Conversions may not be good ideas if a client is simply tax-adverse, has no heirs for estate planning or is an older retiree who may not have time left to benefit from long-term tax-free growth, Pon points out. Roths also offer little charitable-planning advantages over traditional IRAs.
Also, what part of a Roth conversion is taxable will depend on the total basis and value of all the client’s traditional tax-deductible IRAs. Under the pro rata rule, the total balance of all after-tax amounts in a client's IRAs is divided by the year-end balance of all a client’s traditional IRAs. The resulting percentage is then applied to the conversion amount to determine the portion that is tax free.
Pon says he also sees many Roth conversions into contracted annuities or other types of products complicated to unwind. “If you purchased an annuity product inside a Roth IRA, many times the annuity company will not allow you to reverse or re-characterize the Roth conversion. You need to be very careful and take seriously any Roth conversions,” he says. “Always get the tax advisor involved.”