Are savers missing> out on a huge opportunity to generate tax-free income in retirement? This year for the first time, people with more than $100,000 in annual income are able to roll over savings from a traditional IRA to a Roth IRA. The sales pitch: Pay income tax on the amount rolled over now (at a tax rate presumably lower than a future rate) and be rewarded with tax-free withdrawals later. But a recent survey conducted by Putnam Investments found many Americans skeptical about the benefits of converting to a Roth IRA. Only 14% of respondents said they were considering a conversion, and 56% said they definitely wouldn t convert.
That skepticism comes despite a highly visible marketing push aimed at attracting higher-income savers to roll over assets into a Roth. Some financial advisors say that pro-Roth campaign was aimed more at gaining market share than at serving the interests of investors. Roth conversion has been pitched to financial advisors as a means of expanding one s practice, says Michael Kresh, a certified financial planner and the president of M.D. Kresh Financial Services, Inc. Kresh says the marketing blitz gave him pause because if [an idea] is really good, it just has to be presented, not sold.
Fidelity, which has been advertising around the idea of converting to a Roth, says 58,000 savers made the switch in the first quarter this year, four times as many as last year. The firm isn t trying to drive Roth conversions, but simply to make sure people understand all their options, says Chris McDermott, Fidelity s senior vice president of investor education, retirement and financial planning. We re not suggesting all investors should or need to convert, but they should consider it, McDermott says.
Last fall, many clients were interested in learning more about converting to a Roth, says David Steiner, the principal of Zebulon Financial, LLC. Now that he s had a chance to do the math, only one of his hundreds of clients has actually gone through with a conversion, Steiner says.
Because savers who convert traditional IRAs to Roth IRAs have to pay income tax upfront on the balance of the account being converted, the move only makes sense for those young enough to be confident they can recoup that initial loss of capital before they retire, Steiner says. For his clients in New Jersey, for example, a higher tax rate that kicks in for income over $500,000 could mean paying nearly 40% on a balance being converted a hit that could take more than 30 years to recover from at a typical rate of return on investments, he says. Steiner says his only client to go through with a conversion was under 40. A partial conversion is also possible, and could help savers begin building a Roth without being pushed into a higher tax bracket, McDermott says.
Investors who do wish to convert will also need to have extra cash on hand to pay that tax bill, or face early withdrawal penalties for paying the taxes out of the balance of the IRA. The move likely doesn t make financial sense unless the money used to pay the income tax was previously earning a very low rate of return, for example in a CD, Kresh says.
Financial planners and investment professionals say a Roth IRA can be a good vehicle for estate planning. Here, too, a long time frame helps a few hundred thousand dollars could ultimately become millions in tax-free income for your grandchildren if they withdraw the money over 60 years, Kresh says.
Savers hoping to pass assets on through a Roth need to be sure their own lifetime financial needs are met first, however, Kresh says. For his clients in New York state, for example, the balance of a traditional IRA is considered a protected asset for the purposes of qualifying for Medicaid, but a Roth IRA isn t protected meaning that a saver who runs out of money for long-term health-care costs could see that account depleted before children or grandchildren can touch it, Kresh says.
These examples underscore the bottom line for savers: There are many factors involved in deciding whether to convert to a Roth IRA, and your best bet is to sit down with a financial advisor to see if it makes sense in your particular situation. Many people who have heard about the new rules assumed they could just use an online calculator to make a quick decision, says Tracy Flaherty, the senior vice president of retirement strategies at Natixis Global Associates. The decision may be more complicated than that, but the good news is, it s an opportunity to have a good, in-depth retirement planning conversation with your advisor, Flaherty says.