Individual retirement accounts are probably the most pervasive yet least understood retirement account available. To be truly effective for our client, advisors must be able to clearly convey the features and benefits of each type of IRA, including traditional, Roth, SEP and SIMPLE. We cannot fault clients for not understanding the details of the IRA rules, because many advisors do not take the time to learn the nuances either. For advisors who are well-versed in this area, there are ample opportunities to bring value to new and existing clients.
For example, I am sure I speak for many advisors when I say that questions about Roth conversions are coming out of the woodwork this year. The MAGI limits surrounding Roth conversions have been removed for 2010, and as a result, clients are interested in finding out if they can benefit from the changes. The conversations are typically short, as realization of the potential tax consequence of the law mysteriously extinguishes interest levels very quickly. However, the conversion may still make a great deal of sense for a client who needs tax diversification; and the fact that clients have the option to pay the tax over two years, makes the process more attractive.
Although the income limits for regular contributions are still in place, clients who qualify should without a doubt establish a Roth account. Of course, advisors must caution their clients that future tax rates and legislation are factors to consider, though tax rates look to be on the rise, and concerns about changes to the tax-free nature of the Roth are, in my opinion, overblown. As added protection, the government actually gives you a mulligan in the form of a recharachterization should the conversion not work out.
A strategy that I suggest every advisor should take advantage of, and one that I am utilizing with my own clients, involves jumpstarting the Roth clock by doing a small conversion in the amount of $1,000 to $2,000 this year. This small conversion allows the 5-year holding period to begin on the accounts and the client can subsequently add funds according to their individual contribution schedule without being subject to the 5-year holding period on the new money. This rule also holds true for future Roth conversions or roll-overs from a Roth 401(k).
In addition, your high-income-earning clients, who are prohibited from making Roth contributions, are allowed to take advantage of a Roth conversion this year, starting the 5-year clock and putting the account in place for future benefit.
Aside from the Roth issue, we need to stay on top of other relevant IRA topics. For instance, there is legislation currently pending in terms of the “automatic IRA” proposal. This would require small businesses that do not offer an employer plan to automatically enroll employees in an IRA and make a deduction on their behalf. Employees would retain the right to alter the contribution rate or opt out of the program. As budget deficits continue to grow and the state of Social Security becomes more and more precarious, the importance of individuals saving more is abundantly clear. SEP and SIMPLE IRAs are mainstays for self-employed individuals and small businesses. Many small firms do not offer 401(k)s or profit sharing plans, and these IRA accounts are the only option. The plans are generally administratively friendly, portable and offer diverse investment opportunities. I find it wise to partner with a capable administrator to confirm that documentation and filings are in order, especially if I am taking over an existing plan with assets. SEPs have higher contribution limits and SIMPLE plans have a few quirky rules, like the 25% penalty for withdrawals pre 59 ½ and prior to two years after inception.
On a non-traditional note, I think that annuities should also be included in any discussion about individual retirement accounts. Annuities offer tax deferral and the ability to generate lifetime income in retirement. We could spend hours on annuities alone, but suffice it to say they are unique planning tools that can provide a great deal of value to your client when properly researched and utilized. Contrary to the conventional wisdom, annuities are absolutely appropriate vehicles to be used within IRAs as they can provide additional benefits that are not available anywhere else.
When used appropriately, annuities, whose primary objective is to provide a lifetime income, have the same ultimate goal as IRAs whose primary objective is to provide retirement income that lasts a lifetime, or two.
Once you have advised your client on the appropriate IRA plan, designating beneficiaries is paramount. This can be as important as the selection of the right plan. I have won accounts by simply discussing per stirpes versus per capita beneficiary registration. It is a simple distinction, but can prevent problems if there are multiple beneficiaries, and one or more of them predeceases you. I have seen the gamut of situations and horror stories throughout my career and therefore I make it a point to review beneficiary reports for accuracy at every client review meeting.
The statistics that show the amount of money invested in IRA accounts are staggering. Boomers consistently look to transfer large portions of those dollars to their heirs, and they need guidance on how to do it most effectively. It is our responsibility as advisors to help clients understand individual retirement accounts, the intricacies involved, and the benefits behind maintaining assets in these accounts.