President Joe Biden has pledged to raise taxes for higher-income Americans and corporations, but even if his proposals win the support of Congress, they likely won’t take effect until the 2022 tax year. That makes Roth IRA conversions continue to look attractive for several types of clients who think their tax rate may go up next year or later.
Roth conversions garnered attention last year when an unexpected opportunity arose from the CARES Act. The legislation Congress passed to offer relief from pandemic hardships allowed eligible clients to suspend required minimum distributions (RMDs) for tax year 2020, creating a window in which they could instead convert some or all of that money into after-tax Roth accounts at a historically low tax rate. However, the RMD relief ended with the close of the 2020 year.
Nevertheless, there are numerous reasons for advisors to identify clients who still could benefit from moving Traditional IRA funds into a Roth IRA in 2021.
Bill Vasil, a tax partner at Ary Roepcke Mulchaey CPAs and tax expert for FP Alpha, an AI-driven comprehensive financial planning solution that helps advisors identify actionable opportunities to their clients across 17 planning disciplines, pointed out three types of clients whom advisors might target for recommending Roth conversions.
• Retired Clients in Their ‘Gap’ Years: First, Vasil says, think about clients who are in their “gap” years, meaning they’ve retired but haven’t started taking RMDs or Social Security. They are ideal candidates for a Roth conversion because they are typically in a lower tax bracket after leaving their career. As such, advisors can recommend a strategic transfer of some of their retirement funds to a Roth account to take advantage of the temporarily lower taxation before the client starts RMDs. In addition, the Roth conversion removes pressure for forced distributions later in life and erases the tax burden on beneficiaries of the account.
• Younger Clients With a Smaller Traditional IRA: Converting now from a pretax IRA in a favorable tax environment not only allows for tax-free growth of the Roth account funds over their lifetime, it also allows them to start completing annual back-door Roth IRA conversions once their future income climbs above the maximum allowed by the IRS for regular Roth contributions, Vasil suggests.
• Business Owners or High-Income Earners Struggling During the Pandemic: These clients experienced depressed income or losses last year, and are having trouble recovering financially as coronavirus cases and restrictions persist into 2021. Similar to the gap-year retirees, Vasil encourages advisors working with these clients to use his or her current drop in tax bracket to maximize the benefits of a Roth conversion while the tax load from moving the assets into an after-tax Roth account is reduced.
Tax planning should occur throughout the entire year, but it’s especially crucial early in a new year to present financial planning clients with relevant ideas on how to manage their tax burden, shortly before returns are filed.
Andrew Altfest, President of Altfest Personal Wealth Management, a $1.5 billion RIA in NYC agrees. He and his team pride themselves on providing specialized planning to their entire client base, of which, tax planning plays an integral role in their comprehensive service offering.
“Our defined tax planning process begins with the review of a client’s tax return and identifying the many triggers that facilitate our analysis,” Mr. Altfest said.
“As an advisor, I was searching for a tech solution to help me provide specialized recommendations to all of our clients, in a scalable manner. It simply did not exist, so I built it. FP Alpha. FP Alpha enables advisors to move beyond conventional financial planning to pair effective tax reduction strategies, for example, with the complete financial picture of existing clients and prospects”.
Ultimately, advising clients to make a Roth conversion this year has the potential to result in meaningful long term financial gain, if suitable for the client’s needs and goals. However, this is not an easy decision — as there are a number of factors to take into account.