One of the many estate planning challenges is reducing estate taxes and eliminating income tax your heirs could have to pay on assets they inherit. One such asset, a traditional IRA, can have its tax bite reduced significantly by converting it into a Roth account.

First, Roth IRAs are not subject to the minimum withdrawal rule, which applies to traditional IRAs, that requires annual distributions after you reach 70 ½. When you convert a traditional IRA to a Roth, you can leave the balance untouched while it continues to grow tax-free. Bear in mind that conversion is only available to single or joint income tax filers with adjusted gross incomes of less than $100,000 (converted amounts are not included in your AGI when determining your eligibility). If you decide to convert to a Roth IRA after reaching 70 ½, you will have to take a minimum withdrawal distribution for the conversion year. The remaining balance can then be converted to a Roth IRA.

Converting requires that you pay tax on accumulated earnings and tax-deductible contributions. You should pay this tax from other assets. That’s because when you pay this tax, you are in essence advance paying your heirs’ income tax without owing gift tax or surrendering any of your estate tax exemption. Advance paying also reduces the taxable amount of your estate.

When you die, your heirs won’t owe any income tax on withdrawals from the inherited Roth IRA. At your death, however, the Roth IRA becomes subject to the same minimum withdrawal rules that affect traditional IRAs. If your heirs aren’t in a hurry to take distributions, they can stretch them over an extended period of time while the remaining balance continues to grow tax-free.

An effective way to capitalize on the Roth’s unique estate planning capabilities is for a husband and wife to establish a long-term, tax-free annuity for their child. Here’s how it works. The husband designates his wife as the beneficiary of his Roth IRA upon his death. When he dies, the wife puts the account in her own name and designates their child as the beneficiary upon her death. The child must begin taking minimum distributions by December 31st of the year following the mother’s death. The minimum distributions are spread out over the child’s life expectancy. This maintains the account’s ability to earn tax-free income for as long as possible and creates an annuity-like effect. However, the child must take these distributions as required, or the account will have to be liquidated after five years.

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