Roth conversions easier, but are they right?

When you are deciding whether to convert your IRA/401(k) to a Roth seek the advice of an objective financial professional. With the increasing tax environment we need to assess the value of a conversion now. It may be right for some and not for others.

Scrabble Series Roth IRA Ver2
Scrabble Series Roth IRA Ver2 (Photo credit:

So when might a Roth conversion make sense?Appleby said the following are some of the cases in which Roth conversions may make sense:

  • The IRA owner wants to leave a tax-free inheritance to his beneficiaries, and does not care how much it costs him to pay the taxes now, even if it would cost more if he pays the taxes instead of his beneficiaries paying the taxes.
  • The results of comprehensive Roth conversion analysis shows that a Roth conversion will very likely make good tax/financial sense.
  • The IRA owner is at the lower end of the tax-rate scale now, and will very likely be in a much higher tax-rate scale as his income increases including during retirement.
  • The IRA owner has enough deductions and tax credits to offset the tax bill that would be due on the Roth conversion.

There is no cookie cutter solution to the question, should I c3onvert my IRA/401(k) to a Roth? Each individual has unique circumstances and should the objective advice of an independent fiduciary.

Please comment or call to discuss how this affects you and your family.

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IRS raising limits on retirement contributions for 2013

Now is the time to maximize the contributions to your retirement accounts. The government is encouraging the conversion of qualified accounts to Roth accounts. Unless Americans become more responsible for their own retirement the government will take this over as well. Many are criticizing the over spending of the government, however perhaps we should look at the spending habits of all Americans. Individuals need a balanced budget and a saving strategy for the future.

Retirement (Photo credit: Wikipedia)

With many Americans worried about potential tax increases coming next year if the “fiscal cliff” remains unresolved, the extra boost in potential savings could be coming at a good time, said Garth Scrivner, a certified financial planner with StanCorp Investment Advisers in Albuquerque.“It’s kind of nice with the potential increases in taxes next year to have the ability to defer a bit more money,” Scrivner said. “We’re encouraging people at the end of the year to take an inventory of tax changes that are happening next year and, to the extent that they can, maximize the 401(k) limits.”

For those over 50 years old, the additional “catch-up” amount allowed will remain the same at $5,500, meaning the overall limit for such workers will be rising to $23,000 from $22,500.

In addition to raising the contribution limits, the IRS has also expanded how many people are eligible to contribute to Roth IRAs. For married couples, the upper income limit will rise to $188,000 from $183,000. For singles, the limit will increase to $127,000 from $125,000. (All amounts are adjusted gross income.)

Monthly Social Security benefits are also set to rise 1.7 percent, another move meant to keep up with inflation.

There are two other tweaks to look out for: The IRS is raising the limit on tax-free gifts to $14,000 from $13,000. And Americans living abroad will be able to exclude up to $97,600 in foreign earned income starting next year, a modest increase from the current $95,100.

The higher contribution limits toward retirement plans come as many Americans look for ways to juice their returns after seeing their portfolios battered in recent years.

Investors have enjoyed a pretty strong year in 2012, with the Standard & Poor’s 500-stock index rising about 13 percent. Despite concerns about the fiscal cliff, some analysts see signs that next year could include even more stock gains, driven by an improving housing market and rising consumer confidence.

But many workers saving for retirement still have a lot of ground to make up.

More than half of working households run the risk of being unable to maintain their standard of living when they retire, according to a report released in October by the Center for Retirement Research at Boston College.

By building a globally diversified portfolio and remaining disciplined, investors can reach their long term financial goals without anxiety. Many Americans are not saving for retirement because they do not know how to invest. Plan sponsors can eliminate this concern by automatically enrolling employees in a age appropriate portfolio.

Please comment or call to discuss how this affects you and your family.

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If Roth 401(k) were a human being, he would be going through an existential crisis.

Part of every retirement plan discussion should include the use of the Roth 401(k). Not everyone would benefit from this component but it should be considered when planning your retirement.

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“[The] lack of savings by our population is going to be one of the biggest crises our country will face,” says Mark Ratay, financial adviser with The Ratay Group and Corporate Retirement Director of Morgan Stanley Smith Barney in Lisle, Illinois. “But when you go out there and start talking to the masses, all but the most sophisticated investors don’t get it. They’re already confused about saving in a 401(k). So, when you get into the Roth topic, you’re throwing one more thing up in the air to confuse them,” he says.

“Of all the issues that are out there, I’m not sure I would have this at the top of my list, since there are so many variables with Roth. We all know that [participants] are not saving enough, and the issue of lifetime income from a 401(k) account is taking up a good amount of education time,” says Sean Deviney, Financial Planner, Provenance Wealth Advisors in Fort Lauderdale, Florida, agreeing with Ratay’s sentiment.

“I do think the Roth is a great option, but it isn’t a ‘problem’; it just hasn’t been adopted as quickly as the industry thought it would be,” he says, adding that the Roth 401(k) option is more of a tax planning tool, not necessarily a better alternative than the traditional 401(k).

At the very least, advisers say, plan sponsors should have the Roth option in their 401(k)s.

The Roth 401(k) is a great option for part of your retirement savings, however it should be discussed with your tax professional. The biggest challenge is and should be increasing savings rate for all American workers.

Please comment or call to discuss how to improve the savings rate for your company employees.

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Been There, Done That. Now What?

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Plan design is a very important component to allowing you plan to attract and retain top talent. This talent will be crucial in small to mid sized companies to remain competitive.

Paying Now or Paying LaterWhat we said: As with self-directed brokerage accounts, the Roth conversion window (and its affiliated tax acceleration) seems most likely to appeal to the highly compensated minority. The impetus for the conversion itself is not only the timing window, but also the (still) looming sunset of the Bush Administration’s tax cuts. Of course, the real issue may be a shift in assumptions about taxes; what if they won’t be dependably lower in retirement?

Where we are: Perhaps the most surprising trend to emerge from this year’s PLANSPONSOR Defined Contribution Survey was a huge increase in the offering of Roth 401(k)s, an option that “plan sponsors have long been reluctant to push since their pay-it-now concept on taxes seems at odds with the traditional tax-deferral mantra, and their benefits are often seen as skewed toward more highly compensated workers.” This year’s survey found that 38.2% of all plans now offer the option, compared with just 20.2% a year ago, and that increase was broad-based across market segments. Of course, just try finding someone today (who is not running for political office) who is expecting taxes to be lower in the future.

What’s ahead: As with self-directed brokerage accounts, the Roth conversion window (and its affiliated tax acceleration) seems most likely to appeal to the highly compensated minority. Many more plans are now offering the choice, but it remains to be seen if participants will respond in kind. I would guess not that many in the short term—but that, of course, could change.

Plan design is critical to many small businesses to realize a true employee benefit. One which will attract and retain talented employees.

Please comment or call to discuss how this could affect you and your company.

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The Value of Tax Deferral


History of top marginal income tax rates in th...
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Tax deferred account / qualified plan

Contributing your $3,000 to a 401(k) or other qualified plan, you have the whole amount to invest and investment earnings are tax free – but you have to pay tax when you withdraw it.  Leaving it in for, say, 20 years you would have $6,414 after paying your tax:  $3,000 x (1.06 ^ 20) x (1-.3333).

Taxable account

Contributing to a taxable account, you have $2,000 to invest after tax ($3,000 x (1-.3333)) and investment earnings are taxable so your effective investment return is 4% (6% x (1-.3333)).  But then you’re done paying taxes.  After 20 years you would have $4,382:  $2,000 x (1.04 ^ 20).

What if’s:  rising tax rates, capital gains, return, deferral period, Roth

In this simple example, the qualified plan clearly beats the taxable account.  But what if tax rates are higher at withdrawal?  For the $4,382 in the taxable account to beat the qualified plan, the tax rate would have to suddenly jump to 54.5% at withdrawal:  $3,000 x (1.06 ^ 20) x (1-.545) = $4,378.   Any tax increase that happens more gradually would be worse for the taxable account, with no effect on the qualified plan.

What about capital gains?  If the current 15% long term capital gains rate is sustainable and all your investments qualify, your effective return is 5.1% (6% x (1-.15)).  You still start with $2,000 to invest after tax, so after 20 years you would have $5,408:  $2,000 x (1.051 ^ 20).  That’s not bad, but it’s still less than the $6,414 you would have had from a qualified plan.

What about different investment returns and deferral periods?  We’ve used 6% return for 20 years in this simple example, but how does it change for other returns and time periods?  The short answer is that higher investment returns and longer deferral periods favor the qualified plan.  Lower returns and shorter time favor the taxable account.

What about a Roth IRA or 401(k)?  As it turns out, Roth and regular 401(k) results are identical if your marginal tax rates are equal at contribution and withdrawal.  Roth is better if your marginal rate at withdrawal is higher than at contribution time; otherwise a regular 401(k) is better.  And they both blow the taxable account out of the water.

These examples confirm the value of tax deferral in qualified retirement plans. As included in the examples the tax rate would have to increase to 54.5% at withdrawal to make tax deferral a bad deal. The Roth example is simple yet effective.

Please comment or call to discuss.

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