When you really run the numbers, converting to a Roth is not convincing in very many cases, concludes Townsend, the president of Townsend Asset Management. "You need a special circumstance," he says, such as business losses to offset the income created by converting, or a high-net-worth client who has funds she'll never need.
Even if the circumstances are right, some advisors still tread cautiously. Tedone recommends conversions only if beneficiaries can draw down the IRA over their life expectancies. "When the Roth is going to be the only inheritance and the beneficiary needs it to live on, a conversion probably doesn't make sense," he says. "The biggest benefit comes when you stretch the account as long as possible. Our clients who converted had optimal fact patterns."
Chappell plans to revisit Roth conversions with his wealthiest clients before December 31. "We'll show them scenarios where they will benefit from a conversion and scenarios where they won't, to make sure they are comfortable they've made an informed decision," he says.
Advisors should explain to clients that a partial conversion mitigates tax risk, adds Ben Norquist, the CEO of Convergent Retirement Plan Solutions LLC, a Roth conversion software developer in Brainerd, Minn.
"We don't know what's going to happen with marginal tax rates," Norquist says. "Converting a portion of the IRA diversifies the tax risk."
It's urgent that advisors speak with clients before New Year's Eve because there's an option to report income from a 2010 conversion in 2011 and 2012 (half each year) instead of declaring it all this year. And so we have come full circle: back to the uncertainty surrounding the EGTRRA's sunset and future tax rates.
Fortunately, this decision need not be made until the client's 2010 return is filed and that could be as late as October 17, 2011, the extended due date for 2010 returns, says Tedone. If worse comes to worst and things are somehow still up in the air come April 15, Tedone plans to file extensions for his clients who converted and make sure they have paid the IRS as if the conversion will be reported in 2010, to avoid underpayment penalties.
Yet another option for handling a 2010 conversion is to forget it altogether by recharacterizing it by October 17, 2011.
New Benefit Plans For Small Businesses
If a successful business owner client wants to save more for retirement by putting aside more tax-deferred money than currently allowed (which is only $49,000 in 2010 for defined-contribution plans) he has a new option this year, the DB(k). This plan pairs a traditional defined-benefit pension with a 401(k) and is cheaper to administer than two separate plans.
Although this hybrid hasn't proved popular so far, "There are cases where it could work," says Jim Van Iwaarden, a Minneapolis consulting actuary and head of Van Iwaarden Associates. "It would be good for an employer that has been having trouble passing the non-discrimination tests for a 401(k) plan and who is concerned about administrative costs."
In addition to what a business owner defers through the 401(k) portion of the plan, he can get a pension for himself of whichever is less: either 1% of his average pay for every year he's in business, or 20% of his average salary during his five consecutive highest-earning years. But like any pension, the DB(k) requires the employer to contribute for workers, too, Van Iwaarden notes. Moreover, the company must match the contributions employees (including the owners themselves) make to the 401(k) plan, up to 2% of pay. So in the end, the DB(k) is most appropriate for profitable, established businesses with dependable cash flow.