As advisors ponder year-end tax strategies, they're finding anything but solid footing for making moves and optimally positioning clients for the future. Why? That little deficit tussle in Washington.
"Most everything I'm seeing indicates the 12-member 'super committee' is going to raise revenues," Susan Hartman of Raymond James said before Labor Day. It is possible that some new rules could take effect next year, or be phased in over several years, according to Hartman, a senior tax and estate planning consultant in the St. Petersburg, Fla., home office.
However, Congress must say yay or nay to the committee's suggestions before Christmas. If they are approved, the changes could become effective upon enactment, potentially quashing financial planning strategies that are currently available. Or worse, changes could be made retroactive to January 1, 2011.
These mind-boggling possibilities are chilling for financial plans right now. Hartman is telling her advisor network, "Make year-end moves that make sense, but also prepare 'if-then' plans now so that you are ready to act when the super committee's recommendations come in."
In the meantime, advisors can only forge ahead based on current law. Even so, planning hinges partly on what you anticipate happening in Washington.
Recharacterizing 2010 Roth Conversions
Monday, October 17, is the deadline to recharacterize a 2010 Roth conversion. Last year was the first time anyone, irrespective of income, could convert a traditional individual retirement account to a tax-free Roth, so long as they paid ordinary tax on the amount converted. Now the final day of reckoning is at hand.
A prime motive for recharacterizing is a drop in the account since the conversion. If the value has fallen, sticking with the conversion means the client pays tax on wealth that has evaporated-ouch. Unfortunately, advisors say there is no definitive answer about how much of a decline merits recharacterizing.
A change in the client's overall objectives is also grounds for undoing a conversion, says life planner Michael Kay, president of Financial Focus in Livingston, N.J. "Maybe their cash flow or estate-planning needs have changed," Kay posits.
Another reason to recharacterize is to avoid the irksome pro rata rule. "This is for the client who has some IRAs funded with pretax contributions and some funded after-tax," says Harold Weston, a clinical assistant professor of risk management and insurance at Georgia State University in Atlanta.
Converting the after-tax IRAs might seem like a clever way to pay tax only on the investment gains in those accounts, but no. When the client also has pretax IRAs, "he must make a computation under the pro rata rule that could render most of the after-tax IRA conversion taxable, as well as require painstaking paperwork during the withdrawal years," Weston says. Recharacterizing escapes this nightmare.