Should I convert my retirement plan to a Roth IRA? It’s an important question, particularly considering the Biden administration’s intent to raise taxes on high-earning individuals. Given the often-sizable nest egg that people have accumulated during their careers, converting to a Roth IRA may be a smart move.

Roth vs. Traditional: What’s the Difference? 

Taxes now or taxes later. Simply put, that is the main difference between a Roth and Traditional IRA. 

Contributions to a Roth IRA are made post-tax, but withdrawals are made tax-free. While contributions can be withdrawn at any time tax-free, earnings from the IRA cannot be withdrawn without penalty until age 59.  

Contributions to a traditional IRA are made pre-tax, but withdrawals are taxed as ordinary income. Individuals must wait until age 59½ to begin withdrawing funds without penalty and are required to start taking minimum distributions at age 72.   

A Roth IRA is often beneficial for individuals who expect to be in a higher tax bracket in the future. Those individuals can contribute now at a lower tax rate and then avoid paying taxes at a higher rate in the future. Likewise, a traditional IRA is often beneficial if the individual will be in the same or lower tax bracket in the future.

For estate planning, a Roth IRA may have two significant benefits. First, a traditional IRA forces an individual to take minimum distributions and pay taxes on those distributions, even if they don’t need them. A Roth IRA does not require any distributions. Second, a Roth IRA enables an individual’s heirs to withdraw funds tax-free, whereas the beneficiaries of an inherited traditional IRA will incur taxes on distributions. 

Cost of Conversion

When an individual converts a traditional IRA to a Roth IRA, the contributions and earnings in the traditional IRA account will be considered ordinary income and taxed as such. 

An individual must also be aware that the income realized from the conversion could push them into a higher tax bracket for the year and thus must make those calculations.  

Fortunately, there are no penalties for conversions, and account holders will avoid the typical 10% that the IRS charges for early retirement withdrawals. 

Tax Rates and Considerations

Which will be higher: your tax burden now, during conversion, or your tax burden during retirement, when you take distributions? That’s the million-dollar question. 

The Tax Cuts and Jobs Act reduced individual income tax rates from 2018 through 2025. Unless Congress enacts new legislation to cut taxes, rates will increase in 2026. Furthermore, the Biden administration would like to pass legislation increasing both spending and taxes. Even though the Build Back Better bill did not pass the Senate, it doesn’t mean that components of the bill won’t be carved out into smaller pieces of legislation and passed.  

Regardless of how Congress affects future tax rates, an individual may experience a higher or lower future tax rate purely due to their future income level. An individual who is early in their career or a shareholder in a growing company may have higher earnings in the future and be pushed into a higher tax rate.  

Where someone plans to live out their golden years also matters. Federal laws apply across the board, but state laws vary in how they tax retirement income. In some states, required distributions from IRAs are not included in state income tax. 

Future tax rates are important for those who plan on taking distributions during retirement. However, individuals who don’t plan on taking distributions and instead want to leave the funds for their heirs would benefit from a Roth IRA. Heirs are not taxed on Roth accounts and will also have several options for withdrawing funds from it.

As you can see, there are many things to consider when it comes to retirement planning and potentially converting your traditional IRA to a Roth IRA. This article only provides a high-level overview and is not a substitute for speaking with one of our expert advisors. Please get in touch with our office if you would like to discuss your specific situation and determine the best path for you and your family. We’re always happy to help.

 

When creating an estate plan, you’ll have to make several important decisions about what happens to your assets once you can no longer enjoy them. Many people fear that the money and assets that they’ve earned over a lifetime will be squandered haphazardly or lost to a creditor. Heirs might spend too much, be manipulated for money, or become victim to litigation, any of which could drain a lifetime of earnings. To help protect against these situations, you may want to consider using a spendthrift trust. 

A spendthrift trust provides certain protections over trust assets and how and when they are distributed to beneficiaries. In this article, we’ll explain what a spendthrift trust is and why they are used.

What is a spendthrift trust?

A spendthrift trust can provide a beneficiary with distributions over time instead of a lump-sum inheritance. Contrary to the name, it is not a specific kind of trust but is a clause that can be included in any type of trust. The term “spendthrift” came about because of the clause’s use for passing money or assets to individuals who have difficulty managing money. While that purpose remains true today, there are several other strategic reasons people use spendthrift clauses in their trusts.

Protection from creditors

A significant benefit of a spendthrift trust is creditor protection. 

If the trust is not already irrevocable, it will become irrevocable upon the grantor’s death. The terms written into an irrevocable trust cannot be modified in any way, nor can anyone add or remove assets unless specified by the terms. 

Creditors of a beneficiary cannot seize or gain an interest in trust assets so long as the assets remain in the trust. This is because the assets do not become the beneficiary’s property until they are disbursed. And, there is no way to compel a beneficiary to access the trust assets because distributions are controlled by the trustee per the terms of the trust.

Finally, a spendthrift trust typically prohibits the beneficiary from assigning their rights to future payments from the trust. This prevents the beneficiary from obtaining a loan secured by future payments from the trust.

Control over distributions

Beyond the creditor protections, another benefit of a spendthrift trust is that it enables grantors to maintain a certain level of control over their assets after passing away.

Maybe a beneficiary is a child or grandchild who has not fully matured, whose financial habits have not yet become clear. Maybe the assets are intended to benefit multiple generations, so distributing it in smaller sums protects against rapid or reckless spending. Or maybe a beneficiary has irresponsible or erratic spending habits, and holding the money for a longer time restrains instincts that would otherwise lead them astray.

Whether it is one of those reasons or another, a spendthrift trust provides the unique advantage to exert some control over their assets, even after they pass.

Control through generations

The terms of a spendthrift trust can specify what happens upon the death of a beneficiary. For example, suppose a married beneficiary passes away before their spouse. The terms can specify whether specific assets in the trust are allocated to the surviving spouse, children, or other beneficiaries. This ensures that assets are disbursed in a way that most closely matches a grantor’s wishes.

Who governs the trust?

A trustee oversees the funding and manages the trust assets per the terms of the trust. Generally, the trustee is the sole person who interacts directly with trust assets, serving as an intermediary between the assets and the recipients. 

The trustee is appointed to the trust and is either an individual or an institution. Usually, grantors choose a family friend or a financial institution they trust. Reliability and strength of character are critical attributes of a trustee since the administration of funds can be ensnared in legal battles and property issues.

Planning what will happen with your assets after you pass away can be daunting. A spendthrift trust is one of several tools that can help ensure that your assets go as far as possible. While this article provides a brief overview of a spendthrift trust, it is not a substitute for speaking to one of our expert advisors. Please contact our office if you are interested in learning more about building your estate plan and perhaps setting up a spendthrift trust.

The information provided in this article does not, and is not intended to, constitute legal advice; instead, all information, content, and materials available on this site are for general informational purposes only. 

The Tax Cuts and Jobs Act (TCJA) of 2017 brought about a number of changes to the way that research and experimentation (R&E) expenses are treated under Section 174 of the Internal Revenue Code. While many provisions of the TCJA went into effect immediately, changes to Section 174 were only effective after December 31, 2021 – meaning businesses will have to navigate these new changes in the 2022 tax year. 

At its core, Section 174 of the Internal Revenue Code (IRC) provides certain tax benefits for companies that incur R&E expenditures incurred in connection with the taxpayer’s trade or business. R&E expenditures generally include all costs incurred in the development or improvement of a product. (26 CFR § 1.174-2).  

Prior to the TCJA Amendment to Section 174, taxpayers could deduct the full cost of R&E expenditures in the year they were incurred. Now, however, these costs must be amortized over at least 5 years. Fundamentally, this means that businesses will see an increase in taxable income the first year those expenses are incurred. 

Overview of the changes

The TCJA amendment to section 174 requires taxpayers to capitalize and amortize their R&E expenditures from the midpoint of the taxable year in which expenses are incurred. Prior to the TCJA, taxpayers could immediately deduct R&E expenditures or amortize the expenditures over a period of 5 (for domestic expenses) or 15 years (for foreign expenses). Most taxpayers opted to use the immediate deduction, but that option will no longer be available. This change will likely lead to a year one increase in taxable income, but businesses could see increased deductions for subsequent years if they were previously deducting expenses up-front.

For instance, if a business has $1 million in domestic R&E expenses for a calendar year, it must amortize $1 million over five years ($200,000 annually) instead of taking a $1 million deduction in the first year, as was the case in the past. Also, they must amortize the expenses from the midpoint of the year, potentially cutting the first year’s deduction in half. In this case, that means the business can only deduct $100,000 in the first year, instead of the entire $1 million. 

Additionally, the research expenses that must be capitalized are broader than those typically associated with R&E costs under section 41 of the IRC. Section 41 of the IRC provides for a tax credit (called the Credit for Increased Research Activity) for certain R&E expenditures, but it only covers a narrow range of R&E costs that are not the same as those defined under Section 174. In a nutshell, costs eligible for the deduction under Section 174 are broader than costs eligible for the credit under section 41. 

For example, the Section 41 credit applies to salaries, supplies, and contract research, while the Section 174 deduction can include expenses for things like utilities, depreciation, attorneys’ fees, and other costs incident to the development or improvement of a product. 

This difference between eligible expenses means taxpayers will have to partition and calculate Section 174 expenditures separately from expenditures eligible for the Section 41 credit as the Section 174 expenditures will need to be amortized. 

What these changes mean for businesses and their accountants

As a result of the Section 174 changes, some taxpayers may have to file an Application for Change in Accounting Method (Form 3115) if they were not previously amortizing their R&E expenses. Businesses also need to ensure all R&E expenditures are properly identified as a result of these new guidelines. 

For those companies who were already capitalizing and amortizing their R&E expenditures, the Section 174 changes will be minimal – but it stands to dramatically affect businesses who were deducting the full cost of R&E expenses in the year incurred. 

Contact our office for assistance

While this article provides an overview of changes to the Internal Revenue Code, it is not a substitute for speaking with an expert advisor. If you’d like to learn more about R&E deductions or credits, contact our office and we’ll discuss your unique situation.