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Roth Conversions : Do They Offer Protection from Higher Tax Rates?

Investments - Open Door to Diversified Investing Growth

Roth conversions are a common topic of conversation between financial advisors and clients who have IRAs. One of the goals of optimizing tax planning is to pay taxes whenever rates are lower. However, just as it isn’t always easy to predict when to buy low or sell high, choosing the ideal time to convert to a Roth IRA can be a challenge.


The reason is most clients can’t accurately predict their tax bracket during retirement. While people often end up in a lower tax bracket after retiring, that shift isn’t guaranteed. When doing a Roth conversion from a traditional IRA, taxes are paid before they’re legally required.. Since advisors are generally in the practice of deferring taxes, any action that means paying taxes early is not something they want to do.


Estimating the future tax rate of a client can be an uphill battle.  As a result, it’s generally worthwhile for advisors to focus their attention and client conversations on a few other reasons. Let’s take a look at some of these reasons.


Diversifying Tax Risk


Diversification isn’t a principle that only applies to investing. It also plays an important role in tax planning. An optimal strategy is to have a mix of funds that are tax-free, tax-deferred, and taxable, and within the taxable accounts to have some funds invested to generate ordinary income and others that will produce capital gains. The role a Roth conversion plays in tax-risk diversification is filling up the tax-free basket as a hedge against potentially costly future tax increases.


This also brings up an important point to communicate with clients, which is that this conversion isn’t an all-or-nothing choice. Instead, the best option may be to do a partial conversion or systematic partial Roth conversions over multiple years to keep income in a lower bracket while still converting something on an annual basis. This will make Roth funds more valuable in the event tax rates do increase.


Eliminating Required Minimum Distributions


Roth IRAs are not subject to lifetime required minimum distributions (RMDs). After the tax is paid during conversion, Roth funds normally become tax-free. This is true even for beneficiaries (although beneficiaries are subject to RMDs). Since many clients want full control over their retirement distributions, converting to eliminate required minimum distributions can be a compelling option for clients.


Insurance Against Higher Tax Rates


Another tax benefit of a Roth conversion is being able to insure against higher tax rates in the future. Although those rates are unknown, this conversion can provide clients with a great sense of certainty during retirement. Because there is an opportunity cost associated with this conversion, it’s important for advisors to help clients choose the optimal time to take this action.


Why Keeping a Will Updated is Just As Important As Having One

Notary officer helping mature client

According to recent studies, more than half of all Americans are likely to die without a will. In this event, applicable state laws will dictate what happens to the assets of the estate. The decedent will have no say in the disposition, nor will the surviving family.


In general, state laws will direct the assets to spouse and children, or parents and other family members if the decedent was not married and had no descendants. There is no provision for bequests to friends, benefactors or charities. But even those who have a valid will might not have the distribution go entirely according to their wishes.


When a Valid Will Isn’t Enough


There are several reasons for this disparity. First of all, many assets do not pass through probate and thus are not subject to will provisions. Most people are aware that any insurance proceeds will go to the named beneficiary, but there are also other items to consider. Retirement accounts, annuities, transfer on death (TOD) and joint accounts will pass outside the will, as will any property held in joint tenancy with rights of survivorship.


Another consideration is that a person’s circumstances may have changed. Change is an unavoidable part of life, as we all know. Some of the major changes one might experience include marriage, divorce, the death of a loved one or the birth/adoption of a child or grandchild. Whether planned or unexpected, every change requires some adjustments, but often people overlook the less obvious items. For this reason, clients should be reminded to review their wills on a regular basis and update them as necessary.


How Planners Can Help Clients Manage Their Wills and Related Documents


Just as important, though, is to review the beneficiary designations (both primary and contingent) on all retirement plans, insurance policies, annuities and such.  Many a court battle has developed when an individual neglected this important detail. For instance, if a person fails to change the beneficiary after a divorce, insurance proceeds could be paid to an ex-spouse rather than the children or current spouse. Some states have laws that invalidate ex-spouse beneficiary designations after a divorce, but these laws don’t necessarily apply in every case, and can be superseded by any applicable federal statutes.


For retirement accounts covered by ERISA, a spouse automatically has rights to the account unless he or she has signed a waiver. So if, after a divorce, you name your children as beneficiaries of your 401(k) and subsequently remarry, your new spouse will get the assets absent a valid waiver. Any other beneficiary designation will be disregarded.


Every change in circumstance should prompt a review. An unmarried person may have designated parents or a sibling as beneficiary of an insurance policy and then married but never updated the beneficiary. Perhaps the original beneficiary of a plan or policy has passed away, in which case the choice of contingent beneficiaries comes into play. Should they be moved up to primary, or is there reason to make a different choice? Maybe there’s a new child in the family who needs to be provided for, or donating to a charity becomes a better option.

Given the certainty of change, a planner should not only exhort clients to execute their wills, it’s important for the planner to also remind them to review and update all of their documents and designations regularly.

The 5 Things Successful Financial Advisors Take Very Seriously

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Financial planning professionals who are great at what they do enjoy their work. The most successful financial advisors understand that enjoyment does not exclude taking things seriously.


When pundits tell students to follow their passion, they often gloss over a very important component of what passion truly means. True passion for work comes from mastery. And the only way to get really good at something is to work hard and focus.


So if you’re working towards a future in this field, it’s definitely smart to learn as much as possible from trained financial advisors who are already successful. With that goal in mind, let’s look at the five things excellent planners take very seriously:


1. Character: An advisor who’s committed to long-term success is always going to do what’s best for their clients instead of being influenced by things like a quick payday.


2. Collaboration: It’s easy to romanticize the idea of the lone wolf professional. But great advisors know that’s not the best way to work. That’s why they look for opportunities to collaborate and create a positive outcome for everyone involved.


3. Commitment: Successful advisors honor their commitments to others. They also make a conscious commitment to putting in the work that’s necessary to find lasting success in this field.


4. Consequences: Stellar financial advisors don’t blame anything that goes wrong on other people or the market. Instead, they think through scenarios with the realization that they’re responsible in the event something goes wrong.


5. Control: Successful financial advisors who do well understand that they’re in control of things like their daily activities, and not in control of other elements like their clients’ attitudes.


How Can Future Financial Advisors Get This Type of Experience?


After passion and mastery, the most important requirement for a financial planner is getting the right kind of experience. One of the biggest challenges for upcoming financial advisors is gaining experience from exposure to the situations professional advisors deal with on a daily basis. Although it’s obviously important to pass the CFP®Certification Exam, this exam isn’t simply about regurgitating knowledge. Instead, students who want to put themselves in the best position for future success should use this exam as an opportunity to develop the critical thinking skills of an advisor.


With Keir’s THINK LIKE A PLANNERSM study program, students preparing for the CFP® Certification Exam will learn the thought process needed to ace the exam and thrive in the world of certified financial planners. Keir’s THINK LIKE A PLANNERSM Method goes beyond simply comprehension and incorporates analysis, synthesis, and evaluation of information. For any student who wants highly relevant experience for what a future job will demand, our proven method of study is the way to go.