A client's estate planning goals may be more important when considering a switch from a traditional IRA to a Roth IRA than the person's level of assets or his proximity to retirement, says a retirement and IRA expert.
"In terms of estate planning, a Roth IRA can provide ways to benefit from a tax perspective. Conversions are not being made, for the most part, by those in or nearing retirement. It is those involved in estate planning, " says David Tyrie, personal retirement solutions executive for Bank of America Merrill Lynch.
This year through the beginning of October, Bank of America has seen more than $2 billion in Roth IRA conversions, compared will $111 million at the same time last year. During the first nine months of 2010, clients made more than 35,000 conversions. For Bank of America, the assets converted to Roth IRAs in just the third quarter topped the number for all of last year. But the third quarter of 2010 wasn't the best one this year: Most conversions were done during the first quarter and are expected to jump again in the fourth quarter, Tyrie says.
Some of the movement was promoted by income limitations being eliminated, allowing just about anyone to convert. Previously, only those with under $100,000 in modified adjusted gross income could convert traditional IRAs to Roths. Also fueling conversions are rules that, for this year only, you can choose to take all the income from the conversion in 2010 or split it between 2011 and 2012.
"Those planning intergenerational giving make up a large percentage of the clients who are converting to Roths," Tyrie says. "Conversions are occurring at all asset levels, but the most are in the high-net-worth area of $5 million in assets and above. The change is not predominated by those in retirement or nearing retirement."
In households with assets of $250,000 to $1 million, 1.1% converted some assets to a Roth; for $1 million to $5 million, 2.3% made a conversion, and for above $5 million, 4.1% made a conversion, with much of the interest focused on estate planning.
As part of a conversion, the money from a traditional IRA can be segmented into several Roth IRAs and invested in different asset classes or sectors. At Merrill, about 14% of clients with more than $5 million in household assets have used the strategy. The advantage is that if the investments in one Roth decline, the conversion can be reversed and tax savings could be greater.
For example, an investor could open separate Roth IRAs to hold different asset classes, such as domestic and/or international mutual funds and bonds. If the value of the Roth holding the stock funds dropped significantly, that conversion could be reversed, or "recharacterized," while the bond fund assets could remain in its separate Roth IRA. The IRA owner has until October 15 of the calendar year following conversion to consider and close out the recharacterization equation before finalizing the conversion (in 2011 the date is October 17, 2011, based on when the weekend falls).
"Conversions should be the basis of an intimate conversation by the investor with his financial advisor," Tyrie advises. "However, the information needed is not something an advisor may have unless he has had special training in Roth conversions."