Three Steps to Consider
Once you’ve established an understanding, it’s time to shift focus from therapist to planner. While every client’s circumstances are different, here are three steps to consider:
1. Roll over the client’s 401(k) to an IRA
Newly laid off clients may be tempted to raid their 401(k), but that’s a move that would likely trigger taxes and penalties. A better idea might be to roll over their 401(k) to an IRA — a move that puts control of the assets in the client’s hands. Rather than being restricted by the investment options of their former plan, the client would be able to invest where it makes the most sense. In addition, they won’t have the logistical hassles of dealing with their former company’s HR department in the future. This move assumes the benefits of rolling over the 401(k) outweigh any potential drawbacks, such as higher fees.
2. Convert traditional IRAs to Roth IRAs
Because they’re out of work, there’s a good chance your client’s income for 2020 will be less than in 2019. If that moves them to a lower income tax bracket, it could be a good time to convert to a Roth IRA. The client will pay ordinary income taxes on the converted assets, but with a Roth, earnings will grow tax-free and withdrawals after age 59 ½ will also be tax free.
Another thing to consider is that tax rates in the future are likely to increase as the government seeks to pay back the $3 trillion in stimulus from this year. The possibility of higher tax rates in the future is another reason to convert to a Roth.
3. Estate planning and the Secure Act
Converting a traditional IRA to a Roth IRA comes with an added bonus in terms of the client’s estate planning. Under old rules, heirs could take distributions from an inherited “stretch” IRA over the course of their life expectancy. When the Secure Act went into effect on January 1, that provision was eliminated. Heirs now have to liquidate the entire inherited IRA within 10 years, with every distribution taxed as ordinary income. For heirs in their peak earning years, those distributions could bump them into a higher tax bracket. By converting all or a portion of a client’s IRA to a Roth (Step 2), heirs will be able to take distributions without paying taxes. To the extent they’re able to leave the assets alone over that 10-year period, they will benefit all the more from the power of tax-free compounded growth.
Losing one’s job can be an extreme blow, especially in an economy as uncertain as today’s. The combination of listening, empathy and a practical action plan can help your client regain a sense of control over their life while gaining a deeper appreciation for you as their advisor in the process.