IRA Alert

Ed Slott

Planning Roth conversions during tax reform uncertainty

Financial advisers should use the summer to evaluate all 2016 and 2017 Roth conversions for clients

Jun 23, 2017 @ 3:57 pm

By Ed Slott

What will 2017 or even 2018 tax rules look like? Going into summertime it's starting to look like any major tax reform may not be effective until 2018.

One thing is for sure, though: Roth conversions will be affected, both the conversions already done and any future conversions being contemplated. Financial advisers should use the summer to evaluate all 2016 and 2017 Roth conversions for clients.

Remember that the core of Roth IRA conversion planning is not how much you convert; it's how much of that conversion you keep. Or put another way, how much of the conversion is recharacterized or even re-converted.

(More: Many investors are still not using this IRA strategy to save on taxes)

First, let's review the Roth conversion options.

A client can convert to a Roth IRA, recharacterize (undo) all or any part of that conversion and even re-convert those same funds or convert other funds. When the conversion is done, the pre-tax converted funds will be taxed at ordinary income tax rates, but there is never a 10% early distribution penalty.

All or any part of a Roth conversion can be undone by recharacterizing it back to a traditional IRA by Oct. 15 of the year after the conversion. The recharacterization requires the converted funds along with the income or loss on those funds to be directly transferred back to a traditional IRA.

Those same converted funds which have now been recharacterized can be re-converted, but not until the year after the conversion or 30 days after the recharacterization, whichever is later. Other IRA funds can be converted at any time, since the waiting period does not apply to funds not yet converted before.

In essence, that is the Roth conversion planning cycle: the Roth conversion, the recharacterization and the re-conversion.

(More: How advisers can dispel the confusion between IRAs and Roth IRAs)

Now to the planning in light of uncertainty about tax reform.

First, evaluate all 2016 Roth conversions now. Speak with clients. You probably already know or have a good idea of the tax cost of these 2016 conversions. Let clients know that with tax reform looming, the tax bill could be lower in the future. It might pay to recharacterize those funds and wait it out until next year for a lower tax cost.

But before undoing that conversion, the status of the converted funds must be reviewed.

Have the converted funds appreciated substantially since being converted to the Roth IRA? If so, that would have to be factored in and may be a reason to keep that conversion. Even a future lower tax rate can end up costing more if it is on a higher balance.

If the client took advantage of a low tax bill in 2016 due to business losses or high deductions that year, that may also be a reason to keep that conversion. The client may also be on a plan to do smaller annual conversions to make the most of the lower tax brackets each year. But even in that case, looking ahead to a lower future tax rate may be a reason to undo part or all of the 2016 Roth conversion and wait it out until next year.

What about 2017 Roth conversions? If clients have already done them, advisers have more flexibility and waiting time since those conversions can be undone up to Oct. 15, 2018. By that time, hopefully there will be more tax rate certainty.

For clients who have not yet converted IRA funds to Roth IRAs but are thinking about it, it might be wise to delay these conversions until we have a new tax law. However, each client has their own situation, and a Roth conversion now could still pay off without waiting for lower tax rates if the funds are expected to appreciate substantially before then. Along those same lines, look at converting IRAs with depressed values.

(More: 4 ways to reduce RMD taxes)

Bets can also be hedged by converting different investments to separate Roth IRAs providing more flexibility in recharacterizing only some conversions.

Remind clients that it's not an all or nothing approach. Partial conversions and recharacterizations are permitted and can be used to tailor the timing for the optimal Roth conversion.

Ed Slott, a certified public accountant, created the IRA Leadership Program and Ed Slott's Elite IRA Advisor Group. He can be reached at irahelp.com.

0
Comments

What do you think?

View comments

Recommended for you

Upcoming Event

Sep 13

Conference

Women Adviser Summit - Denver

The InvestmentNews Women Adviser Summit, a one-day workshop now held in four cities due to popular demand, is uniquely designed for the sophisticated female adviser who wants to take her personal and professional self to the next level.... Learn more

Featured video

Events

Transamerica's Boan: Crafting better retirement income conversations

Retirement income is a challenge for investors. How can advisers have better conversations about retirement income? Transamerica's Joseph Boan offers insights and tips for advisers.

Latest news & opinion

What's in a name? For TCA by ETrade, everything

Trust Company of America is gone, and there's big buzz over the name change. But turning the custodian into an industry powerhouse will take a lot longer — if it happens at all.

When it comes to regulating AI in financial services, murky waters are ahead

Laws are unclear on how the technology fits in with compliance.

As Ameriprise case shows, firms on hook when brokers go bad ​

The SEC will collect $4.5 million from the brokerage firm for failing to supervise brokers who were ripping off clients.

10 highest paid professions in America today

These are the top-paying jobs in the U.S., according to Glassdoor.

Ameriprise to pay $4.5 million to settle SEC charges that five reps stole more than $1 million from clients

Agency censures firm for not protecting clients from thieving brokers.

X

Hi! Glad you're here and we hope you like all the great work we do here at InvestmentNews. But what we do is expensive and is funded in part by our sponsors. So won't you show our sponsors a little love by whitelisting investmentnews.com? It'll help us continue to serve you.

Yes, show me how to whitelist investmentnews.com

Ad blocker detected. Please whitelist us or give premium a try.

X

Subscribe and Save 60%

Premium Access
Print + Digital

Learn more
Subscribe to Print