More On Tax Planningfrom The Advisor's Professional Library
- ETF Taxation The use of ETFs may be attractive to certain investors. The tax advantages may make them even more attractive.
- Health Insurance: Health and Medical Savings Accounts A Health Savings Account is a trust created exclusively for the purpose of paying qualified medical expenses of an account beneficiary. Although they are popular, they are not without their pitfalls and the regulations can be complicated. Learn more about how to avoid federal taxation on the accumulation and distributions of HSA.
Now that the fiscal cliff deal lets 401(k) participants convert their pretax savings into a Roth IRA plan, advisors have an opportunity to guide retirement plan sponsors through the complexities of the American Taxpayer Relief Act.
In a “Rethinking the Roth” webinar on Tuesday, 401(k) expert Bob Kaplan of ING urged retirement plan advisors to grow their business by showing sponsors how plan participants can now convert pretax dollars to an after-tax Roth account. Sponsors may not yet realize that the tax act opens up Roth conversions to a broad range of plan participants, Kaplan said.
“A lot of advisors I talk to downplay the Roth, saying people don’t want it. But anytime there’s talk about taxes going up, people want to consider it. What a great opportunity to demonstrate your value,” said Kaplan, ING U.S.’s national retirement consultant and 401(k) technical expert. “A lot of young people have started to do the Roth conversion, so don’t assume you know which employees want to do it. We’ve seen across-the-board participation in all ages and income levels.”
Demonstrating Value to Plan Sponsors
The House and Senate approved the fiscal cliff deal on Jan. 1, and President Barack Obama signed the Taxpayer Relief Act into law immediately after the vote. The legislation sets out a new rule allowing 401(k) participants to complete intraplan Roth conversions if the employer offers designated Roth accounts under the plan, regardless of whether the individual is allowed to take a distribution out of the plan, according to financial planning guru Michael Kitces. The transaction, Kitces said, will be taxed in a similar manner to any other Roth conversion.
An advisor can demonstrate his or her value to a sponsor by showing how the new tax act allows a plan to be amended to allow in-plan conversions, Kaplan said, adding that such amendments are voluntary and not required by law.
“If a plan already has a Roth deferral feature, focus on tax diversification,” he suggested. “If a plan does not have the Roth deferral feature, talk with the plan sponsor about adding it.”
Roth contributions are typically most appropriate for younger, lower-income workers, Kaplan continued, while Roth conversions tend to benefit older and higher-income workers who anticipate higher tax rates in the future. Using the Roth for estate planning purposes may provide heirs with tax-free income, he said.
Taxable Wealth Is Key to Conversion
However, tax law professors Robert Bloink and William Byrnes point out that conversions can also be beneficial for younger savers.
“These clients may not have reached their full earning potential and may fall into a lower tax bracket today than they expect to reach later in life. Further, these taxpayers have a longer period before retirement, meaning that the funds converted will have more time to grow tax-free within the Roth,” Bloink and Byrnes write in a Jan. 15 blog post for AdvisorOne.
For older savers, they add, the primary downside of converting a large chunk of 401(k) money this year is that ordinary income taxes have been raised for 2013 for many high-income taxpayers. “If the conversion would cause the client to cross the $400,000/$450,000 income threshold for higher income, capital gains and dividend taxes in 2013, converting may not be worth the cost,” they write.
According to a Tax Facts Online article on IRA eligibility published earlier this month, to establish a Roth individual retirement plan, an individual must:
- Have compensation, either earned income of an employee or self-employed person, or alimony
- Not have adjusted gross income in 2012 of $183,000 or above in the case of a taxpayer filing a joint return, of $125,000 or above in the case of a taxpayer filing a single or head-of-household return, or of $10,000 or above in the case of a married individual filing separately.
An individual who satisfies these requirements may establish and contribute to a Roth IRA even if he or she has attained age 70½. While Roth accounts don’t offer an upfront tax break, all withdrawals are tax-free after an individual has held the account for five years and reaches the age of 59½.
Read Fiscal Cliff Deal Opens Floodgates for 2013 Roth Conversions by Robert Bloink and William Byrnes at AdvisorOne.