Questions Regarding My Dad's 403(b) -> Roth IRA Conversion

[Joshua C]

My Dad is on the verge of turning 72. He is still working and has a 403(b) with the non-profit that he started. I was educating him some on the benefits of rolling his money from the 403(b) to a traditional IRA, and then to a Roth. His charitable contributions amount to close to $50K/year, so he does not have any tax liability. Thus the reason I was encouraging him to roll that money over, because it would basically be seen as income, but pretty much cancelled out by his charitable contributions.

Herein lies my connundrum. If he is still working, then he cannot roll his money into a traditional IRA. However, since he is past the 70.5 minimum distribution age, what is he allowed to do with those distributions? In the end, I'm looking for how to decrease his tax burden on the money that he has in his 403(b). Thanks.

 

[Matt]

It's a little complex... and perhaps there are opportunities here within the wider picture, but from what you have said all I can suggest initially there is a way to defer the RMD beyond 70.5 (until a year after whenever a person retires). But I believe that this is disallowed for greater than 5% owners, so if he 'started it' does that mean he owns more than 5% of it?

Also, are you certain that the plan disallows an in service rollover? Depending on the structure of the plan it may be possible..

 

[Joshua C]

@Matt, thanks for responding. What do you mean by 'owns more than 5% of it'? Are you talking about vesting? I'm still trying to find info on whether or not his 403(b) with Franklin Templeton will allow it. Will post back when I get more information!

 

[Matt]

@Matt, thanks for responding. What do you mean by 'owns more than 5% of it'? Are you talking about vesting? I'm still trying to find info on whether or not his 403(b) with Franklin Templeton will allow it. Will post back when I get more information!

Generally speaking, 401(k) and 403(b) plans do not require minimum distributions (RMD) at age 70 1/2 if the employee is still working there. Instead, they may elect to accumulate the funds and commence distribution at 1 year after actual retirement. EG if he retires at 85 he should distribute in the year after that.

However, if he actually owns the company (not the vesting of the plan) for more than 5% then he is likely excluded from this option. Your verbiage in the OP was:

with the non-profit that he started.

And I wondered if you meant:

He started up a non profit business (and is therefore an owner) and is still working there.. if so then he may be excluded.

However, if:

He started a 403b at a nonprofit (and is not a 5% or greater owner of the company) he might be ok.

 

[Joshua C]

That's great info, thanks again.

I'm advising him to find out from his tax accountant the max amount he can take out now and still not be taxed or at least still have a low tax burden (currently he gets huge tax returns). At his charitable contribution rate, it makes more sense for him to take as much out as possible now, than when he is retired and no longer making such big contributions.

Is that correct thinking on my part?

 

[Matt]

That's great info, thanks again.

I'm advising him to find out from his tax accountant the max amount he can take out now and still not be taxed or at least still have a low tax burden (currently he gets huge tax returns). At his charitable contribution rate, it makes more sense for him to take as much out as possible now, than when he is retired and no longer making such big contributions.

Is that correct thinking on my part?

I'm not sure, it is hard to say from what I see here. But what I mentioned earlier is that he may not have to take anything from the accounts at this time.

Your comment about 'charitable contribution rate' isn't clear - since charitable contribution rates tend to be elective, why would they drop off after he retires? If he wanted to, he could still contribute at that time, and then doing so may drop his effective tax rate?

 

[Joshua C]

You and I are essentially thinking the same thing. However, the difference is, his charitable contributions will be a lot less, because he will no longer be working and thus won't be drawing a salary. That's why my thinking is for him to withdraw as much now as possible, at a lower effective tax rate.

 

[Matt]

Yeah this is what I mean by it being hard without more details. You mention in the OP that he donates about $50K per year to charity making an 'essentially zero' tax rate. However, charitable donations are limited to 50% of AGI, so it isn't that he earns a salary of $50k and that is eradicated (or 60ish K with standard deductions) it means his salary should be somewhere up in the $120K+ range (guessing here)..

So that would mean that if you added on additional compensation today he would be starting at a base of 15%, and quickly raise through the brackets as you distribute the 403b.

Alternatively, if he was to continue to contribute to the 403b he would lower his present day tax bill, and wouldn't need to give as much to charity to achieve the same tax goal today, allowing him a fund that could be donated in the future. When he does retire his salary is removed from the income tax equation, so he could 'draw down the 403b' with a lot less impact.

I have to say that at this level of gifting and his age you might want to speak with a certified financial planner, and also start some more elaborate estate planning techniques, as it is important to not things such as the 403b being an IRD asset (income in respect of the decedent) so he may also want to consider what the impact would be if he was to continue to fund the asset and bequeath it, doing so would mean that the asset would be taxed at the beneficiaries rates.

Additionally, with $50K level gifts you are into some interesting levels of trust strategy, such as CLT (lead trusts) or CRT (remainder trusts).

The lead trust you somewhat 'lend' the charity a lump sum, which kicks off an annuity (say $50K) that they receive each year, and at the end of a term the balance can be taken back into the estate, or passed to another. Due to the way that the IRS calculates tax on that it is a way to both donate to charity and also pass along assets at what can be substantially discounted rates.

The remainder trust works in the inverse, in that it pays him an annuity, and at the end of the term the charity gets the balance.

The CLT has a LOT of potential, and could save hundreds of thousands of dollars. It's something to look further into.

 

[Joshua C]

You are correct in stating that he doesn't only make $50K, but he doesn't make $120K+ either. However, I'm assuming you're thinking my dad donates $50K for the tax benefits, he doesn't. He gives because he wants to and is able. However, once he retires, since he won't be drawing a salary and only drawing on his 403(b) for living expenses, he will not be giving charitably in that kind of amount. I've advised him to talk to his financial accountant regardless. What he decides to do is up to him. Will post back if he gets back to me and has any questions. Thanks for your help, man!

 

[Matt]

You are correct in stating that he doesn't only make $50K, but he doesn't make $120K+ either. However, I'm assuming you're thinking my dad donates $50K for the tax benefits, he doesn't. He gives because he wants to and is able. However, once he retires, since he won't be drawing a salary and only drawing on his 403(b) for living expenses, he will not be giving charitably in that kind of amount. I've advised him to talk to his financial accountant regardless. What he decides to do is up to him. Will post back if he gets back to me and has any questions. Thanks for your help, man!

Good luck with it. One thing I'd re-iterate is that he can still gift the same amount of money over a longer period of time and it would save taxes... if he's not making $120K then he's leaving tax money on the table.. eg he could do $40K per year for 5 years instead of $50K for 4, charity still wins, and he gets the full benefit. There is a carry forward on the taxes, but if he is consistently giving over the amount he can claim then he may well lose out on that.