Converting an IRA to a Roth IRA can provide tax-free income but you can’t convert if your income is $100,000 or more. If you’re faced by this problem, buy insurance on your life, using the money you would have paid in tax on a Roth IRA conversion. The beneficiary can invest the insurance proceeds in a municipal bond fund and create a “Roth IRA look-alike.”
Suppose, for example, you leave your son a $500,000 traditional IRA. With a 33-year life expectancy for your son, and a 3 percent required first-year withdrawal, he might have to withdraw $15,000 (3 percent of $500,000) and owe around $6,000 (40 percent of $15,000) in income tax.
If your son was named beneficiary of an insurance policy, and invested the proceeds in a municipal bond fund, he could cash in $6,000 worth of municipal bond fund shares. He’d wind up with $15,000, from the bond fund and the after-tax regular IRA distribution, the same as the amount he would have received from a Roth IRA. This can go on, year after year, as long as there is enough money in the bond fund.