Roth IRA conversions can benefit clients by helping them level out tax obligations over time by reducing future required minimum distributions that would be taxed at the clients highest marginal rate.

A Roth IRA conversion is simply converting an account holder’s traditional assets into a Roth IRA. In 2010, the IRS eliminated its previously-established income status and filing conditions applied to Roth accounts. This change also allows investors to begin converting traditional IRAs into Roth IRAs, no matter their income.

Weighing the Pros and Cons of Roth IRA Conversions

Financial advisors play an important role when helping clients understand the benefits of Roth conversions. This includes recognizing when Roth conversions are helpful, when they should be utilized, and which Roth conversion strategies should be used. 

What are the advantages of Roth IRA conversions? 

  • Roth IRA conversions can lower the total amount of taxes paid in the future.
  • Converted amounts, contributions, and earnings can grow tax-free.
  • Many account owners will likely owe less money in taxes over the long-term by keeping funds in their Roth IRA accounts over traditional IRAs.
  • Account owners can make withdrawals at any time without having to pay taxes on them. However, you may have to pay taxes on earnings made within five years of the conversion.
  • Required minimum distributions (RMDs) aren’t required for account owners on converted Roth IRA accounts when they reach the age of 72. If the funds aren’t needed immediately, they can be passed onto their children, grandchildren, or heirs. In many cases, distributions can be delayed up to 10 years after the owners death. 

What are the disadvantages of Roth IRA conversions?

  • Account owners must pay taxes on a Roth IRA conversion when it’s completed, and these taxes could be high. 
  • If the future tax rate is lower than the current rate, account owners won’t benefit from the conversion. 
  • Clients must wait at least five years from the date the Roth account was to make tax-free withdrawals, regardless of their age. 
  • Calculating taxes can be complicated if you factor in other retirement accounts, and account holders will likely need the assistance of an experienced financial advisor. 
  • Software like Tax Clarity® and Income InSight® can take the guesswork out of Roth conversions and overall retirement tax planning. 
    • Tax Clarity® identifies opportunities for possible Roth conversions in any given year. 
    • Income InSight® gives financial advisors the ability to show clients the lifetime impact of carrying out Roth conversions.

How to Determine the Best Approach to Roth IRA Conversions

Although converting funds from a traditional IRA into a Roth IRA can be a good tax technique for many of your retired clients, determining when and how much to convert can be a complicated and time-consuming process.

1. Understand the needs of your client.

As a financial advisor, helping clients determine the best time and method for claiming Social Security benefits can help improve their retirement strategy. Roth IRA conversion strategies should factor in Social Security payments. There are different ways to utilize these strategies simultaneously, especially when it comes to possible tax breaks. 

For example, some clients may want to withdraw from their traditional IRAs while delaying Social Security benefits. This can help increase their total benefit amount. Other clients may wish to withdraw from taxable accounts and complete conversions while delaying benefit to lower their taxes and convert larger amounts to Roth.

3. Create a retirement income tax strategy.

To help clients understand their options, develop different scenarios that demonstrate the effect of various IRA withdrawal schedules, Social Security benefits timing, and retirement age. This will help you pinpoint the best strategy to secure the lowest effective marginal tax rate possible and support a successful wealth management strategy that meets your clients’ goals. Creating a tax map can help identify the tax rates associated with various IRA withdrawal strategies.

3. Plan for the unexpected.

Ideally, retirement plans should be flexible. They should be well-equipped to adapt to different scenarios, such as:

  • A down market
  • Unforeseen healthcare events
  • Expensive emergencies
  • The early death of a spouse
  • Social Security benefit cuts
  • And more

Roth conversions should be considered based on future income and tax scenarios. Your clients’ annual conversion threshold is the maximum amount they can convert during a single tax year before income falls into a higher tax rate. This threshold will be different for each client depending on the overall household income, assets, and spending needs.

Help Your Clients With Roth IRA Conversions

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