The hottest estate planning move last year may well have been the Roth IRA conversion. Fidelity Investments came out with a study last week reporting that December 2012 saw a rise in Roth conversions of 52 percent from the year earlier. For 2012 as a whole, Roth conversions were up 12 percent from 2011.
There was a reason for that: Tax changes that took effect at the beginning of this year made the conversion imperative for a lot of people. With marginal tax rates going up for the highest tax bracket, it made sense for those people to move their money from a regular IRA — which is funded with tax-free dollars but is taxable upon withdrawal — to a Roth, where that money goes in after you've paid taxes on it, but is tax-free upon withdrawal. So it made sense that people wanted to push more taxable income into 2012, which had lower marginal rates than 2013.
It wasn't so long ago that this wasn't even a valid question for many people. Prior to 2010, only people with adjusted gross income lower than $100,000 were eligible to convert a regular IRA to a Roth. So for many of your clients, this is a relatively new issue.
But what happens in 2013? Does it still make sense for people to convert their regular IRA to a Roth? Here are some folks for whom conversion might still be fiscally advantageous:
- Those who expect to be moving into a higher tax bracket. The impetus behind the flood of conversions in 2012 was that many high-income people anticipated that their marginal income tax rates were going to increase. If your client is on the fast track to the corporate boardroom, or runs a growing practice of one type or another, a conversion could make his or her IRA income tax-free down the line. With a regular IRA, the withdrawals would be taxable. If the client would be in the highest bracket even into old age, the Roth makes sense.
- Clients who are comfortable enough that they want to wait until well after retirement to begin withdrawals. A regular IRA requires that the client begin taking the money out no later than age 70 and a half. A Roth imposes no such limitations. If a client wants to leave that money untouched as long as possible, a Roth makes more sense.
- People who aren't interested in managing a legacy or strong charitable contributions in their retirement years. Since a regular IRA is taxable when the money is withdrawn, it has the possibility of reducing the amount of money available in retirement. Someone who wants to be around to give grandchildren tuition gifts might want to keep that retirement income higher.
See also: What if grandma's uninsurable?
- People with temporarily low income. The money converted from a regular IRA to a Roth counts as regular income in the year the conversion is done. So if there's a lull in your clients' income — the business has had a down year or your client took a yearlong sabbatical — that might be a good time to make the conversion and pay income tax at the lower rate.
- Clients who are recently widowed. Tax rates for married couples filing jointly are more favorable than those for single filer. If a client has lost his or her spouse this year, it might make sense to convert to a Roth, take the tax hit at the more favorable rate, then receive the tax-free withdrawals in subsequent years when their rates might be higher.
- Clients who expect to gain terrific returns on their investments. Remember, clients are not only exempt from taxes on the withdrawal from the Roth, they are also exempt from taxes on gains from investments within the account.
On the other hand, if your client converted to a Roth at the end of 2012 and is now thinking it was a bad idea, there is still an alternative. The IRS has decreed that any IRA conversions that took place during 2012 can be unwound before Oct. 15, 2013. That little bit of leeway might be enough to entice your clients to just take a look at this estate-planning option.
