Pershing

Topics for Tax Season: Roth IRA Conversions and Contributions

Issue 13, 2010

With financial records and year-end tax statements readily available, now is an ideal time to talk to clients about their retirement savings. The impact of the recession has taken a toll on the value of most clients' retirement assets, and they will likely be looking to you for steps they can take to rebuild their nest eggs.

The ability to convert to a Roth individual retirement account (IRA) will be a new opportunity for some clients, and may be a positive action step to take to maximize retirement assets. Yet, is a Roth conversion the right strategy for your clients? Can they afford to pay the taxes out of another taxable account?

To answer these questions, consider using the new Pershing Roth Conversion Calculator to run a few sample scenarios that are representative of many of your clients. Have the examples ready to use during client meetings. Then, if a client situation looks favorable for implementing a conversion strategy, you can use the tool to enter their specific data.

The graph illustrates one example of a Roth conversion strategy and the tax liability. The hypothetical client is 45-years old with a $250,000 Traditional IRA. She plans to retire at age 65, and wants to know if she should convert her IRA to a Roth IRA this year (which is the only year that gives her an option to spread her income from the conversion over two years).

If she converts to a Roth IRA, there is a $70,000 tax bill (assuming she is in the 28% tax bracket) for 2010. This may be a significant amount of cash to remove from her other taxable accounts, whether she pays the full amount this year or chooses to include the income and pay the tax over 2011 and 2012. The question becomes, can she afford to pay the taxes due with either her IRA assets or from a nonretirement account?

Another consideration is the future value of the retirement assets. If she keeps the traditional IRA intact, the estimated future value after taxes is $958,009, in this example. However, the value of the tax-free Roth IRA is estimated at over one million dollars: $1,075,491 (assuming a pre-tax rate of return of 5% before retirement and 3% post-retirement and she pays her income taxes due with regular savings, not from her IRA.)

Further, while she would have a tax bill of $70,000 at the time of conversion, she ultimately pays substantially more in taxes if she keeps the Traditional IRA: $109,369 beginning when she reaches age 70 ½ and is required to take minimum distributions and for her remaining life expectancy.

There is no easy answer for clients who are deciding whether to convert to a Roth IRA or not; or, whether to do a full or a partial conversion. Proactively discussing the options with your clients during tax season will help them think about their personal situation and will give them ample time to make their decision.

Annual Contributions Help Maximize Tax-Deferred Savings

One easy proactive step clients can take to rebuild their retirement assets is to make annual IRA contributions for 2009—and for 2010. First, some facts for 2009 IRA contributions:

There are also some new considerations:

Do not overlook each client’s modified AGI and earnings changes. There may be more savings opportunities or new opportunities than in previous years.

Access Pershing’s Retirement Tools

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For Professional Use Only.

Tax laws are complex and subject to change. The information contained herein is based on current federal tax laws in effect at the time it was written. Pershing LLC and its affiliates do not provide tax or legal advice. This information is not intended nor written to be used for the purpose of avoiding tax penalties that may be imposed on the taxpayer. Individuals are urged to consult their tax or legal advisors to understand the tax and related consequences of any actions or investments described herein.