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Better Go Direct

By Michael Lynch CFP®

The time comes in most retirees’ lives when they are struck by an “ah ha” moment that changes everything. After a working life of systematic saving that often came at the expense of luxuries and adventurous experiences, they realize that not only are they financially secure for the rest of their lives, but that if they maintain their current lifestyle, they will make their children and perhaps grandchildren financially secure as well.

It’s at this point that their mindset shifts from scarcity to abundance. This is often disorienting, since enriching the next generations has never been a priority. At these moments, I find myself recommending weird things for a financial advisor. Pay more to sit in the front of the plane. Order the appetizers and top-shelf drinks at your favorite restaurants. Purchase the luxury car. If you think something will bring you joy, pleasure, or even transient happiness, do it. Purchase it.

Holy Smoke, We’ve Got Too Much Money

Such thoughts recently entered the head of Mark. A modest lifestyle, systematic savings, a strong pension, Social Security, and a wife working through retirement years will catch up to you at some point. When it does, well, you have too much money.

Mark asked me if he should he start converting his traditional IRA to a Roth IRA so his children would pay less tax on their inheritance. Through my prattling, he was more than aware of the SECURE Act’s slaying of the stretch IRA, a slang term for the ability to withdraw inherited IRA funds over the life span of the beneficiary. With this new law in effect, all the money must come out in ten years, a change that potentially increases taxes on, and therefore decreases the value of, one’s savings.

“So, your goal is to optimize the after-tax value of your retirement assets over two generations?” “Yes,” he confirmed.

I told Mark that I wasn’t sure about the answer to his question. It was an empirical question and I’d need more information from him. Mark, of course, is getting older and he’ll soon be required to distribute money from his pre-tax (traditional) IRAs.

RMDS: Cash Only, No Conversions

These distributions cannot be converted to Roth IRAs. That’s the law. This often frustrates overfunded retirees. In Mark’s case, even if he was able to convert the money into a Roth IRA in his name, these funds would ultimately bounce down to his children anyway when he assumed room temperature without spending the money. The only impediment to this (passing it down to his children) was his spending the dough on fun stuff—not likely—or sending it to the nursing home, a risk that the scheme hatching in my head would address.

“Would you consider your children high, moderate, or low earners?” I asked, not knowing exact details of his family. I had a hunch after years of conversations, but I needed confirmation. It turns out his daughter is a teacher and his sons earn their money as a police officer and an auto mechanic.

Gotcha, I replied, so they are likely in the same or a lower tax bracket than you, correct? “Likely lower,” he said.

Gotcha, I shot back. We were Zooming. I pulled up a spreadsheet loaded with the current federal tax brackets on my computer to work through my plan with Mark.

I punched a few keys and demonstrated that if he voluntarily converted his pre-tax funds to a Roth IRA, Mark would likely pay more in taxes just so his progeny didn’t have to pony up at lower rates. This would destroy wealth. His goal was to make his family’s life better, not make Uncle Sam richer.

Back Door RMD Conversion

I confirmed that his goal was to optimize the after-tax value of his life’s savings and suggested an alternative. When your required minimum distributions (RMDs) commence next year, use them to fund Roth IRAs for your children and eventually your grandchildren, when they start to work for wages. If you like and trust their spouses, I added, you should do it for them as well.

I wanted to cut out the middleman, which was his Roth. Take the RMDs and pay the tax, I told him. You don’t have a choice anyway unless you send the RMDs directly to a charity with a Qualified Charitable Distribution. Set up Roth IRAs for your children. (If they have Roth IRAs, you can send the RMDs directly there.) They, not you, will own the Roths. This does mean they will control the money. But since it’s a retirement account, they will likely respect it as long-term money. The only requirement is that they have enough earned income to qualify them for the contribution and not too much to disqualify them: $140,000 for a single filer and $208,000 for a married couple in 2021.

“Do you think they are contributing to Roth or traditional IRAs already?” I asked. I needed to know this because a dollar they contributed was a dollar he could not, as the contribution is limited per person, not per account. “No,” he replied.

Technically It’s a Gift!

Another beneficial aspect of this strategy, I explained, is that the contribution will be considered a gift under federal income tax rules. You can give $15,000 a year to as many people as you want. Your wife can as well. Since the maximum IRA contribution is only $6,000, you can’t run afoul of this rule here and you won’t need to file any tax paperwork. As a gift, this removes the money from your financial estate, which is at risk for rapacious long-term care expenses in the Northeast. In other words, this strategy permanently protects these assets from evaporating in the unpleasant haze of nursing home expenses. This is the only risk most middle-class millionaires face when it comes to spending all their money. (It does expose the money to the children’s creditors, but since it’s retirement plan money, it has some protection.)

No Ten-Year Rule

Like the Ginsu Knife, this scheme just keeps getting better, I said with a smile. If you converted to a Roth in your name, your kids and grandkids would lose tax deferral ten years after your death, thanks to the SECURE Act. By setting up the account in their names, you ensure that deferral can last for their lifetime plus ten years. That’s a long time.

Mountains of Money

I switched over to the software I use that’s loaded with historical investment returns. These are never a prediction of the future, just as Mike Trout’s last year’s batting average says nothing about how he’ll hit this year. But it is what happened. It’s not commentary.

I showed Mark that 20 years of Roth IRA contributions for his three children into funds in which he currently invests, if started 20 years ago, would have produced just under $1 million each. Each Roth IRA is entirely tax-free and since it’s funded with RMDs, this strategy is not increasing Mark’s taxes either.

What’s the Alternative?

Money, like water, must flow somewhere. If Mark lets nature take its course, the RMDs will come, income taxes will be paid, and he will either invest the funds in a non-qualified investment account or, heaven forbid, put it in the bank to depreciate due to sub-inflation interest.

The latter is too horrible to contemplate, I told him. If you put them in an investment account in your name, you’ll pay tax as you go. Given current proposals on capital gains taxation circulating in Washington DC, you may get whacked again at death. Since you’re not into self-punishment, you should avoid funding either bank profits or DC profligacy.

A Triple Play

Mark’s a thoughtful guy. He said I’d given him a lot to think about. My hunch is that when he’s done pondering, his kids are going to get three new accounts. It’s a win for Mark, a win for his kids, and a loss for the IRS. In my book, that’s a win, win, win, or a triple play.  

Michael Lynch CFP is a financial planner with the Barnum Financial Group in Shelton CT, a member of Ed Slott’s Elite IRA Group and the author of Keep It Simple, Make It Big: Money Management for a Meaningful Life, October 2020. You can find more articles and videos at He can be reached at or 203-513-6032.

Securities, investment advisory and financial planning services offered through qualified registered representatives of MML Investors Services, LLC. Member SIPC. 6 Corporate Drive, Shelton, CT 06484, Tel: 203-513-6000. Any discussion of taxes is for general informational purposes only, does not purport to complete or cover every situation, and should not be construed as legal, tax or accounting advise. Clients should confer with their qualified legal, tax and accounting advisors as appropriate. CRN202412-1384458