But if tax rates do go up, a person whose distributions came only from qualified plans would face income tax on all that cash flow. Using Roth IRAs for some part of future distributions will result in lower income and Social Security tax payments, as well as Medicare co-payments.
"I think the question for clients is always, Will my tax rates go up going forward?" says Llanes. "Should I pay my taxes now or later? Given the fact that there will be a lot more need for entitlement spending in the years ahead, I'd rather pay my taxes in two years than in 15 years."
Investment professionals who specialize in IRAs are rubbing their hands together with glee over the Roth opportunities on the horizon. "The big deal to me is higher-income folks haven't had access to Roths before," says Jaime Raskulinecz, chief executive officer of Entrust Northeast LLC in Verona, N.J., whose company acts as a custodian and consultant to investors interested in creating self-directed IRAs, which give them the flexibility to invest in real estate and a broad range of alternative investments generally not available from a broker-dealer.
Higher-income folks have little if anything in Roths currently. Wealthy individuals found that their income exceeded the IRS' household income caps, so they couldn't contribute or convert. "Now, we're hearing clients making plans to convert to Roths," says Raskulinecz.
Unlike 401(k) plans, IRAs allow direct investment in real estate and some individuals who are planning to convert are interested in that option. Raskulinecz says she is working with one client who is eyeing the purchase of waterfront property. By converting her old 401(k)s and traditional IRAs to a Roth in 2011, the 40-year-old client will have enough funds to purchase property, build on it and rent it out until she's ready to retire after age 59½. "Presumably, she'll pay a lot less to purchase and build her dream vacation home at 40 than she would at age 59½, and any gain will be tax-free because of the Roth," Raskulinecz adds. "Our clients like the investment flexibility and the complete tax savings." And just imagine never having to pay gains on highly appreciated real estate again.
What about all those investors who are self-employed and have created and funded their own SEP-IRAs or profit-sharing plans? In many instances, some or all of the balances in those accounts can be converted to a Roth IRA, even if the investor is still self-employed and saving for retirement.
"I don't think this is on the radar screen yet for everyone, and that's a mistake for both investors and advisors," says Gail Buckner, a retirement specialist with Franklin Templeton. While higher-income investors will be able to make conversions from 2010 onward, the two-year window to pay income taxes is only available to investors who convert to a Roth in that year. "I think everyone has to start planning from an asset and tax perspective starting now," Buckner says. "Some people's tax bills will be significant even if they're broken down into two years, and it helps if they start setting aside funds now."
Buckner, who is also an instructor at Franklin Templeton Academy, says that future tax rates should figure prominently in investors' deliberations on whether to convert. "I believe, looking at Washington, that there is a good chance that rates will go up, especially for high-net-income folks. I certainly don't think rates will come down."
At the very least, investors should diversify their portfolio so they have a hedge if they need one if ordinary income tax rates climb significantly in the years ahead. "Just like you diversify an investment portfolio, it pays to diversify your investments from a tax perspective as well," Buckner says.