The upcoming calendar year will prove to be very busy for advisors. As we all know, the Roth conversion strategy is scheduled to become available to high-income earners based on the elimination of the $100,000 AGI restriction. Spouses who file separate returns and who have, until now, been excluded from the Roth conversion parade will also get the chance starting in 2010.
The potential tax benefits of such a move, discussed and dissected in just about every financial publication for years, are clear. But let's look at one additional strategy involving the Roth conversion that offers a great deal of value for your clients - one that has nothing to do with taxes.
In 2008, asset values decreased across the board (except for government securities and gold). As advisors, we speak to clients about converting IRAs when the values are down in order to pay less in tax, and for the future tax-free build up. Consider a scenario where your 72-year-old client owns a variable annuity with a decimated account value in his IRA. The contract was established with an enhanced death benefit, as your client wanted something to pass to his spouse. The client is in a bind, as the investments were clobbered throughout 2008, and the required minimum distributions on the contract are threatening the viability of the death benefit. The client may have insisted on reallocating the contract to a more conservative mix to stem losses. To add to the dilemma, remember the rider fees are based on the guarantee value, not the contract value. Although the $100,000 initial investment accrues at 5 percent to 6 percent, based on the rider, it is now worth only $30,000 after the market collapse, required distributions and fees and will potentially implode in the near future unless something changes. You can potentially skip the required minimum distribution. This is an excellent solution, especially if the client is much older or in poor health. With the account value down, the 50 percent penalty on a $3,000 or $4,000 amount not withdrawn may not be so bad, and you avoid the more damaging result; the loss of the death benefit.
Enter the Roth conversion solution. The client should consider converting the contract to a Roth registration, and this will address the immediate concerns. Yes, there will be tax to pay on the conversion, and with annuities we need to get this right. The IRS says you must use the "fair market value" of the annuity on the date of conversion, taking into account any guarantee values as well. The client will be able to stop the minimum distributions, and preserve any death benefits for heirs. Without the drain of the distributions, you can play defense with the allocation and attempt to ride out the market storm.
The rules allow for your client to convert one account at a time (if it makes sense). The taxes can be paid over a two year span as well. It is recommended that the client be able to pay the resulting income tax from a source other that the converted account.
2010 will provide ample opportunity for advisors to provide additional solutions to clients. Take a closer look at clients' assets, especially anything held with an outside or competing advisor. There may be an opening for you to gather more of your clients' assets and attention.
Mark A. Cortazzo, CFP is senior partner with MACRO Consulting Group in Parsippany, N.J.