Should elderly clients always defer income taxes?

• Author: Korb, Phillip J.

In most situations, tax practitioners advise their clients to defer income taxes. However, with corporate and personal graduated tax rates and higher estate tax rates, it is often wiser for elderly clients to recognize income currently, rather than deferring it to future years.

Timing of Distributions

The first situation involves timing distributions taken from regular IRAs. In many situations, clients are advised to take only the minimum required distribution from a regular IRA on reaching age 70 1/2. Clients are also advised to have their IRA contracts written so that their minimum annual distributions are computed over joint life expectancies with their spouse, to have life expectancy factors recalculated each year and to use any other options that would result in the lowest required annual distributions.

Although these provisions should remain in IRA contracts, there is no penalty for withholding more than the minimum annual distribution. In fact, with graduated personal income tax rates and higher estate tax rates, it is often wiser to distribute more than the minimum annual distribution. For example, when the imposition of estate taxes is not far off, elderly clients should take more than the minimum annual distribution if they have not taken full advantage of their lower personal income tax brackets. Because personal income tax on a regular IRA distribution must be paid eventually, by the client or his beneficiaries, the personal income tax liability could be reduced if the annual distributions during the client's life were increased to take full advantage of his lower personal income tax rates. In addition, because the prepayment of taxes reduces the value of the client's estate, his net worth would be lower, thus reducing potential estate tax.

Converting to a Roth IRA

The second situation involves the conversion of a regular IRA to a Roth IRA. Because a client or his beneficiaries must eventually pay personal income tax on a regular IRA distribution, the decision to convert a regular IRA to a Roth IRA is currently an effective tax strategy; prepaying taxes reduces the value of the client's estate, thus reducing the potential estate tax. In addition, on distribution of the Roth IRA to the client's beneficiary, no income tax is due; the Roth IRA grows tax-free. Although the current payment of personal income taxes reduces the amount available to reinvest, the benefit of the reduction of estate taxes often exceeds the loss in the...