Clients are bombarding you with cost-basis questions. There's a steady stream of new directives from “corporate.” It's becoming impossible to find a couple hours a day to figure out the office's NCAA pool.
But it might behoove you to put down the brackets and pick up the phone. There are only a few more depositing days left until we reach the deadline for clients to make IRA and Roth IRA contributions for the 2006 tax year. No, you won't get much richer today from sliding a few thousand dollars into any of these self-directed retirement accounts. But your clients could benefit now, and in the future, and you'll cement your status as their shrewd, unselfish advocate.
An End-Around to a Roth IRA
Let's start with your high-income clients. Residents of your “A” book have earnings that exceed the limits for making a contribution to a Roth IRA (for 2006, eligibility tops out at $110,000 for single filers and $160,000 for married filing jointly). Unless they have access to a Roth 401(k) at work, they have little hope of building an account that could provide tax-free income in retirement.
But recent legislation may be riding to the rescue. The Pension Protection Act of 2006 allows anyone at any income level to convert an IRA to a Roth IRA without a penalty — but with taxes — beginning in 2010. Until then, only taxpayers with less than $100,000 of adjusted gross income are eligible to make a conversion.
Here's how you can use this upcoming window to get a Roth IRA for a client who suffers from that mid-six-figure salary. First, open a non-deductible IRA for 2006 (and one for a spouse, as well). As you no doubt surmised by the phrase “non-deductible,” this move won't cut any taxes this year, but it will shelter any future earnings from taxation, at least until withdrawal. More useful is the prospect that if the laws hold, in three years your client will have the option of converting that IRA to a Roth IRA — again, regardless of his age or income at that time. And, since he received no tax deduction for the original contributions, if the client has no other IRA accounts open at the time of conversion, he will only pay taxes on the “earnings” portion of the account — not the contributions. (You can reduce future headaches for you, your client and his CPA by keeping non-deductible IRA contributions in an account separate from any other pretax IRAs.)
You probably also have some clients whose adjusted gross income allows them to make a Roth IRA contribution for 2006, but who are hesitant to tie up money that might be needed well before retirement rolls around.
But here's what your clients don't know — and you might have forgotten — about Roth IRAs. Although earnings withdrawn before age 59 1/2 can be subject to taxation and penalties, contributions withdrawn are not. If your client takes money out of a Roth IRA before age 59 1/2, the IRS lets him or her classify the funds withdrawn as “contributions,” at least until the money taken out equals the money put in.
Here's a demonstration. Let's say your client puts $4,000 a year into a Roth IRA and the account grows at a hypothetical 7 percent per year. Ten years from now the balance would be worth just about $60,000.
Even if your client hasn't reached 59 1/2, she could now take out up to $40,000 (10 years of $4,000 annual contributions) for any reason whatsoever and leave the other $20,000 to grow until retirement, when it can be withdrawn tax-free. And if she doesn't need to take any money out until after turning 59 1/2, you will have saved her taxes that she would have otherwise paid on dividends, interest and capital gains, had the assets been outside a tax-sheltered account.
But wait — there's more. The ability to take back Roth IRA contributions at any time without a penalty means that it can serve as a retirement savings account as well as a college-savings vehicle. If the client reaches middle age and finds that a child's tuition costs are a bigger concern than a comfortable retirement, those Roth IRA contributions can be withdrawn and put toward Junior's matriculation.
Child's Roth IRA
Speaking of your clients' children, there's an opportunity to pop open a retirement account for the wee ones, too — at least those who had earned income in 2006. Although many working teens earned less last year than their parents took home in a good week, the kids have about five decades until retirement. So a few bucks set aside today can make a big difference several tomorrows from now.
Say your client starts by putting $4,000 into a Roth IRA for his 15-year-old daughter this year, then continues doing so for the next three years as well. If the account grows at a hypothetical rate of return of 7 percent per year, by the time she's 65, the $16,000 deposited would be worth over $425,000.
Keep in mind that eligibility to make a contribution to a Roth IRA for a minor is based on the kid's earned income, not that of the parents. So unless your client is raising the kid actor who plays Harry Potter in the movies, the client's working teenager will qualify to make a deposit.
If your client's teen is one of those rare kids who would rather spend a paycheck than save it, the client can make the deposit into the child's Roth IRA. But doing so counts as a gift to the child, who can then do what she pleases with the money upon reaching adulthood (sadly, the legal definition of “adulthood” is based on age, not maturity).
What if college is just around the corner for the kid in question? If savings, financial aid and income aren't enough to cover the cost of higher education for the child, the Roth IRA contributions can be taken back out free from tax and penalty to pay for any uncovered expenses. The Roth IRA is an especially smart place to stash money for your child, as many schools don't even consider a student's retirement account in calculating how much financial aid will be made available.
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. kevinmckinley.com
Time Waits for No Advisor
Due to a quirk in the calendar, this year's deadline for income tax filing and IRA/Roth IRA contributions is April 17. But just because there are some extra days available doesn't mean you should put it off. If your clients find out you neglected to maximize their options for a comfortable retirement, they might start to think about sending you off into the sunset.
|Open a non-deductible IRA, with an eye toward converting the account to a Roth IRA after 2010||Deposit $4,000 or earned income, whichever is less ($5,000 for those over 50, spousal IRA available as well)||Best for those who don't qualify for a Roth IRA or Roth 401(k)|
|Good for clients who may be in a lower income tax bracket soon after 2010|
|Open a Roth IRA||Deposit $4,000 or earned income, whichever is less ($5,000 for those over 50, spousal Roth IRA available as well)||Contributions can be taken back out at any time with no taxes or penalties|
|Income Adjusted gross income of between $95,000 and $110,000 for single filers, $150,000 to $160,000 for married filing jointly||May be good for clients who can't decide between saving for college and building up retirement accounts|
|Open a Roth IRA for a minor||Deposit $4,000 or earned income, whichever is less||Parent can make a deposit with his own money, but it counts as a gift to the child|
|Income must have legitimate earned income to qualify||Roth IRA is preferable to an IRA, as tax-deduction of the latter has little value to a low-income teen|