From the October 2009 issue of Investment Advisor • Subscribe!

October 1, 2009

B/D Briefing: Conversion Time

Merrill Lynch makes a big push to prepare reps for Roth conversions

One of the pleasures of being President is that your influence on Americans doesn't end with your term(s). That's certainly the case with George W. Bush, whose signature tax cuts have become a pressing issue since so many of them--such as those on estates and capital gains and dividends--are due to expire in 2010. But there's another Bush era tax law that may and perhaps should affect many of your clients next year: the Roth IRA conversion opportunity that flows out of the 2005 Tax Increase Protection and Reconciliation Act, or TIPRA. Under one provision of that law, starting in 2010 and continuing thereafter, the prior $100,000 income level for converting a traditional tax-deferred IRA to a Roth IRA goes away.

Aimee DeCamillo puts it this way: Beginning in 2010, "individuals at any income level will be able to convert their IRAs to a Roth IRA. What's unique about 2010 is that if you wish to spread the [Roth tax] liability over [the subsequent] two-year period with a 50-50 split, you can do so, through 2011 and 2012, as long as you claim it in 2010." However, says DeCamillo, head of personal retirement for Merrill Lynch Global Wealth Management, "even in 2015--assuming the Congress doesn't change anything--you'll still be able to do the conversion."

That uniqueness has led Merrill Lynch and its partners at Bank of America, U.S. Trust, to make a big push to educate and train its financial advisors about the opportunity, and DeCamillo, who heads that effort, said in early September that after only a month, more than 20% of Merrill brokers had gone through the training. In addition, DeCamillo says Merrill is also providing advisors with "white papers and additional proprietary tools on their desktops to illustrate to the client the advantages of converting, or not."

While the opportunity for higher-income clients to convert their IRAs might be obvious, it must be done in a holistic way.

That's because, says Lester Law, a senior wealth strategist for U.S. Trust who follows tax and estate planning regulation and legislation and educates his colleagues, along with some HNW clients, on those issues, you have to "understand the nuances" of Roth conversion and where it fits into the client's life stages.

For instance, Law says that when considering the stage when a client needs retirement income, he looks at the period from conversion to age 70 1/2 , which he notes is the "magic date when traditional IRAs have to start being distributed." But he also considers the period from age 70 1/2 to death. Why? "When you convert, you have to pay the tax, and the best way to do this is to run the numbers to see when it makes sense. So for the first phase we look at conversion to age 70 1/2 , and we look at from the death of the participant--that is, the IRA creator--all the way through the beneficiary's life expectancy.

U.S. Trust has developed its own internal software for doing the number crunching, and he's found that "the real benefit, the big huge number increases, happen in the post-death situation."

Moreover, there are some strategies, he says, that apply only for certain clients. "There will be individuals who will have net operating loss carryovers, or capital contribution carryovers, maybe there will be a big adjustment in income because of retirement in a particular year--those kinds of opportunities are ones we like to look at because one could play a tax arbitrage game, by either waiting for those opportunities to occur or, if they're already here, to take advantage of those opportunities."

He looks at the conversion exercise as "purely a numbers game; we're trying to get the net after-tax-benefit for the participants and the beneficiary."

Another nuance is that if you convert in 2010, you can defer paying the tax by bringing the income into 2011 and 2012. "So people say, 'Great idea--you get to defer!'" Law reports. But he responds, "Hold on, you always want to look at the net after-tax returns!"

In light of the Obama Administration's budget, Law says drolly, "it appears that income tax rates might significantly increase." So if you defer your conversion income into 2011 and 2012, "it doesn't say you calculate the tax at 2010 rates and pay that in 2011 and 2012; you pay at the 2011 and 2012 rates. If there's a huge increase in income tax rates, it might make sense to pay the tax upfront in 2010 instead of deferring."

Law's point: "You can't look at this in isolation. You have to look at it multigenerationally, and with the high-net-worth it's also an estate planning issue."


Group Editor-in-Chief Jamie Green can be reached at jgreen@investmentadvisor.com.
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