Roth IRA Conversion - Nursing Home Resident

[JohnH]

Now here's an interesting twist on the Roth IRA conversion.

Client has an elderly uncle in his 80's who's permanently in a nursing home for medical reasons, with qualified medical deductions of about $70K/year. The uncle has no children and the client is the 100% beneficiary of an IRA the uncle owns - balance is about $40K.

The uncle has enough liquid assets to pay for his care for many years, and is currently taking RMD's from the IRA only because he must. So the client is suggesting that the uncle convert the IRA to a Roth. There will be no tax consequences since the medical deduction will wipe out the entire taxable income from the IRA and his other income (primarily from CD's paying paltry rates right now).

If the uncle lives long enough to exhaust all his assets, the point is moot. But if he dies before tapping the converted Roth IRA, the nephew will receive the entire amount with no tax consequences to him. Seems like a win-win for the nephew, and the uncle is in favor of it since it makes no tax difference to him either way and he'd like to help the nephew out if his assets outlive him.

Anybody see any problems here?

[erchess]

Problems

It does seem like win-win and if the Uncle is of sound mind and can approve this well and good. I don't see pitfalls for the uncle or the nephew except of course that Congress could always change the rules. I see pitfalls for you but the risk in my opinion is minimal if he signs the right statement which presumably you write.

Get his signature witnessed and attested to by an RN MD or administrator at the nursing home. The point about the witness is that the person should have the ability to testify in court that the uncle is of sound mind and is not being coerced. The statement should say that he is of sound mind and wants to do this because the tax consequences of the income will be erased by his medical expenses and it will benefit his nephew if the account does indeed survive him. The statement should say that he is freely deciding to do this for his nephew and should clearly state your role as adviser. You probably have some boilerplate language that you put in all written tax plans about how it is that tax laws and life circumstances change from time to time and these affect the actual outcomes of tax planning so you can't promise that the effects will be as desired. Put that in with a statement that he understands it so you don't get sued if Congress changes the tax free nature of Roths the way it did Social Security.

[JohnH]

Good points, and thanks for the input. I don't plan to be involved in the transaction and I'm not writing anything. All I'm doing is answering quesitons posed by them.

The nephew holds a Durable POA for all the uncle's affairs and he manages all the uncle's finances, although the uncle does participate in any major decisions. Seems to me all that needs to do be done is for one of them to sign the Roth conversion paperwork from the trustee without any further documentation. (Sometimes too much documentation with extraneous info has the potential to come back to bite you)

[Snaggletooth]

No-Brainer

Unless I'm missing something this sounds like a no-brainer. Everyone wins. An example of tax planning that others should follow.

[Lion]

Reason

If you or the nephew or the IRA owner needs to state a reason at any time, use something like not wanting to be required to take RMDs while he doesn't need the money for his current expenses. Don't talk about benefits to the nephew or any other beneficiary, even though estate planning is a common reason for an older person to convert a Traditional to a Roth. As Eric has said, you want to leave few loops for a disgruntled heir to grab and argue and maybe even sue.

[Kram BergGold]

One point

This scenairio assumes the uncle's income before the Roth Conversion is under $35,000.
If say his income was $50,000 and then with the conversion it would be $90,000 he would pay tax on everything over the $70,000 plus his exemptions.

[JohnH]

I did simplify the numbers to keep on track, but let it suffice to say that adding the entire IRA to his current income will not generate any tax liability. He has other itemized deductions (contributions, property taxes, etc) that I didn't mention. Also, interest rates on his laddered CD's have been continually resetting at much lower rates so his taxable income continues to decrease.