President George W. Bush signed changes in the tax bill into law on May 17.
The bill extends the dividend and capital gains tax cuts that Congress first enacted in 2003, which set the maximum rate for both at 15 percent. While most of the attention has been focused on the amount of income exempted from the alternative minimum tax, dividend and capital gains, the Roth IRA conversion provisions in the Tax Increase Prevention and Reconciliation Act of 2005 could benefit advisors and their clients much more than any tax cuts.
Other big beneficiaries will be clients with six-figure incomes who have large individual retirement accounts. Starting in 2010, millions of single and joint tax filers who earn $100,000 or more in adjusted gross income will be
allowed for the first time to convert their traditional IRAs to Roth IRAs. They would make a large one-time tax payment but would then be able to withdraw money from the account tax free. They would not be forced to withdraw funds at age 70 and could pass the money to heirs in a more tax-advantageous way.
Roth IRAs are popular because an account holder does not have to pay tax on the earnings when the money is withdrawn. Plus, the Roth IRA does not set minimum distribution rules as with traditional IRAs. But these new provisions have the potential to have a significant influence on the millions of baby boomers who make more than
$100,000 a year.
ESTATE PLANNING WINNERS
The Roth IRA's highest value will be in the estate planning area. A high-net-worth selfemployed person will be able to move money from qualified retirement savings plan such as 401(k)s into a traditional IRA.
Almost every financial advisor has high net-worth clients who own some form of a qualified retirement plan. Now that qualified plans can be rolled over into traditional IRAs when a distribution event occurs, there is potential for billions of dollars to then be transferred into Roth IRAs.
Large firms are already gearing up for this transfer of wealth (see 2006 white paper "Preparing for Tomorrow -- The Role Of The Advisor in a Depleting Asset Environment" at www.thornburg.com).
Wall Street firms have targeted high-networth investors and other IRA clients by focusing on pre-retirement advice. Full-service brokers and advisors are in the process of creating comprehensive business strategies to establish relationships with investors during the pre-rollover timeframe.
The affluent private client market, which has been served primarily by independent advisors, has become one of the most attractive segments to target in the financial services market. Advisors and large financial service firms have also targeted the baby boomers, who are beginning to liquidate and transfer large amounts of money tied up in their homes and private companies and who also are beginning to roll out of their 401(k) plans.
Another benefit contained in the new tax law is that taxpayers who convert in 2010 will be able to pay the tax over the following two years. After 2010, income tax will have to be paid in one year.
LOWER TAXES
By paying income tax on their IRA funds in advance, the amount paid at the time of the conversion can be removed from the IRA holder's estate. This will potentially lower the amount of tax that will have to be paid.
Beneficiaries of the Roth IRAs must begin taking distributions when they receive the accounts, but the distributions can be spread out over their life expectancy, and the money is then tax free.
However, the Roth IRA conversion provision, unlike tax cuts, is permanent. Some estimate a $6.4 billion income windfall to the government over the next 10 years as baby boomers convert and pay income taxes on money withdrawn from traditional IRAs (whether it's spent or converted, either way the government wins).
This is something all advisors should talk to their clients about. The Roth IRA conversion is a new method they can use to store more assets for the future -- one that is immediate, unlike traditional annual contributions.
Ken Ziesenheim, JD, LLM, CFP, is president of Thornburg Securities and managing director with Thornburg Investment Management. He can be reached at Kziesenheim@thornburg.com.
