To convert or not to convert?

By Karlan Tucker

Tucker Advisors


Beginning on January 1, 2010, changes to the federal income tax code went into effect that could create a huge annuity sales opportunity. The two changes are:
  • The Modified Adjusted Gross Income (MAGI) limit of $100,000 is eliminated, thus enabling anyone to convert to a Roth IRA, regardless of income or filing status

  • The income tax payable on the conversion income can either be paid entirely in 2010, or split in half during 2011 and 2012.
Because of these changes, many advisors will be talking to clients about converting their traditional IRAs and 401(k)s. Since clients of high net worth can now take advantage of a Roth IRA, conversions in many cases could result in huge sales for advisors.

At the same time though, advisors must not recommend Roth IRA conversions through new annuity sales to all of their clients, just for the sake of the sale. What must be taken into account are the client's particular financial situation and whether or not the conversion makes sense. In other words, always do what is right for the client.

To take it a step further, most of your clients probably will not want to convert, even if it makes sense, because they will be paying taxes now, as opposed to in the future. So, should you spend time talking to prospects and clients about conversions?

Absolutely! The reason is simple. It provides another opportunity for you to meet with existing clients and uncover other opportunities. Think about it. Even if you have clients who have already done business with you in the past, have you kept in touch with these clients on a consistent basis? Do you know everything there is to know about their current financial situation?

In many cases, the answer to both of these questions is "no." Contacting these clients now to review their IRA situation could help you uncover not only IRAs which may or may not make sense to convert, but also non-qualified funds of which you were not previously aware. The fact is you should look at Roth IRA conversions as a great opportunity to connect with your existing clients.

Even if you don't write new business after meeting with these existing clients, you have re-established the relationship and have solidified in your clients' minds that you are an advisor, not just a salesman! Plus, in the future when they come into new money, they will think of you.

In addition to contacting all of your existing clients, this is a great marketing opportunity for you as an advisor. While you certainly know the benefits of the annuity products you sell and can make a sale if you are in front of a prospect, many times you may struggle to find enough prospects with which to meet.

The Roth IRA conversion topic provides you with the perfect reason to contact prospects and set up a meeting to review their current IRA situation. Just like with existing clients, whether a conversion does or doesn't make sense, you will be able to see all of their savings and investments, whether qualified or non-qualified, and if suitable, write new business.

So, when meeting with an existing client or a brand new prospect, how do you know whether or not it makes sense for them to convert to a Roth IRA? There is no exact method to determine that in every case; however, if you ask three basic questions, you can generally make a fairly accurate recommendation every time:
    1. When will the client need the money?

    2. What does the client think future tax rates will be and in what tax bracket does the client think their future income will be?

    3. Where is the money coming from to pay the tax for their conversion income?
Let's address the first question. For purposes of this article, I don't want to go into great detail as to the tax rules on Roth IRAs. Because of the various five-year rules for Roth IRAs and the order of withdrawal of conversion funds, contribution funds, and earnings, it can become very confusing as to how to address this issue.

Suffice it to say that if your client will need the money before the age of 59½, or sooner than five years from the conversion, it almost never makes sense to convert, due to the potential taxes and penalties your client will incur. Generally, your client should be looking at closer to a 10-year window before needing to access the money for the conversion to make sense.

As far as the second question is concerned, if your client thinks they will be in the same or a lower tax bracket in the future (due to a lower retirement income in comparison to their present income), converting probably doesn't make sense. The problem with this question is that even if your client thinks they will be in a lower tax bracket, neither they nor you know what future tax rates actually will be.

While my opinion is that tax rates will likely increase, my clients may not share that opinion. So essentially, even if you think the conversion will make sense for your client due to potential higher tax rates, ultimately it is up to your client.

Lastly, the ideal situation would be that your client has non-qualified funds available to pay the income tax on the income that will result from the conversion. Let's take the example of $100,000 in a traditional IRA being converted to a Roth IRA.

If your client's tax rate happens to be 25 percent, they would then have a $25,000 tax bill. Taking the $25,000 out of the $100,000 pot of money would reduce that balance to $75,000. Now your client will only have $75,000 in their newly converted Roth IRA and usually (even with a bonus product) it will take quite a few years to get back to the initial $100,000 and grow from there.

While a client certainly could do that, the fact of the matter is that taking the money directly from the IRA will to some extent defeat the purpose for the conversion, primarily if the client wants to see that IRA grow throughout their lifetime and then pass that money on as a Stretch IRA to their beneficiaries.

So, what should you as an advisor do with this information? More than anything, don't get hung up on whether or not a client should convert to a Roth IRA; use this as a marketing opportunity.

Meet with your prospect or client and help them determine if they would be a candidate for a conversion. The ideal candidate for a conversion:
  • Has a time horizon of at least five to 10 years before ever needing the money or even more ideally, thinks that they will never need the money

  • Has no plans to spend before age 59½ (if the money will be spent)

  • Thinks they will be in the same or a higher tax bracket during retirement

  • Has the money available for the taxes on the conversion income in a non-qualified account

  • Plans to pass the money on to beneficiaries
However, even if you meet with the ideal candidate, the majority of those people will probably not want to convert. At that point, don't be the advisor who has nothing further to discuss. Use this tax change as a means of not only getting in front of people you might have never been able to meet with in the past, but also as a means of uncovering opportunities and selling more.

That's what I plan to do, and so can you.

I wish you great selling!