Roccy DeFrancesco, the attorney and author who founded the Wealth Preservation Institute, is launching a major enhancement to his OnPointe software suite in the form of a detailed Roth individual retirement account conversion analyzer.
DeFrancesco previewed the new Roth IRA conversion calculator during a recent interview with ThinkAdvisor. In the discussion, he also shared what can only be described as highly pointed criticism of the wealth management industry’s existing Roth conversion tools — especially those that are made free to the public on advisory firm websites as a marketing and lead generation strategy.
“After spending over a year reverse engineering other Roth conversion software apps, it became clear that their flaws are significant and unknown to advisors,” DeFrancesco said. “The byproducts are advisor recommendations that will have negative financial consequences for clients and their heirs.”
Following the discussion, DeFrancesco shared a detailed analysis that shows a wide variety of ways that, in his view, less detailed Roth conversion calculators can lead both advisors and clients astray. The following are some highlights.
1. Many tools only run conversion calculations in isolation.
One way Roth conversion tools can result in suboptimal calculations is by only running the numbers as they pertain to the money in a single individual retirement account.
A superior approach, according to DeFrancesco, is to review all assets and income from all sources — with the ability to change multiple variables that will affect the final calculations as they pertain to a variety of related but distinct goals.
These goals can include retirement income, accumulating wealth, avoiding income-related Medicare surcharges and more. Ideally, all calculations and conclusions will be regularly reviewed and updated to identify emerging risks and opportunities.
2. Many tools use inaccurate or static tax assumptions.
According to DeFrancesco, many conversion software tools do not appear to be calculating important numbers correctly.
Specifically, many tools don’t appear to calculate the effective income tax rate every year and instead rely on a hard input from the software user as to what the client’s adjusted gross income is or will be.
“This is one of many fatal errors I noticed with the software,” he said. “[Such a program] is doomed to be inaccurate because of this static nature, its inability to take into account all assets and income on an annual basis, and because it focuses incorrectly on tax reduction and RMDs — not the ultimate goal of clients.”
This overarching goal, DeFrancesco said, should be generating more overall wealth for themselves or their heirs — or more cash flow for clients who are not planning for a legacy.
3. Many tools rely on shaky assumptions about future tax liability.
In DeFrancesco’s experience, many tools assume that the client will be in the same tax bracket in retirement as when the tax-deferred asset is funded. In reality, he argued, most clients are not going to be in the same tax bracket in retirement. Rather, most are going to be in a lower tax bracket.
“It’s the same problem we see over and over with Roth conversion software,” DeFrancesco said. “It doesn’t calculate the effective tax rate every year in retirement, and software that does is not doing it correctly most of the time. This is because it is not inflating the income tax brackets every year.”
Another issue is the failure to accurately calculate potential future IRMAA penalties.
“Again, the ones that do are not calculating this correctly, either because they do not increase the income brackets and/or the Medicare premium and penalty,” DeFrancesco said.
4. Many tools (and advisors) focus too much on RMDs.
Many advisors assert that Roth-style accounts simply work better in retirement because they eliminate (or mitigate) required minimum distributions.
“But, when one runs the numbers holistically, this is often mathematically inaccurate,” DeFrancesco said. “When you run the numbers correctly, you can find scenarios where RMDs are higher, and yet the client has a better outcome by not implementing a conversion.”
This is also a fatal error many Roth “gurus” fall prey to, according to DeFrancesco, insofar as they focus almost exclusively on tax savings when that is only part of the equation.
5. Many tools don’t update tax brackets every year.
“Another big issue is that most software doesn’t increase the income tax brackets every year,” DeFrancesco said. “These are critical, even fatal flaws, since income tax brackets inflate every year. In fact, going back 30 years, income tax brackets have inflated quicker than inflation.”
The practical result of this oversight is that software often assumes that an increase in a client’s income will kick them up into a higher tax bracket — thus making Roth conversions look inherently more attractive than they otherwise would be.
6. IRMAA income brackets also need to be regularly updated.
DeFrancesco said he has “little doubt” that many tools are operating on faulty assumptions when it comes to the Medicare income-related monthly adjustment amount, insofar as they aren’t updating the IRMAA income bracket every year.
“Just like income tax brackets, the IRMAA income brackets shift every year,” he pointed out. “If you don’t account for that, the client will be in a higher IRMAA bracket than they will be in the real world.”
Again, this can make Roth accounts look misleadingly attractive.
7. Many tools (and advisors) run assumptions with overly ambitious longevity assumptions.
“When I see Roth conversion examples, the client seems to always live until age 95,” DeFrancesco said. “The older someone is when they die typically makes Roth conversion numbers look better.”
Another key consideration is how to deal with spouses of different ages who will die at different ages.
“The income and IRMAA brackets will change dramatically when one spouse dies,” he noted. “I’ve never seen anyone try to calculate the lost opportunity cost of paying IRMAA penalties. It’s interesting even if not a practical or usable number.”
The bottom line, DeFrancesco said, is that failing to run the effective income tax rates correctly and failing to properly consider true IRMAA costs correctly will result in flawed outputs.
8. Many tools don’t offer sufficient nuance in heirs’ income assumptions.
To be truly accurate in a legacy planning context, DeFrancesco argued, Roth conversion software should be calculating the inheritors’ effective income tax rates every year with anticipated future distributions.
“If you’re not doing this, the numbers are not accurate,” he said. “What if the kid is a ditch digger making $50,000 a year? What if they are a doctor is making $500,000 a year? The software has to run legacy numbers for the heirs. If you are not running these numbers, your projections are not going to be anywhere near accurate — especially if you are using top tax bracket rates versus annually calculating effective tax rates.”
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