For the first time in many months, there's something other than the financial crisis to talk about with high-net-worth clients and prospects: the opportunity to convert to a Roth IRA.

If you have not lined up your talking points and tools for advising on Roth IRA conversions with your clients, some other advisor could seize that opportunity.

With the global financial crisis leaving Americans wary of all things financial-including their advisors- it's wise for those advisors to plan a comprehensive campaign to advise on the 2010 Roth IRA conversion rule changes.

While it was of less importance in the past, the Roth IRA is now set to play a larger role in 2010 personal financial plans. With income restrictions on conversions lifted, your wealthiest clients for the first time ever can choose to pay an up-front tax bill on a traditional IRA in order to gain the promise of tax-free capital gains for life from a Roth.

The Roth IRA was established by the Taxpayer Relief Act of 1997, but at first the conversion wasn't allowed for those with more than $100,000 of modified adjusted gross income, so these individuals couldn't enjoy the Roth's advantages: its tax-free income, its lack of required minimum distribution and its estate planning benefits.

However, the Tax Increase Prevention and Reconciliation Act of 2005, signed into law in May of 2006, eliminated the income restriction on converting in 2010. With the new law, it's estimated that more than 13 million affluent households will gain access to the Roth IRA conversion option, and about half of all IRA assets will become eligible for the conversion-in other words, some $1.4 trillion.

The media storm has already begun. Google lists dozens of articles extolling the virtues of converting to the Roth. And that public interest should lead to lots of questions from your clients and prospects about whether they should be jumping at the chance as well.
The choice to convert, however, is not nearly as simple as the media generally reports. Three variables must be factored into the equation, and the only way to give clients a correct answer is to actually run the calculations for them and show them the interplay between the variables-RMD avoidance, future tax rates and the available cash they'll need to pay the up-front tax.

Without a doubt, we will see some advisors in the months ahead cynically exploit the conversion opportunity as a sales windfall. We will see product pushers find angles and explain why one type of product is perfect for a Roth conversion strategy, even though the Roth IRA decision is actually product-neutral, since the same products in a traditional IRA will work and perform the same way in the Roth.

As these sales gimmicks and puffery abound in the months ahead, independent advisors will have an opportunity to differentiate themselves by illustrating the complexity and thoughtful planning that must go into any decision to convert. By warning clients to avoid the quick-fix-solution providers and by emphasizing education and careful deliberation, an advisor can stand out from the brand and promote prudent wealth management.

That doesn't mean sitting on the sidelines. You do have to find a Roth IRA advice strategy. But you want to avoid sounding like a cheerleader for Roth conversion and instead you want to sound like the coach.

Trouble is, most advisors have little experience in advising on the Roth conversion equation because it never before applied to the mass affluent and high-net-worth markets. Moreover, the tools used by advisors have been relatively simplistic, and they fail to illustrate the conversion scenarios properly by showing the dynamics in each of the three financial variables.

That is where new tools, like the one from Convergent Retirement Plan Solutions LLC, will come into play. Convergent, along with Archimedes Systems, has developed the Roth IRA Conversion Optimizer, which takes conversion analysis and client illustration to a new level for advisors.

"Because so many affluent clients have been kept from converting, the Roth IRA conversion market never matured and neither did the tools advisors use," says Ben Norquist, the president of Convergent, which is based in Brainerd, Minn. "What the industry has done wrong is examine the variables involved in the Roth conversion calculation in isolation without looking at the complexity of their interrelationships. In too many instances, advisors have looked at each of the variables as all-or-nothing propositions instead of considering the in-between situations-because the tools were not sophisticated to illustrate the in-betweens."

Norquist says that often when advisors measure a traditional IRA against a Roth, they consider paying all of the tax out of the IRA instead of considering a payment of just part of the tax up-front and a partial conversion. "In fact, what often makes the most sense is a partial conversion," he says.

One way you can help your client is by illustrating the dynamic nature of the variables. Take a look at Figure 1. This example uses a married couple, ages 64 and 62, trying to figure out conversion options for the $700,000 they have in IRAs. They plan to use the option under the federal law to defer the income on their 2010 conversion until 2011 and 2012, which also defers the tax liability on the assets they withdraw from the traditional IRA to convert to the Roth.

Convergent's optimizer uses just eight inputs to create a client illustration.

Next, there is a Figure 2 with the tab with the results, which the Web-based optimizer calculates almost instantly. On the left side of the results screen, you can adjust the sliders to fine-tune key variables and look at the full range of different conversion possibilities open to each client. For instance, this illustration assumes that there will be a real return of 4% annually on all the assets and a future tax rate of 40%. It also assumes that the couple will begin making monthly withdrawals of $5,100 in 2010.

The bar chart on the right of the results screen displays the benefits of partial conversion. Each bar represents a different conversion scenario, with each bar showing the net benefits of converting an additional 10% of the traditional IRA's assets. In this example, converting 100% of the $700,000 seems advisable because it will provide this couple with a projected net benefit of $71,000 of assets based on the IRA joint life expectancy tables. However, things are not always so simple.

  One problem is that if the couple converted 100% of their IRA assets, they would need $276,491 in cash outside of their IRAs to pay the tax bill. What if they don't have that cash available outside of their IRAs? What if they only have $200,000 of cash in the bank? And what if they don't feel comfortable spending down all of that cash to pay their Roth conversion tax bill? Take a look at the results shown in Figure 3, where we limit the non-IRA cash outlay to pay conversion taxes to about $100,000.

In this scenario, the total net benefit of converting is $49,000, and all of that benefit is consumed by the retiring couple and no assets are left to their heirs. This additional data is provided in the optimizer by clicking one of the bars that adjusts the conversion amount, and in this instance we assumed there would be a 100% conversion.

The interplay of the key variables becomes far more important when you are advising high-net-worth families that won't need the income from their Roth IRA to live on. For instance, if in addition to the $700,000 in IRAs, this same couple also has a pension plan and other investments, they may decide that they do not need to make any monthly withdrawals from their Roth IRA account.

In Figure 4, you see how taking no monthly withdrawals catapults the net benefit of converting to the Roth from $49,000 to $1.17 million, almost all of which goes to the couple's beneficiaries. A residual amount goes to the offspring of the couple's beneficiaries (Figure 5).
Being able to isolate each of the key variables is where a tool like this one comes in handy. The dynamic interplay of factors in the conversion decision creates too many moving parts for a simple tool.

Some advisors will likely object to this new breed of Roth IRA tools as "black boxes." To allay those fears, Norquist has published a four-page list of assumptions that are made in the optimizer, explaining how outside assets and distributions are treated. State and local income taxes are not factored into the equation, and no inflation rate is applied to monthly withdrawals taken by retirees for income. While some advisors may not like all of the assumptions, it seems to be a fair trade-off to make for a tool that streamlines illustrations.

One wild card question advisors should expect from clients is the future of tax rates. In the illustrations above, we assumed there would be a 40% top marginal rate, which seems realistic. That's because in 2011, income tax rates in effect before 2001 spring back into effect in accordance with the Economic Growth and Tax Relief Reconciliation Act of 2001. The top income tax rate returns to 39.6%. With the nation's economic recovery packages costing hundreds of billions of dollars, talk of the need for yet more stimulus, and federal tax rates at an all-time low since the advent of the income tax, the Democratic Congress can do nothing about the tax hike scheduled to take effect after 2010 but allow those higher tax rates established under a Republican administration to take effect. Unless the tax code is totally revamped and a value-added tax (VAT) tax is imposed, most observers expect higher marginal tax rates to be adopted over the next couple of years.  
Another wild card could come from a recharacterization of the Roth IRA income. Could Uncle Sam suddenly change its mind about the tax-free status of Roth income? "The likelihood of a complete reversal is very low," says Norquist. "It would be like a bait and switch to the people who have converted, tantamount to breaking a contract with the American people. And, apart from being politically untenable, I wonder whether such a move would even be constitutional."

Norquist cautions, however, that the government could at some point decide that Roth income must be calculated as part of the formula for determining an individual's eligibility for Social Security benefits. Or, he says, perhaps the government could reverse the Roth IRA's exemption from required minimum distributions.

Advisors will likely hear a lot more about tools like Convergent's Roth optimizer in the months ahead. While it does not store cases you've created, it produces PDF reports tailored to each client, enabling you to provide a ten-page takeaway that discloses all of the assumptions made in the calculation. Convergent has also partnered with Advisors Trusted Advisor, a practice management consulting firm, to provide seminar scripts, PowerPoint presentations, and other marketing support for promoting Roth IRA conversion advice for $1,500.
Along with tossing out the old rules, advisors must toss out old tools.

Editor-at-large Andrew Gluck, a veteran financial writer, owns Advisor Products Inc., a marketing technology company serving 1,800 advisory firms.