WealthManagement Magazine

Roth Wrongs

To convert or not to convert? That is the question. And it seems that Roth IRA calculators--which number about 35--dont offer an easy answer.When the Roth IRA first came on the scene, tax advisers, financial planners and brokers scratched their heads as they waded through proposed regulations and tried to make good recommendations to clients about whether to convert traditional IRAs to Roth IRAs.

To convert or not to convert? That is the question. And it seems that Roth IRA calculators--which number about 35--dont offer an easy answer.

When the Roth IRA first came on the scene, tax advisers, financial planners and brokers scratched their heads as they waded through proposed regulations and tried to make good recommendations to clients about whether to convert traditional IRAs to Roth IRAs. Adding to the confusion now are the various software programs designed to help investors decide whether converting makes sense. Critics claim the Roth calculators are not only inconsistent and unreliable, but in the hands of the uninformed, they can be downright dangerous.

Its frightening to think individuals without any professional training are using them, says Carrie Coghill, senior vice president of D.B. Root & Co., an independent financial advisory firm in Pittsburgh.

Articles in leading newspapers with titles like Roth Calculators Give Only Partial Answers and Converting to a Roth IRA? First, Check the Calculator, are laying bare the disquieting truth: All Roth IRA calculators--or analyzers, as they are sometimes called--are not created equal. There are some calculators you can rely on, and there are others that cannot be trusted.

In theory, a Roth IRA software program that prompts users to input pertinent financial information, does the math, then spits out calculations sounds like a godsend. In practice, most of the software programs fall short of addressing the full range of complex variables that must be considered to calculate the real financial ramifications of converting to a Roth IRA. The result is that one person plugging the same information into two, three or four calculators might come up with different answers, says Gary Battenberg, managing executive of Royal Alliance in Kingwood, Texas. One problem is that many calculators provide answers without a discussion of the underlying assumptions, he says.

Free Roth IRA analyzers are widely available via the Internet. Some mutual fund companies post the calculators on their Web sites. Many of these calculators use the same software program, manufactured by Arensmeyer Communications, and the companies customize it with their name using a graphics package. Michael Bleck, a tax associate with Schumaker Romenesko & Associates in Green Bay, Wis., has studied several of the calculators, but regards the free programs as marketing vehicles rather than real tools for analysis.

Professional versions of Roth IRA calculators are available for anywhere from $50 to $500. Brokers and investment advisers use them to crank out reports for clients who are struggling with whether to convert by Dec. 31, 1999, the deadline for being allowed to spread tax liability over four years. Even the professional versions have their pitfalls, offering results that need human interpretation, experts say.

The calculators can be used as a good starting point, but they should not be used as a basis for a conclusion, Bleck says.

Gobind Daryanani, Ph.D., an independent Roth IRA conversion consultant and founder of Bernardsville, N.J.-based DQI Inc., has analyzed 24 calculators and published his results in a 300-page study available for purchase (908/204-9559, $2,000). Daryanani, who also is author of a Roth IRA textbook for brokers and financial planners (rothirabook.com), analyzed the software programs on the basis of case studies, simulation of the programs algorithms and discussions with respective company management on program design philosophies.

Based on his analysis of the free calculators, Daryanani gives the highest marks to the T. Rowe Price program for two reasons: It is based on the annuity payout model, and it addresses minimum required distributions. The T. Rowe Price calculator operates on the assumption that the investor will withdraw money from an IRA account in installments over a period of years. This is in contrast to lump-sum calculators from Vanguard, Schwab, DataChimp, Strong Funds, Fidelity and others, which assume that the individual will withdraw the entire amount.

The lump-sum calculators are easy to program, but theyre not an accurate representation of what people do, nor do they give an accurate answer, Daryanani says.

>From the professional calculators category, Daryanani praises those by Brentmark, Money Tree, Denver Tax, R. Planner and, of course, the DQI Optimizer--a program designed by Daryanani and due out soon. They use the annuity model and provide several methods for addressing minimum required distributions.

Another way to differentiate among the professional programs is to determine whether the calculator addresses estate taxes and what happens to the Roth account after the clients death. Also, look for a calculator that has an automatic tax calculation function--only the Money Tree and DQI programs do. Most calculators ask for preretirement and postretirement tax rates. Daryanani says the problem with this is that most people cant predict their after-retirement tax rate.

Whats the bottom line on Roth IRA calculators? Understand the assumptions made by the program and determine whether they match your clients situation.

Look at the assumptions page and see if the assumptions being made by the calculator make sense for your clients, says Beth Streeter Rousseau, marketing program manager for mutual funds with American Skandia, in Shelton, Conn. If you come in with a different thought process than whats in the calculator, it wont many any sense.

The best calculators ...

Use an annuity model, not a lump-sum model

Factor in the minimum distribution requirements

Calculate what happens to the account after a clients death

Address estate taxes

Automatically calculate tax rates

More information on Roth IRA conversion calculators can be found on the Internet at www.rothira.com, including a longer list of what good programs should be able to do, written by Michael Bleck, a tax associate with Schumaker Romenesko & Associates in Green Bay, Wis.

The difficulty inherent in deciding whether to convert a traditional IRA to a Roth IRA was lamented at the Securities Industry Associations Savings, Retirement and Estate Planning Conference in Denver during June. Speakers at the event also commented that conversion calculators dont necessarily simplify the process.

IRA conversion is the most technically complex thing brokers have to do, said Maryanne Elias, Morgan Stanley Dean Witters IRA marketing director.

Mark Tulley, A.G. Edwards manager of IRA retirement plan services, warned the audience against using Roth IRA calculators indiscriminately. He said if brokers simply run the numbers through their firms calculators, they usually come to the conclusion that conversion is a good idea.

But you need to ask the client: Do you want to pay taxes now? Do you have money outside of your IRA to pay taxes? Do you need to take distributions within the next five years? Tulley said.

Merrill Lynch restricts how its brokers use Roth calculators, said Janice Maggio, a Merrill retirement planning staffer. For IRAs up to $1 million, brokers are free to use the firms calculator themselves to make recommendations. For larger accounts, the firm provides a more sophisticated analyzer, but brokers arent allowed to run it. They submit the data, and the firm takes over the calculation.

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