30 Ways Your Roth IRA Conversion Advice Could Be Wrong

Roth IRA conversions are the latest surging sales idea from financial advisors and insurance agents carrying their latest products on their backs.

But what happens when fear of missing out and bad advice occupies the same space?

We can make poor financial decisions.

Roth conversion advice serves as a good example.

Conversions can be a powerful tax planning move, for the right people and facts. Tax planning is the top in-demand service for investors today; conversions can lower lifetime taxes and add valuable flexibility.

The problem? Roth conversions don’t work for most clients.

The analysis behind conversions seldom considers important data needed to evaluate the decision, and most software programs contain flaws in even the most fundamental variables in the analysis, such as federal income tax rates.

Example: most Roth conversion software requires the user to estimate the client’s federal tax bracket. That one data point is used for the conversion period and the duration of the projection.

Aside from not knowing future tax rates (and concluding they will be much higher), the analysis ignores the fact of tax bracket inflation.

Federal tax brackets grow every year for inflation, about 3% on average for 50 years. Extrapolate your income forward 20 years, and the income projection you made for taxes on an effective 22% rate can be foolishly faulty.

We need the software to calculate – or at least test - the tax rate each year during and after the conversion to have reliable numbers.

Does your Roth conversion project know the cost basis and gain on the assets sold to pay taxes on the conversion income?

If you hold funds in a bank account earning 2% to pay tax on annual conversions, and that money can safely earn 6%, the spread is lost on most agents or advisors who just finished their talk about U.S. national debt.

Insurance agents pitching up-front bonuses to ‘pay the tax’ on conversions is one of the biggest mathematical failures and a red flag. Annuity bonuses are not cash, and they come from a finite pot of money. But it gets worse.

If the bonus annuity has an earnings cap of 6% and another annuity choice has a 10% cap, the difference in investment return is overlooked in the conversion decision. You’re stuck with much lower compounded earnings.

Converting funds after a steep drop in market investments can be a winning strategy. But converting “up to the top” of your current marginal tax bracket (the most common conventional advice) treats the stock market as a static number; real life ups and downs in the markets occur will have a dramatic effect on whether the conversion makes financial sense or not.

Other timing variables matter too. Calculating the short- and long-term benefits of conversions are complicated by Medicare premium surcharges (IRMAA) based on income from two years prior.

IRMAA is ignored or incorrectly factored by many advisors and the software they use. The calculations are complicated. The brackets to calculate surcharges increase with inflation, but the top bracket is fixed and does not.

What to do?

Most Roth IRA conversion software applies fewer than ten variables, and most conversion advice considers fewer than six. We use software with more than thirty variables to project Roth IRA conversions.

When would you like to know if the conversion makes sense, before or after you make it?

If your advisor or agent is pitching bonus annuities to ‘fund’ a conversion, stop, cold. Let us do a conversion analysis with a Certified Roth Conversion Specialist (CRCS™). We’ll show you the math.

Email us at: rcattanach@aswealthmanagement.com or call (651) 773-8400 with your name and ROTH CONVERSION in the subject line.