WealthManagement Magazine

Doing the Family a Favor

I've got a way to boost your tax bill right now is one of the least effective ways to generate positive client interest, second only to a sign on your door proclaiming This office has been lawsuit-free for 38 days! So when you suggest to your recently retired clients that they consider moving money from an IRA to a Roth IRA, you may not want to highlight the fact that this year's check to the IRS

I've got a way to boost your tax bill right now” is one of the least effective ways to generate positive client interest, second only to a sign on your door proclaiming “This office has been lawsuit-free for 38 days!”

So when you suggest to your recently retired clients that they consider moving money from an IRA to a Roth IRA, you may not want to highlight the fact that this year's check to the IRS is going to be a bit bigger than expected. Discuss it, yes. Open with it, no.

Instead, talk about what your clients will buy for those extra dollars being sent to the government. More money and fewer taxes throughout retirement seems likely. But most importantly, you'll have created a tax-free money machine for the clients' descendants — and earning the favor of the next generation might ensure your oversight of the accounts doesn't die when your clients do.

The Upside

Here's what converting an IRA to a Roth IRA will do for your retiring clients:

My Social Security checks are taxable?

Yes, if your clients have over $32,000 in adjusted gross income for a married couple. But distributions from a Roth IRA aren't included in adjusted gross income, so withdrawals won't trigger the tax on Social Security payments.

Six-figure income, 8 percent tax bracket

Assume a couple in their early 60s has no income source other than their IRAs. If they take $100,000 from a taxable IRA in a single year, they will pay over $14,000 in federal income taxes. But if they take $70,000 from a taxable IRA and $30,000 from a Roth IRA, their bill from Uncle Sam will be a little over $8,000.

No mandatory distributions

The IRS wants your clients' IRAs to be depleted by the time the account owners hit their mid-80s. That will be disappointing to the one-in-four 65-year olds who are projected to live into their 90s. Yet as there is no requirement to begin liquidating Roth IRAs (even after age 70 1/2), octogenarian and nonagenarian owners of these accounts will have more flexibility and less taxes to pay than their nonconverting peers.

Taxes paid can't be taxed again

Clients bumping up against the estate tax exemption ceiling ($1.5 million in 2005, $2 million in 2006) may be comforted by the knowledge that taxes paid on conversion will of course be removed from their taxable estate.

The Happy Heirs

And, of course, we can't forget the true beneficiaries of your wise advice: your clients' survivors. Particularly the high-income adult children whose earnings preclude them from opening a Roth IRA (but not from inheriting one).

How big can the payoff be? Let's say you have a 62-year-old client with a $100,000 IRA, a 35-year-old daughter and a newborn grandson. Assume an 8 percent annual return for both the IRA and the new Roth IRA. If the client converts $20,000 of the account each year over the next six years and remains in the 15 percent tax bracket, his total payments to the IRS will be around $17,500.

Now figure the client dies at 82, when, if left untouched, the balance of the Roth IRA will be worth about $510,000. If the daughter is the inheritor and withdraws just the required minimum distribution, she'll take out a total of $2.2 million from the age of 56 until she depletes the account at 84. If the grandson is the beneficiary, under the same terms the lucky kid will withdraw well over $15 million, from the ages of 21 to 83.

Which retiree clients of yours are best suited for converting IRAs to Roth IRAs? Here are a few of the deciding factors, in order of importance:

  • Modified adjusted gross income must be below $100,000.
  • Conversions taxed at 25 percent or less are good.
  • Conversions taxed at 15 percent or less are great.
  • Not yet taking Social Security.
  • Enough non-IRA money to cover the extra taxes on the conversion.
  • Descendants/heirs likely to be in upper income brackets.

Writer's BIO: Kevin McKinley is a CFP and vice president of investments at a regional brokerage and author of Make Your Kid a Millionaire — 11 Easy Ways Anyone Can Secure a Child's Financial Future. onyourmoney.com

Hide comments

Comments

  • Allowed HTML tags: <em> <strong> <blockquote> <br> <p>

Plain text

  • No HTML tags allowed.
  • Web page addresses and e-mail addresses turn into links automatically.
  • Lines and paragraphs break automatically.
Publish