Upper-income investors are taking advantage of a change in the tax law and rushing to convert their traditional individual retirement accounts or old 401(k) plans into Roth IRAs, according to an informal survey of investment companies.
New rules took effect Jan. 1 that allow those who earn more than $100,000 annually to convert to Roth IRAs. Previously, only people who earned less than that amount could convert.
As a result of this expansion of eligibility, investment companies have been doing a huge amount of business.
The Vanguard Group Inc. converted almost 30,000 traditional IRAs into Roth IRAs in January alone — nearly 70% of its 2009 totals.
Vanguard typically converts about 1.5% of its accounts per year and expects the conversion rate to increase to between 4.5% and 5% in 2010, Amy Chain, a company spokeswoman, wrote in an e-mail.
“We are averaging between 400 and 800 calls per day in 2010 on
Roth conversions — about 30% of our daily complex retirement call volume,” she wrote.
Fidelity Investments handled 22,000
Roth IRA conversions in January, about four times the number of such conversions a year earlier.
T. Rowe Price Group Inc. conducted more than 4.5 times as many
Roth IRA conversions in January than it did in in January 2009, though the firm declined to provide specific numbers.
And registered representatives at
Raymond James Financial Inc. made 1,459 such conversions in January, up from 666 in January 2009. For the year, the firm saw a total of 4,138.
“There's no doubt about it,” said Russ Shipman, senior vice president and managing director of the retirement strategy unit at Janus
Capital Group Inc. “There's a groundswell of interest.”
Janus hasn't yet crunched its numbers, but Mr. Shipman said that his conversations with intermediaries suggest that interest will only grow.
“I think the general sense is, this thing will really pick up pace when we get through the tax season,” he said.
Considering the advantages of a
Roth IRA over a traditional IRA — for example, withdrawals of principal and income are free of income tax, and heirs don't pay income tax on withdrawals from inherited IRAs — it would seem an easy decision to convert.
Additionally, though investors still must pay ordinary income tax on each dollar converted, they can spread the tax bill over two years, splitting it between their 2011 and 2012 tax returns.
But some financial advisers warn that Roth IRAs aren't for everyone, a message that they fear is being lost because financial companies are pushing conversions to collect the fees and commissions that come with them.
“I don't think there was an inherent curiosity on behalf of the public until financial firms started marketing conversions,” said Richard Schroeder, executive vice president of Schroeder Braxton & Vogt Inc., a financial advisory firm with $170 million in assets under management.
And stoking investor curiosity can lead to disastrous results.
“It's just not simple,” J. Michael Martin, president of Financial Advantage Inc., said about the decision to convert. His firm has $250 million in assets under management.
For example, many investors and advisers don't understand that there can be multiple “five-year clocks” running simultaneously that apply to Roth IRA withdrawals, said Susan Hartman, a tax expert in the
financial planning department at Raymond James.
A five-year clock starts the day a Roth IRA is opened and funded. Earnings can be withdrawn tax-free without penalty after five years and a qualifying event such as turning 591/2 occurs.
An additional five-year clock, however, is set for each IRA that is converted.
That means that if an investor is younger than 591/2 when a particular conversion is done and that investor withdraws money before the clock associated with that conversion runs out, he or she is hit with a 10% penalty.
It is one of the most common misunderstandings surrounding conversions, Ms. Hartman said.
Having said that, Raymond James is working with its reps to make sure that they understand everything there is to know about Roth IRA conversions, she said.
Ms. Hartman characterized Raymond James' efforts around Roth IRA conversions not as an attempt to sell clients something they don't need but an attempt to educate them on a new opportunity.
Fidelity Investments is also “agnostic” with regard to conversions, said Lizanne Campbell, the firm's senior vice president of product management.
“We're educating the adviser, home office personnel — and, indirectly, the investor — on the regulations and opportunity surrounding Roth IRA conversions,” she said.
Converting a traditional IRA to a Roth IRA may not be for everyone, Ms. Campbell conceded.
But the tax law changes “certainly offer an opportunity for advisers to call their clients to uncover hidden assets,” she said. “It's a great conversation to have, whether or not they do a conversion.”
John Moninger, executive vice president of advisory and brokerage consulting at
LPL Financial, agrees.
“It really feeds into the planning process,” he said of the changes.
Mr. Moninger, however, was surprised that so many conversions were taking place so soon after the tax law changes went into effect.
He didn't have data with regard to conversions being completed by LPL's reps, but “in talking with advisers, they are saying they're not seeing a lot of conversion opportunity,” Mr. Moninger said.
In many cases, that is because investors don't have cash to pay for conversions, he said.
And in some cases, after doing the math, investors determine that it just doesn't make sense, Mr. Moninger said.
E-mail David Hoffman at [email protected].
