The $70 billion tax cut that became law last month is good news for advisors helping their wealthy clients with retirement planning, because for the first time they can recommend opening a Roth IRA.
“This law definitely benefits high-income individuals, and we are going to bring it to their attention,” says Roger Kruse, senior partner at FFP Wealth Management in Coon Rapids, Minn. The current law allows conversions from traditional IRAs to Roth IRAs only for individuals and joint filers with adjusted gross incomes of no more than $100,000.
As of 2010, however, there will be no cap on income for conversion. Another plus is that while traditional IRAs require individuals to withdraw from the account by age 70 ½, clients can delay taking distributions from the Roth for as long as they like. That way, they can pass on their accounts to their heirs and, as there are no taxes on withdrawals from Roth IRAs, the heirs get the money tax-free.
While the income cap on converting to a Roth IRA has been removed, the income cap on contributing to it is still in effect. Married couples whose adjusted gross income exceeds $160,000 and single filers with income greater than $110,000 cannot contribute to Roth IRAs.
However, this may not be too great an impediment to wealthy clients interested in Roth IRAs. Clients who exceed the limit for Roth IRA contribution can instead contribute to nondeductible traditional IRAs each year, then in 2010 and ensuing years, convert the amounts to a Roth IRA. They then pay taxes only on the returns the traditional IRA account had accumulated up to the point of conversion.
The new law—The Tax Increase Prevention and Reconciliation Act of 2005—also eases the pain of conversion in 2010. The act does this by allowing two payment choices, either by paying the entire tax that year or paying it between 2011 and 2012. Taxes for conversions made after 2010 are required to be paid in one year.
For those clients planning to leave IRAs as part of an estate, converting to the Roth may save their heirs some tax dollars. Instead of paying the estate tax and taxes on withdrawals from a traditional IRA, they will only have to pay estate taxes. They will, however, have to wait a long time for this benefit: the three-and-a-half years until 2010, plus the five years a Roth IRA must be in place to make withdrawals tax-free.
Diane Pearson, director of financial planning at Legend Financial Advisors in Pittsburgh, says, “Generally speaking, anyone under the age of 55 should consider the conversion in 2010 because you will still have about a 15-year window before taking that required withdrawal from a traditional IRA.”
Of course, clients will have to be patient for three-and-a-half years, and even then it may not be right for every client. Pearson, for one, will make use of the time by “running the numbers and deciding whether or not a conversion is right for the client.”