Consumers Should be Wary of Advice That Simply Benefits Adviser’s
Sales Agenda
Alcoa, Tenn.— Just as the film “The Wizard of Oz” can thrill a child, perhaps nothing instills a greater sense of innocence, fear and deliverance for adults than the IRS.
“After all, what could motivate a taxpayer more than the thought of peeking behind the curtain to discover a new way to minimize taxes,” said Andy Oakes, financial adviser for LeConte Wealth Management.
For taxpayers in 2010, the “yellow brick road” is the Roth IRA conversion, which takes advantage of two IRS provisions that are limited to this year alone. However, according to Oakes, consumers need to take precautions.
“Using the ‘Oz’ analogy, the flying monkeys in this story are not IRS agents — instead, they’re the bankers, insurance agents and stock brokers who would counsel a client to convert a Roth IRA simply to close a sale rather than to help the client realize retirement dreams,” Oakes said.
LeConte Wealth Management offers several tips for navigating these tricky IRA waters:
First the Facts:
Two things have changed for 2010. In previous years, if one’s income exceeded $100,000, a Roth IRA conversion was not an option. This limit has been eliminated. More importantly, the typical Roth IRA conversion generates taxes due in the year the conversion takes place. For 2010 only, however, the tax due from conversion can be delayed and split between tax years 2011 and 2012.
“These taxes must still be paid—just at a later date,” said Oakes.
To Convert or Not to Convert:
It is important for consumers to ask themselves, “When do I want to pay tax on my accumulated retirement money?” According to Oakes, the correct answer should be, “When my tax bracket is lowest.”
First, take a look at your tax return for 2009 once it has been filed and determine your “marginal tax bracket,” also known as your personal top tax rate. Then, think about what your income will be in the future, specifically, in retirement. If your tax rate will go up in the future, it may be worth converting. If you will be in the same or a lower tax bracket, it is likely not worth converting.
“Consumers should be sure that their choices on converting or not benefit them, not someone else,” Oakes said.
Below are some commonly asked questions and red flags that LeConte Wealth Management encourages consumers to watch out for if approached to convert a Roth IRA:
1. “My adviser says that if I convert, I can leave my IRA to my kids tax-free.”
That may indeed be the result, but keep in mind that if your heirs will be in a lower tax bracket than you, converting could mean a bigger tax bill. Paying now does not always mean paying less when it comes to taxes.
2. “My insurance agent recommended converting an old 401(k) to a Roth IRA using an annuity that will give me guaranteed income in retirement.”
Converting has nothing to do in itself with what types of investments you choose. Given that 401(k) plans can have very low expenses, and that some variable annuities have recurring annual expenses approaching 4 percent, you should be wary of conversion as justification to alter your investment strategy. This is a classic bait-and-switch where a good strategy and a bad product do not a happy investor make.
3. “Someone at my bank suggested converting my IRA to a Roth IRA, but I was concerned that I wouldn’t have the money to pay the extra taxes in 2011 and 2012. They said not to worry and that I could take a loan on my 401(k) or get a home equity loan to make up the difference.”
Not having a ready source of funds to pay taxes is perhaps the biggest obstacle to conversion. Three things you should avoid altogether in coming up with the money to pay taxes on conversion are 1) depleting your cash reserve or emergency fund, 2) taking any sort of loan, and / or 3) taking a distribution from the retirement account, which may incur early withdrawal penalties. If you do not have a liquid source of capital to pay the taxes, converting is probably not right for you.
Bottom Line:
You should be able to answer “yes” to all of the following questions:
1. Is it probable that a conversion will reduce the overall tax I will pay on my retirement savings?
2. Do I have enough money outside my retirement accounts to pay the tax?
3. Does converting make sense given my specific financial goals?
Visit LeConte Wealth Management’s Web site for more financial information and access to free financial tools and calculators.
ABOUT LECONTE WEALTH MANAGEMENT, LLC:
Established in 2007 and located at 269 Cusick Road, Alcoa, Tenn., 37701, LeConte Wealth Management, LLC helps clients develop a plan to accumulate and preserve their wealth in pursuit of their unique financial goals. With more than 30 years of cumulative experience, the firm’s team provides asset management, retirement planning, estate planning, risk management and business planning. Securities and Advisory Services offered through Commonwealth Financial Network, Member FINRA/SIPC, a Registered Investment Adviser.
