in state tax rates. I am not certain of how the mechanics of the conversion and resultant taxes would work.

Assuming she dies this year, and she does a large Roth conversion, her estate will have a large (multi-$100k's) tax bill due next April. I think she'll in be in the safe harbor for the large tax bill, due to having low income (~$60k AGI) in 2020, so we would not want to withhold taxes from the conversion to maximize the amount that goes into Roth. My brother and I would get a step-up in basis on half each of the taxable account on the day she dies, which we could sell immediately and invest in a safe investment like a high yield savings account. Then, next year, the executor of her estate (my mom's sister) would prepare her tax return with an accountant, and my brother and I would each send her half of the taxes due from our savings, which she would submit to the IRS along with the return. Depending on the amount of the conversion, we would still each have ~$200k cash left over after covering half the tax bill.

Are there any problems I'm not foreseeing? Of greatest concern would be sending the large checks to the executor and hoping it wouldn't cause any gift tax problems. I suppose we could each try to pay her tax bill online directly to the IRS, but is it even possible to pay someone else's tax bill? I also realize there's a counter-party risk of my brother deciding to not pay his half, but I'm not worried about this. Thanks in advance.

[afan]

This is something to go over with the professional who is going to do the final tax return.

The executor should not distribute to the beneficiaries the money from the estate that will be needed to pay the taxes. That should stay in the estate. The beneficiaries should get what is left after all the final bills have been paid, including income taxes. The executor could get in a world of trouble by distributing this money before paying all those bills.

You can reduce the risk of the portfolio by making changes while it is in the tax deferred account or after it is in the Roth.

Have a lawyer expert in this area tell your mom what to do. If your mom is no longer capable of managing things for herself, then whoever has her power of attorney, likely the same person as the executor, should look into it.

Depending on her circumstances, your mom may have large medical expenses that might come out of the tax deferred account. If so, this could reduce the value of the Roth conversions and reduce her income taxes for this year. Be sure she or her attorney in fact is aware to the tax implications here.

Again, the executor would be committing a major mistake and violating her responsibilities if she were to distribute the money to pay taxes with the plan of getting it back in time to file the return. She could find herself in serious legal trouble.

Do NOT do this.

[ENT Doc]

I don’t think I can be of much help but I’m sorry about your mother.

[fyre4ce]

This is something to go over with the professional who is going to do the final tax return.

The executor should not distribute to the beneficiaries the money from the estate that will be needed to pay the taxes. That should stay in the estate. The beneficiaries should get what is left after all the final bills have been paid, including income taxes. The executor could get in a world of trouble by distributing this money before paying all those bills.

You can reduce the risk of the portfolio by making changes while it is in the tax deferred account or after it is in the Roth.

Have a lawyer expert in this area tell your mom what to do. If your mom is no longer capable of managing things for herself, then whoever has her power of attorney, likely the same person as the executor, should look into it.

Depending on her circumstances, your mom may have large medical expenses that might come out of the tax deferred account. If so, this could reduce the value of the Roth conversions and reduce her income taxes for this year. Be sure she or her attorney in fact is aware to the tax implications here.

Again, the executor would be committing a major mistake and violating her responsibilities if she were to distribute the money to pay taxes with the plan of getting it back in time to file the return. She could find herself in serious legal trouble.

Do NOT do this.

Thank you, this is helpful. A few things:

• The idea behind this tax strategy is to (a) perform a large Roth conversion to take advantage of the difference in state tax rates, and (b) pay for the taxes using the taxable assets once they get a step-up in basis. For this to work, there's no reason any assets would have to be distributed to my brother or me before the tax bill is paid - we don't need money urgently. That sounds like the biggest problem, and possibly easy to fix.
• That said, I would want to make sure the taxable assets get a stepped up basis. If large capital gains taxes are incurred, that will counteract much or all of the tax savings. If the executor sells taxable assets after she dies but before assets are distributed to beneficiaries, do they still get a stepped up basis? I think the answer is yes but was not able to find a definitive answer. Also, the assets are invested in individual stocks, so it makes sense to sell them as soon as the basis gets stepped up to reduce risk. Then, the amount expected to be owed for taxes can be put in a savings account, and the rest can be reinvested in low-cost mutual funds.
• I think most of her medical bills are planned to be covered by insurance, so out-of-pocket expenses should be low, certainly small enough to not put a dent in the $1.6M IRA.
• I am a Power of Attorney on her investment accounts, including the taxable account and IRA, and I can make trades and Roth conversions on her behalf. We set this up earlier this year when we discovered how serious her condition was. We have discussed Roth conversions, and I have suggested she gets an estate planning attorney, but so far she has been reluctant to do any real planning - it's too hard for her emotionally. Her approach has been to give me the PoA on her investments and ask me to "do what I think is best" without involving her in the details. So far I have not made any trades or conversions. So I'm trying to do my best from an arm's length, and to minimize any discussions with her to that which is unavoidable. I know her accountant's name, but he doesn't know me and I doubt he would speak to me as I am not a general PoA for all her affairs.

[fyre4ce]

I don’t think I can be of much help but I’m sorry about your mother.

Thanks very much for the kind words.

[White.Beard.Doc]

I am sorry about your mother's health and her struggle with advanced cancer.

NY State has taxes almost as high as California. The savings for a large Roth conversion in NY vs paying the taxes later in CA (spread out over a number of years) are likely minimal, and as I run the numbers, could even increase your taxes. The large Roth conversion in one year could bump Mom's marginal rate this year (is she single?) into the highest federal tax bracket of 37%, plus NY taxes of 6.85% for a combined rate of around 44% (higher than your and your brother's marginal taxes). She would not pay that top marginal rate on all of the conversion, just some of it. However, the savings may be minimal.

You can run the numbers, but at this point it might be best not to sweat those details for a minimal difference in taxes and to simply focus on being as supporting as possible with her health struggles.

[StarTrekDoc]

Sorry about mom's struggles and you having the added responsibility of current finances.

-You're talking mostly about tax efficiency and agree with WBD that CA vs NY - you're talking about the 24% bracket space.
-You and sibling can both gift dollars into the taxable and then pay out of the taxable the taxes on the conversions to avoid needing to cash out the stocks to avoid a sale. That's perfectly fine and the biggest thing to do even on billings and closing out the estate. Fund those expenses and hold off any stock sales in taxable.

[fyre4ce]

I am sorry about your mother's health and her struggle with advanced cancer.

NY State has taxes almost as high as California. The savings for a large Roth conversion in NY vs paying the taxes later in CA (spread out over a number of years) are likely minimal, and as I run the numbers, could even increase your taxes. The large Roth conversion in one year could bump Mom's marginal rate this year (is she single?) into the highest federal tax bracket of 37%, plus NY taxes of 6.85% for a combined rate of around 44% (higher than your and your brother's marginal taxes). She would not pay that top marginal rate on all of the conversion, just some of it. However, the savings may be minimal.

You can run the numbers, but at this point it might be best not to sweat those details for a minimal difference in taxes and to simply focus on being as supporting as possible with her health struggles.

Yes, my mom is single.

I looked into this in detail a couple months back, and there's some complexity here. I'm in the 24% fed bracket (33.3% total) now, about $30k under the 32% bracket. But, at that income, our 199A deduction starts to get phased out, and we pay a combined tax rate of ~53% for about $100k of income - I checked with TurboTax. Above that, the rate drops down again, but we will pay an average rate of 45% on withdrawals around $300k, and the rate climbs again above this. So, my withdrawal strategy over the 10 year distribution period would be to withdraw $30k/year for as many years as possible, leaving most of the money growing tax-deferred, then ~$300k/year for the last X number of years (X being a function of the initial inherited IRA size, and investment performance) so that it's empty by the end of the 10th year. So unless the pre-tax amount is under ~$300k per heir (which would be a $1M conversion) I'll be paying an average tax rate around 42-45% on withdrawals.

My brother's situation is simpler - he's just under the 35% bracket (44.3% total), and any significant pre-tax withdrawals will have him paying 44.3%. There's also the secondary effect that Roth conversions, when the taxes are paid with taxable assets, effectively move more money into tax-advantaged accounts that get a tax-free 10 year stretch - a Roth dollar is worth more than a pre-tax dollar. When you add all this up, my math says that there's a big tax savings with the first $500k of conversion, and diminishing returns, although still a small savings, for larger amounts. It's not a tiny amount either - after 10 years, about $100-150k for me and $150-200k for my brother. Neither of us are in bad financial shape but we can definitely put that money to good use.

As far as worrying about this vs. providing emotional support, I really hope it's not one or the other. This is the way I manage my family's finances, and similar to the work I do professionally (not a doc), so it's a way I feel like I can help. She has told me she wants me to make the best financial decisions with her investments for me and my brother, even though she doesn't want to know the details. I try to be as supportive as I can, and I have traveled to see her twice in the last few months (not easy given our geographic separation) and plan on making more trips soon.

Hope that provides some helpful context.

[fyre4ce]

Sorry about mom's struggles and you having the added responsibility of current finances.

-You're talking mostly about tax efficiency and agree with WBD that CA vs NY - you're talking about the 24% bracket space.
-You and sibling can both gift dollars into the taxable and then pay out of the taxable the taxes on the conversions to avoid needing to cash out the stocks to avoid a sale. That's perfectly fine and the biggest thing to do even on billings and closing out the estate. Fund those expenses and hold off any stock sales in taxable.

A couple things:

• As I detailed in the above post, our marginal tax rates are more like 40-45%. The difference in tax rates between NY and CA is not big, but even a few percent on such a large balance ends up being a significant amount of money (for me, anyway).
• That's an interesting idea, but don't think either of us have enough cash (we're talking ~$100-200k each) to gift to the estate before getting our share of the taxable assets. The goal would be to structure it such that the the taxable assets get a stepped up basis, then are sold to cover the taxes on the conversion. If the executor sells the taxable assets after the owner dies, but before assets are distributed to heirs, is the basis still stepped up? If so, then I don't see a problem - the executor can sell assets to cover the income tax, and then the heirs can get the remainder. But if not, then some kind of gifting plan may be necessary, and maybe a loan.

[White.Beard.Doc]

Yes, my mom is single.

I looked into this in detail a couple months back, and there's some complexity here. I'm in the 24% fed bracket (33.3% total) now, about $30k under the 32% bracket. But, at that income, our 199A deduction starts to get phased out, and we pay a combined tax rate of ~53% for about $100k of income - I checked with TurboTax. Above that, the rate drops down again, but we will pay an average rate of 45% on withdrawals around $300k, and the rate climbs again above this.

Yes, the phaseouts can make for crazy marginal rates. Our income went over the "tax cliff" in our state, and at that point they phase out the marginal rates and tax you at the highest rate back to your first dollar. The combined state and federal tax goes to over 100% marginal when you go over the cliff. This only happens for a certain amount of (very high) income, and then the rate goes back down again, but a marginal tax rate over 100% is crazy! The marginal rate for those going over the state tax cliff was less than 100% when state taxes were a deduction on federal tax returns, but that went away along with the SALT deduction with passage of the TCJA in 2017.

[MPMD]

This is something to go over with the professional who is going to do the final tax return.

The executor should not distribute to the beneficiaries the money from the estate that will be needed to pay the taxes. That should stay in the estate. The beneficiaries should get what is left after all the final bills have been paid, including income taxes. The executor could get in a world of trouble by distributing this money before paying all those bills.

You can reduce the risk of the portfolio by making changes while it is in the tax deferred account or after it is in the Roth.

Have a lawyer expert in this area tell your mom what to do. If your mom is no longer capable of managing things for herself, then whoever has her power of attorney, likely the same person as the executor, should look into it.

Depending on her circumstances, your mom may have large medical expenses that might come out of the tax deferred account. If so, this could reduce the value of the Roth conversions and reduce her income taxes for this year. Be sure she or her attorney in fact is aware to the tax implications here.

Again, the executor would be committing a major mistake and violating her responsibilities if she were to distribute the money to pay taxes with the plan of getting it back in time to file the return. She could find herself in serious legal trouble.

Do NOT do this.

i am not a lawyer or an estate expert but both of these bolded statements are concerning enough to me that i would seek professional help on this and err on the side of not doing it.

again lacking expertise but i think if you mom is not in a position to make independent decisions about her assets i would avoid doing anything as her POA that could only be seen as beneficial to you on distribution of the estate.

[fyre4ce]

i am not a lawyer or an estate expert but both of these bolded statements are concerning enough to me that i would seek professional help on this and err on the side of not doing it.

again lacking expertise but i think if you mom is not in a position to make independent decisions about her assets i would avoid doing anything as her POA that could only be seen as beneficial to you on distribution of the estate.

I appreciate the suggestion. I may personally hire an estate planning attorney in her state to help. It's not so easy being on the other side of the country, but I'm sure we can consult over the phone and pay by credit card. We may run into a wall, because I don't want my mom involved at all, but we can see how far we go.

I agree there is some murky terrain here. The real problem is that my mom doesn't want to discuss a large Roth conversion, or really any other detailed estate planning, because she would view as an acknowledgment she won't survive the year. (Whether she actually will or not is unclear right now.) Frankly I can understand the desire to not be brought forms to sign while on my death bed. Earlier this year, when we discussed the PoA I mentioned the possibility of large Roth conversions and she was OK with the concept, but again has said she doesn't want to know the details. I have taken her statements as permission. The only other person affected is my brother - we are 50/50 on all her accounts - and I've discussed it with him and he's okay with it.

If a conversion would move money from, say, an account where I am a 50% beneficiary to one where I am a 100% beneficiary, then yes, that would be ethically prohibited, but that's not the case here. Or, if one of us were very low tax and the other were high-tax, Roth conversions to benefit one heir could also be ethically dubious, but fortunately we're in very similar tax situations.

One of my mom's sisters (not the executor) is financially literate, and I have discussed this plan with her and she is OK with it. Her opinion is that as long as it doesn't cause my mom any emotional turmoil, and it would save taxes for my brother and me, then it's okay to do.

[Tim]

"I know her accountant's name, but he doesn't know me and I doubt he would speak to me as I am not a general PoA for all her affairs."

This is fixable, very easily, Not just the accountant, but the estate planning attorney. They can easily get authorization to discuss her financial affairs. All are on the same team. You say you have financial POA but it sounds like you have only dealt with the brokerage firm. It is important that both a healthcare POA and a financial POA are in place. You have no idea when you (or your brother) will need them to act on her behalf. It is for her benefit and communicate for her and it provides them with legal authority to communicate with you as well. She can then delegate to you as she wishes.

You are not alone, I would make that call to the accountant and then to an elder law attorney and get their inputs. Of course there are things she does not wish to deal with.
That does not change the facts and circumstances.

[fyre4ce]

"I know her accountant's name, but he doesn't know me and I doubt he would speak to me as I am not a general PoA for all her affairs."

This is fixable, very easily, Not just the accountant, but the estate planning attorney. They can easily get authorization to discuss her financial affairs. All are on the same team. You say you have financial POA but it sounds like you have only dealt with the brokerage firm. It is important that both a healthcare POA and a financial POA are in place. You have no idea when you (or your brother) will need them to act on her behalf. It is for her benefit and communicate for her and it provides them with legal authority to communicate with you as well. She can then delegate to you as she wishes.

You are not alone, I would make that call to the accountant and then to an elder law attorney and get their inputs. Of course there are things she does not wish to deal with.
That does not change the facts and circumstances.

Thanks. She doesn't have an estate planning attorney. I am thinking *I* need to hire one to help me through these questions.

You are correct - I have a PoA form filed with her brokerage that covers her IRAs and taxable account, but it's not a general PoA that I can take to an accountant, etc. It looks like NY state has a form. I'll ask my mom if anyone else is already a durable PoA. If so maybe I could be a separate agent.

[jfoxcpacfp]

Not even going to try to address the issues, b/c I’m not her CPA or attorney. Really need to have a team to go over this and advise, but I (personally) w/b pretty uncomfortable about bringing this up other than in an anonymous situation like this forum. Even then w/b difficult.

Sincerely sorry about your mom. Hope you have plenty of time to spend together talking about your lives and how grateful you are to her for doing such a good job of raising you and your brother. The money really isn’t that important when it gets down to it unless it will make a huge difference in being able to afford basic living expenses, jmpo and what I would say to a client. Sometimes the WCI crowd goes a little overboard in this area w/o realizing it, no disrespect intended.