The ability to convert a traditional IRA to a Roth IRA account is a topic of interest to many high-income earners. Because the income cap that previously existed is no longer in place, those who earn more than $100,000 in income are able to make a conversion from a traditional IRA to a Roth. Plus, no 10% early penalty withdrawal exists if the dollars move from the traditional IRA to Roth IRA within 60 days.

However, one of the biggest stumbling blocks in deciding to convert is having to pay taxes on the converted amounts.

The Power of a Companion Donor-Advised Fund

Here is how the tax-free Roth conversion works.

A client establishes a donor-advised fund (DAF) as a companion to the converted Roth account. They then fund the DAF with cash or a variety of appreciated asset types. The income tax deduction on the DAF contribution tends to offset the increased tax liability resulting from the Roth conversion.

That allows the account holder the full intended benefits of the converted Roth account and achieves the following tax benefits:

  1. Fair market value (FMV) deduction on assets contributed to the DAF.*
  2. No capital gains tax on appreciated assets contributed to the DAF.
  3. The DAF deduction helps to offset federal taxes on the Roth conversion.
  4. There are no required minimum distributions from the Roth while the client is living. Required distributions to beneficiaries can be stretched over their lifetimes, and distributions are free of taxes.
  5. No estate taxes on assets in the donor-advised fund; Roth assets are subject to estate taxes.
  6. Assets in the Roth and the DAF grow tax-free.

An account holder will want to consider using cash or a variety of appreciated assets that are outside of their traditional IRA or pay any taxes due on any converted amounts that exceed DAF contributions.

At AEF, financial advisors can continue to manage the assets gifted into the DAF on their preferred custodial platform.

Contact us or call 1-888-966-8170 with any further questions about DAFs and Roth conversions.

Note: The information provided herein is for informational purposes only and should not be interpreted to constitute legal and/or tax advice. Donors should consult their legal and tax advisors regarding their specific situations.

*This is dependent on various factors, including the asset type. Contact AEF or your tax advisor for more information.