These days it's nearly impossible to open your Outlook inbox on any given morning and not find an e-mail enticing you to consider, extolling the virtues of, alerting your attention to, proclaiming the benefits of, or any number of other ways to peak your interest in the Roth Conversion.
So why all the hubbub? The truth of the matter is that the Roth Conversion has been around for quite some time. Why then are we seeing the experts only now coming out of the woodwork to speak on this subject? Why are the marketing companies scrambling to put together a selling system to support this concept? The answer, as those of you who read your e-mails already know, is TIPRA.
The Tax Increase Prevention and Reconciliation Act of 2005 (TIPRA) was signed by President George W. Bush in May 2006. This act contained several revisions to preexisting tax laws. Included in these taxpayer friendly revisions were the "kiddie tax," the extension of lowered capital gain taxes and the extension of higher exemption amounts for the alternative minimum tax (AMT).
However, TIPRA also gave us something with far-reaching potential, all the way to the future retirement of the American public. In 2010, the existing $100,000 modified adjusted gross income (MAGI) limit on the conversion of traditional IRAs to Roth IRAs has been eliminated. This means that taxpayers earning above $100,000 are now eligible to convert their traditional IRAs to Roth IRAs. In addition, in 2010 only, they may elect to soften the tax blow and spread the taxes incurred over two years and effectively manage their tax bracket.
Before exploring the benefits of a Roth compared to a traditional IRA, consider for a moment where the U.S. economy and future taxes are headed and what we as taxpayers should prepare ourselves for. For instance, we know that if things remain on their current path, we can expect taxes to increase as soon as 2011. Currently the 10% tax bracket is slated to be eliminated, which means that we will pay 15% on the first $17,200 of income that we earn. The Child tax credit will drop to $500, and the 25%, 28%, 33% and 35% federal tax brackets will move up as high as 39.6%.
According to the nonpartisan Congressional Budget Office, the current health care proposal will cost somewhere around $1 trillion over 10 years. This plan would be paid for through increased income taxes, cuts to Medicare and Medicaid, and tax penalties. According to David Walker, former comptroller general and head of the Government Accountability Office, "We are heading for a future where we will have to double federal taxes or cut federal spending by 60%."
To believe that the federal government, with wars being fought abroad, nationalized health care becoming closer to a reality and a national debt at $11 trillion, can cut spending by 60%, is considered naive by many. So where does this leave us? I'll tell you where it leaves me: Worried about my future. It leaves me feeling less in control of the funds I'm putting away now for my future retirement. If there was a way for me to regain some of that control I'd want to know about it.
3 truths of retirement planning
As I talk to my clients, I realize that the majority of them have three commonalities or concerns. I like to refer to these commonalities as the "three truths of retirement planning."
1) If I do my job right, my clients will retire with as much if not more than their highest earned pre-retirement income. There was a time when conventional retirement planning said to defer your taxes while you're working because when you retire, your salary will be at most 75% of what it once was, effectively putting you in a lower tax bracket.
2) The writing is on the wall and it says taxes are going up. We need to plan accordingly. There is an old adage that asks, "Would you rather pay taxes on the seed or the harvest?" In other words, you have two options: Pay your taxes now while you are most likely in a lower bracket, allow your money to grow tax-deferred, then have access to the principle and the growth tax-free regardless of tax rates. Or, option two: Defer all taxes to a future date when rates will quite probably be higher than they are today.
3) Americans on average are living longer. About 50 years ago, the U.S. population lived, actuarially, only five to eight years into retirement. Now, the U.S. population lives 15, 20 and sometimes 30 years into retirement. Longevity should never be an obstacle to anything. However, if not adequately prepared for, it certainly could be an obstacle to a comfortable retirement.
Tax advantages of converting
Knowing the score is important. Knowing what to do about it will set you apart and make you indispensable to your best clients. The Roth Conversion is just such a solution. It gives you the ability to reposition existing assets into a retirement vehicle which affords tax-deferred growth, tax-free distribution, the ability to pass along those funds to heirs income tax-free and allow the heirs, through a "stretch," to receive tax-free distributions over their life expectancies.
Strategies and opportunities like these don't come along every day, and when they do, it is the wise practitioner that recognizes them and takes full advantage.
With the $100,000 MAGI limit removed, many people now have the ability to take full advantage of this concept. Clients can now pay the taxes, sans penalty, on their Traditional IRAs regardless of size and convert them into a Roth. With strict limits on contributions, never before have clients had the ability to a place essentially a limitless amount of money into a Roth IRA and receive such favorable tax treatment: Tax-free growth and tax-free distributions.
Of course to recommend this, we need to make sure it is suitable for the individual client. For many, the upfront tax consequence, even with the two-year provision, may be prohibitive in conducting the conversion. Clients who are already in or are close to retirement may find themselves in this situation. Proper tax calculations must always be conducted and consultations with the client's CPA are highly advised. As a rule of thumb, a Roth Conversion should be considered by those who have a longer time horizon; are willing to pay additional taxes now to increase their future retirement income; do not need immediate income from their current IRA; and wish to maximize their legacy.
Why the change?
Any good financial steward would now ask the question: Why is the government allowing us this benefit? The answer is two-fold:
1) The government is in need of funds now and they are acutely aware of a very valuable economic principle. With inflation looming, the dollar is worth much more today than it will be in the future.
2) With the national deficit as high as it is and the current programs in need of immediate funding, our government has to make a quick buck. The conversion, while a fantastic strategy for the average investor, provides the government with a much-needed infusion of capital and an increase in value on an asset that it currently holds.
Jump through the window
A window of opportunity is open and the opportunity is great. In August, National Underwriter reported on a survey which found that 73% of boomers who own an IRA are not planning to convert their traditional IRA to a Roth. Most, assumingly, have been unaware or uneducated on the benefits of a Roth Conversion. In June, the Investment Company Institute reported, "about one-fourth of Americans' retirement assets, or $3.6 trillion, were held in individual retirement accounts (IRAs) at year-end 2008. The majority of IRA assets, $3.2 trillion or 89%, were held in traditional IRAs."
A down-and-dirty rough calculation will tell us that if approximately 27% of the population plans to convert $3.2 trillion, we can expect to see about $869 billion moved over the coming year. To put that into perspective, according to the Beacon Research Fixed Annuity Study, the entire amount of fixed annuity production in 2008 was only $107 billion. The benefits are great; the opportunity is huge; the time is now.
Ben Nevejans is Vice President of Brokerage for LifePro Financial Services Inc. He has served in the financial industry for the past 10 years in both personal production and advanced producer support. After establishing a LifePro branch office in the New England area, Mr. Nevejans returned to San Diego to help lead a team of support and sales staff for LifePro.
