COVID-19 makes 2020 a good year for clients to consider a Roth conversion, says leading financial advisor Elizabeth “Lizzie” Evans.
I caught up with Evans, founder and managing partner of Evans May Wealth in Indianapolis, after I heard her speak on April 22 as part of the virtual panel, “The Road to Recovery – How the New Economy Might Look.” Led by Sylvia Jablonski, managing director, capital markets—institutional ETF strategist, at Direxion, it included others who have made names for themselves in the advisory business, including Julia Carlson, CEO and founder of Financial Freedom Wealth Management Group; Jeanette Garretty, a managing director and chief economist at Robertson Stephen Wealth Management; and Carin L. Pai, CFA, an executive vice president and head of equity management at Fiduciary Trust International. The panelists covered a multitude of topics, including the financial advice that they are providing to clients in these troubling times.
Evans mentioned during the session that she thinks it’s an excellent time for young investors and high-net-worth families who want to maximize their financial legacy to consider converting traditional IRAs to Roth IRAs. Since most clients of advisors have tax-advantaged retirement accounts, I followed up with her on this point.
What circumstances might make it desirable for a young person to convert either an IRA or a 401(k) plan being rolled over to a Roth IRA? Can you include a specific example?
Roth IRAs are one of the best vehicles to save for retirement, given the tremendous benefit of tax-free growth. My general rule of thumb is that if you are young and can afford to pay the taxes on a Roth conversion, you should do it and the sooner, the better. Put your money to work and allow it to grow and compound for decades to come!
From a timing standpoint, the best time to do a Roth conversion is in a down market. This equates to a lower tax bill because you are paying tax on a smaller investment portfolio. There are many factors to weigh when converting pre-tax funds to a Roth IRA, and conversions should never be based solely on market timing.
What factors does a high-net-worth individual need to consider in deciding whether to convert to a Roth IRA? Can you a describe why you advised a particular HNW client to consider such a conversion?
Often overlooked as an estate planning tool, Roth conversions are a great wealth transfer vehicle. For example, I recently advised a 69-year old client to convert his traditional IRA to a Roth IRA. The rationale behind the conversion was three-fold: (1) under the SECURE Act, he now can delay his required minimum distributions to age 72. He does not need his retirement assets to support his lifestyle. By converting funds to a Roth IRA, he is not required to take out distribution over his lifetime nor will his wife, should he predecease her. This allows for his assets to grow longer tax-free, creating a greater legacy for his family; (2) we believe tax rates are likely to increase in years to come, especially for high- net-worth individuals and families. It is better to pay the taxes today at a lower rate than in the future; and (3) the taxes paid will, in effect, reduce the size of the estate dollar-for-dollar. For families with net worths in excess of the $23.16 million estate tax exemption, every dollar over this limit will be taxed at 40% at the last spouse’s death. Paying the tax now on the Roth conversion may reduce the future estate tax, ultimately increasing his legacy.
Have any clients been laid off as a result of the coronavirus, and if so, have you advised any of them to consider a Roth conversion? What were the circumstances that made this conversion seem desirable?
Fortunately, very few of my clients have had their employment impacted by COVID-19. With that said, if you have been laid off due to COVID-19 and, therefore, will be in a lower income tax bracket this year, then it is worth considering a Roth conversion if you can afford the associated tax liability. The lower income tax bracket will reduce the taxes owed on the Roth conversion, which could result in huge savings. And even if you cannot afford to convert the entire IRA, a partial Roth conversion is worth consideration.
It was mentioned on the call that RMDs are not required in 2020 because of the pandemic. Will this make Roth conversions more desirable for some people? If so, why?
Absolutely. Investors should weigh the benefits of a lower tax liability in 2020 with the benefits of a Roth conversion. For example, let’s say an investor’s 2020 RMD was $100,000, and this investor has either not taken it or is within the 60-day period for returning the funds and has other sources of income to meet their income needs. Said investor may consider a Roth IRA conversion for $100,000. Ultimately, there are many factors to consider when making a Roth IRA conversion, and the 2020 RMD waiver is only one consideration.
Why might doing a Roth conversion now put a client in a better tax situation in the future?
If an investor believes that his/her tax rate is lower today then it will be in the future, particularly over the long-term, then a Roth conversion always make sense. When you convert a pre-tax retirement account to a Roth IRA, you pay the taxes now at the current tax rate in exchange for a lifetime of tax- free growth. Clients often think they will be in a lower tax bracket in retirement. The reality is between RMDs, portfolio income, Social Security, and pensions, clients are often in the same tax bracket as they were during their working years or sometimes higher!
Are you doing any projections on how much a person might save in taxes down the road because of a Roth conversion? If so, can you give me an example of a client situation and how much you projected she could save?
The savings can be significant, but it varies based on a person’s age and tax rate. For example, take an investor who is 30 years old, with a $100,000 IRA and a marginal tax rate of 30%. Assume he/she does a Roth conversion at age 30, does not take distributions from the Roth until age 60, the portfolio grows at 8% per year, on average, and that he/she is in the same tax bracket throughout retirement. I calculate that he/she would save approximately $14,000 per year in after-tax income when distributions begin. If this individual lives to 90, this could result in $420,000+ in future savings by paying $30,000 today!
Dorothy Hinchcliff is the editor of Advisor Perspectives
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COVID-19 makes 2020 a good year for clients to consider a Roth conversion, says leading financial advisor Elizabeth “Lizzie” Evans.
