Advisers find Roth IRA conversion opportunity a tough sell
With the upcoming changes to the Roth IRA conversion rules, some advisers might think that clients would be…
With the upcoming changes to the Roth IRA conversion rules, some advisers might think that clients would be banging down their doors to convert their traditional IRAs to Roth IRAs.
But many advisers are having a hard time persuading clients to make the conversion and pay taxes now instead of later, given that most of them have taken such a huge hit from the market downturn, advisers said.
Starting Jan. 1, people making more than $100,000 annually will be eligible to convert their traditional individual retirement accounts or 401(k) plans with previous employers into Roth IRAs. Currently, only those who make less than that amount a year are eligible to convert.
Logically, it would make sense for many of these clients to convert next year, since their portfolios and their taxable income are probably smaller now than they will be years from now, said Howard Schneider, president of Practical Perspectives LLC, a research and consulting firm.
But emotionally, this is a tough sell, he said. “The challenge is that advisers have to convince clients to give up cash today for the benefit in the future,” he said. “You have to convince them that they will be better off in 10 to 15 years.”
Many accountants and advisers are addressing this by counseling clients to convert their IRAs to Roth IRAs in chunks, Mr. Schneider said.
“Instead of trying to convert a million-dollar IRA, they are taking pieces of the portfolio where there would be less of a tax hit and converting it,” he said.
Jonathan Horn, a certified public accountant, has found this tactic to be effective. “When we do this, I suggest that we sit down with the clients’ financial advisers and look at what assets are in their IRAs that have the greater upside potential,” Mr. Horn said. “Those are the assets that you want to move into a Roth.”
Another tactic that Mr. Horn is taking with clients is telling them to think of their children. “The truth is when you run the numbers, converting means the difference of saving $50,000 over a lifetime, which doesn’t mean much to many of my clients,” Mr. Horn said. “I tell those clients to think about how this would benefit their heirs.”
Wait-and-see is the approach that Darren Neuschwander, a shareholder with accounting firm Neuschwander Faircloth & Hardy PC, is taking.
One of the major uncertainties involved with whether or not clients should convert to a Roth is that current tax rates are scheduled to expire at the end of 2010 and no one knows what Congress is going to do, he said.
At the same time, no one knows what the markets are going to do next year, Mr. Neuschwander said.
He is recommending that clients file for an extension on their 2010 taxes, giving them until Oct. 15, 2011, to change their mind. “So if you convert and then the value of your account increases tremendously, you made a good move. but if it decreased and Congress passes something to put you in a higher tax bracket, you can re-characterize it back to a traditional IRA,” he said. “The re-characterization sounds difficult, but it’s just going through the paperwork.”
Some particularly conservative clients are so mistrustful of the government that they are worried that Congress might decide down the road that Roth IRA withdrawals are taxable and thus they will end up paying taxes twice, Mr. Neuschwander said.
This is what happened with Social Security, he said. “Some clients have asked me, ‘What happens if Congress changes the rules and we have to pay taxes again,’” he said. “To be completely honest, that’s an unknown.”
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