If you know that your clients nearing retirement are likely to be in a high marginal rate after retirement, and if you know that the money they are thinking about contributing to a Roth will likely be needed for living expenses sooner rather than later, it probably does not make sense to recommend a conversion. If you do, you had better be sure to advise the clients, in writing, that your recommendations are based on the premise that the money will not be spent anytime soon. The conversion becomes more attractive when the money is not needed and if the client is likely to stick to the plan when converting but unlikely to save the additional funds that would be spent on the conversion taxes.
There are estate tax issues that are beyond the scope of this article, but, generally speaking, comprehensive programs that integrate a Roth conversion into a plan will illustrate the estate tax impact. Many stand-alone calculators do not (with the exception of Brentmark's Retirement Plan Analyzer).
Please bear in mind that good calculations are not enough. All software forces us to make assumptions about future tax rates, the future spending habits of our clients and many more unknowns. If we discover that our assumptions are faulty shortly after the conversion, we have some time to undo the conversion through a recharacterization and start over again (at least until October 15 of the tax year following the conversion if an extension is filed). But once the recharacterization deadline has passed, we are locked into the conversion.
Since there are many factors to consider before doing a Roth conversion, and since some of these are behavioral (the plan is useless if the client does not follow it) the best we can hope for with conversion software is that it allows us the freedom to illustrate the scenarios we want to illustrate.
With those thoughts in mind, let's look at some comprehensive financial planning programs that are currently being updated to allow for Roth conversion planning and two applications that specialize in the analysis of Roth conversions.
In November 2009, EISI (www.eisi.com) will be releasing an incremental upgrade to NaviPlan's "Standard" and "Extended" versions. The scenario manager in NaviPlan Standard will allow you to choose the two-year tax payment option in 2010, and it will allow you to designate which assets are to be converted. The reports will even highlight the value of the applicable IRD assets. A company spokesperson indicated that the scenario manager in Standard will allow advisors to change most assumptions, with the exception of tax rates (though this may come in the next release, scheduled for the first quarter of 2010). As for the sunset provisions, you can only currently change them at the plan level, so if you want to change assumptions about tax rates or sunset provisions, you would have to run separate plans.
MoneyGuidePro (www.moneyguidepro.com) is currently being upgraded to enhance its Roth conversion capabilities. A new goal strategy called Roth Conversion is being added. The result of any Roth conversion strategy will be displayed using both a straight-line analysis and a probability analysis. Using the "what-if" portion of the program, the advisor will be able to look at multiple scenarios side by side. For example, you can look at scenarios that take into account different income tax rates in the future. The program's default assumption is that Roth assets will be spent last, but advisors will be able to manually alter the spending order. The software plans to offer check boxes for the 2011/2012 tax election in 2010, and it gives users full control over projected returns and tax rates.
MoneyTree (www.moneytree.com) packs a lot of useful tools into its new release of Distribution Solutions. It analyzes lump-sum distributions. It compares taking lump sums against taking out a monthly pension. It analyzes early withdrawals allowed under IRS Rule 72(t). And it analyzes various pension annuity options, including the option of taking a single life annuity and purchasing life insurance to provide a survivor benefit. In addition to those things, it also offers an IRA-to-Roth conversion tool.
The MoneyTree conversion tool offers good flexibility. It allows the advisor to set a return rate for the current IRA account, and if desired, a different rate for the Roth. It allows for a current income tax rate, which can be changed once in the future at a time designated by the advisor. Conversions can take place at any time, and multiple conversions over time are accommodated. For 2010 conversions, you can choose to pay the tax in 2011 and 2012. The conversion tool attempts to account for the outside money spent on the conversion by adding it into the present and future value of the Roth account, but this treatment is awkward. It would be better if the software included the tax dollars along with the traditional IRA and projected out the value of the sum of the two.
Like MoneyTree's solution, Brentmark's Retirement Plan Analyzer includes a number of specialized planning tools. Brentmark is busy at work updating the Retirement Plan Analyzer, but I reviewed the previous version's handling of Roth conversions, and it looked good. It can illustrate the growth of the funds that would have been used to pay the conversion tax. A new version is due for release shortly.