March 31, 2021
When Not to Do a Roth Conversion? | Investing Inside of a Trust
ROTH Conversions are good but it might not always be the answer.
There might be other routes to go depending on how you set up your legal structure, especially if you have Asset Protection Trust. Sure it grows tax-free but it is not protected from a nursing home and Medicaid spend-down.
Atty. Chris Berry explains this further in this episode of Daily Wisdom.
Estate Attorney and Advisor Chris Berry of Castle Wealth Group answers questions on retirement and estate planning every Wednesday at 1pm. Register via this link or give our office a call at 844-885-4200.
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Episode Transcript
Investing Inside of a Trust
Hey, this is Chris Berry with Castle Wealth Group and today we’re going to talk about tax efficient investing inside of a trust. And if you like this information, please subscribe to our YouTube channel.
Christopher Berry is a leading Estate Attorney and Advisor in the area of retirement and legacy planning. He has been featured in publications such as Forbes, Kiplinger’s Crain’s Detroit and more. He’s the host of the weekly radio show and podcast, The Chris Berry Show. He’s a national thought leader as it relates to retirement and legacy planning and has authored the Amazon bestselling book, The Caregiver’s Legal Guide.
So a question that comes up a lot is with regards to investing and investing inside of a trust and a lot of people are concerned about where taxes are going in the future and a lot of people have saved a lot of money in these tax deferred accounts like IRAs, 401(k)s. And the problem with that is that when you pull money out of these accounts, you have to pay tax on it. And a lot of people think, especially with where government is going, that taxes have to go up in the future. And so, if taxes have to go up in the future, then maybe it makes sense to pay the tax sooner rather than later on these pre-tax accounts, like your 401(k)s, 403(b)s, IRAs. And so, if we were to pay the tax, a lot of people look at doing a Roth conversion and there’s pros and cons to that.
The advantage is that now it’s going into something that can grow tax-free. The downside of that, especially if you have an asset protection trust, is that if you do a Roth conversion, whatever you convert inside of the Roth is not protected from that nursing home or Medicaid spend out. So if you’re concerned about long-term care costs, you might not want to do that Roth conversion. And instead we have to look to, instead of moving money from the tax deferred bucket, which we call the always tax bucket and instead of moving it to the tax-free bucket, now we have to move it to what we call the taxable bucket and we call it the sometimes taxed.
Portfolio That’s More Tax Efficient
And the concern some people have is, “Well, if I have my investments in this asset protection trust and it’s in this taxable bucket, I’m going to get killed on taxes.” Well, maybe, maybe not, depending on how you have invested that money. And so, if you’re one of these people using kind of Vanguard and relying on dividends, then yeah, you’re going to have to consider maybe a more tax efficient portfolio, where it’s not necessarily spitting out dividends, there’s other ways to create income. And so, that’s typically when we’re investing inside of a trust, we want to put together a portfolio that’s more tax efficient than your average combination of mutual funds and bonds.
We specifically want to invest it so that it’s not hurting you from a tax perspective, because understanding investing in the taxable bucket, doesn’t mean that it’s necessarily taxed, because we have what’s called long-term capital gains, which depending on your income, may or may not be taxed. And then, also understand when you’re leaving that taxable bucket to the next generation, unlike the tax deferred bucket, as of right now you get what’s called step-up in basis. So if you bought an investment for $100,000 and you passed away as valued at 200,000, and then the kids sell it at 200,000, you get a step-up in basis, where now the basis is the date of death value, not what you originally purchased it for.
So, understand that if you have money invested in a taxable bucket that’s inside of the trust and you leave it to the next generation, chances are it still will be tax-free similar to like leaving them a Roth in the sense that whatever they inherit from you would be tax-free due to that step-up in basis. So understand that the Roth, while it’s good, it’s not necessarily the end all be all, especially if you have an asset protection trust, where there are certain things that we can do inside of that asset protection trust to make things as tax efficient or even tax free. Or we could even tax defer depending on the type of investment.
For example, one of the things that we can invest in inside of the trust, I’m not saying you have to do this, would be, cash value life insurance. Cash value life insurance grows tax free. Or if you wanted to continue deferral, there’s specific types of investments that can offer tax deferral inside of a trust. So understand that, yes, we want to get more tax efficient, but that’s not necessarily just moving money from the tax deferred account IRA doing a Roth conversion, we have different options. And especially if we have an asset protection trust, there’s different options with inside that trust to make it as tax efficient and even maybe tax free.
Roth Conversions
So long story short, Roth conversions are good, but they’re not the magic bullet. They might not always be the answer. There might be other routes to go, depending on how you set up your legal structure, especially if you have an asset protection trust, because remember, a Roth IRA is not protected from that devastating nursing home or Medicaid spend out. Sure, it grows tax-free, but if you have to liquidate that Roth to pay for your care, what was the value of that tax-free growth, right? Versus, maybe instead of the Roth conversion, we pay the tax, move it into the trust, now we can invest it as tax efficiently as possible, but now it’s protected from that nursing home or Medicaid spend out.
So just something to think about. This has been Chris Berry with Castle Wealth Group. If you find this information helpful, please make sure to subscribe to our YouTube channel, so you get notified when we upload new videos. Thank you so much.
Castle Wealth Group has clients across the nation and helps families plan, protect and preserve what is important, by creating a retirement and legacy blueprint.