Traditional 401(k)s and IRA accounts are infected with taxes. By converting them to Roth IRAs, your clients can avoid unnecessary taxes and create a solid, multigenerational family legacy tax plan.

The main advantage of a Roth IRA is its tax structure, which allows tax-free accumulation and distribution, as opposed to a traditional IRA, which defers taxes on accumulations and taxes distributions. In addition, Roth IRAs don't require their owners to take required minimum distribution at age 70½ as traditional IRAs do.

With the inevitable rise in taxes that investors will see in their lifetime, and of course no guarantee of how high they may go, locking in taxes at a lower rate now can save an investor hundreds of thousands of dollars over the long term.

The Roth IRA conversion is a tax strategy and not a specific investment. To convert a traditional IRA to a Roth is an administrative tax tactic. Investments in the IRA can be, but do not have to be, sold or changed to complete the conversion. When a conversion is completed, it triggers an individual taxable distribution to the IRA owner in the year of the conversion. After the Roth conversion, the investments in the Roth account accumulate income-tax free during the accumulation period and are not subject to income tax at distribution. In essence, you pay the tax on the seed rather than the harvest.  

In 2009, a taxpayer does not qualify for the Roth conversion if they have a modified adjusted gross income (MAGI) of $100,000 or greater. In 2010 the limit is removed, so now would be a good time to review with your clients whether it makes sense to convert.   

One of the main things for advisors to consider when discussing the possibility of a Roth conversion with their clients is that investors often calculate their portfolio/assets incorrectly due to "infections." For example, an investor who currently owns a home with an estimated value of $400,000, with no mortgage, can appropriately add that $400,000 estimated value to their assets. But an investor with a $400,000 house and a $200,000 mortgage should only be adding $200,000 to the value of their assets, but instead often adds $400,000 even though the asset is infected with a 50% mortgage.

The parallel is we do the exact same thing with our 401(k)s and our IRA accounts by not calculating the net value after taxes.
Another aspect of the Roth conversion to consider is the immediate "losses" in an investor's account. For example, investor A has $1 million in a 401(k) or traditional IRA and is looking to complete a Roth IRA conversion today; assume she would pay the maximum federal marginal tax of 35%. They would immediately owe $350,000 in taxes to roll that over. Now consider investor B, who has $1 million in a 401(k) or traditional IRA and is leaving the money in that account.

In 10 years, investor A has accumulated $1.3 million in her Roth IRA and investor B has accumulated $2 million in his 401(k). Investor A has the option of withdrawing her funds, tax free, therefore giving her $1.3 million. When Investor B withdrawals from his tax-deferred account and pays taxes in the maximum federal marginal tax of 35%, he also would have $1.3 million after taxes. The net result is exactly the same; however, the difference lies with the taxes paid, if tax rates remain the same.

Investor A comes out with $1.3 million, with only $350,000 paid in taxes, whereas, investor B comes out with $1.3 million and $700,000 paid in taxes. The initial cost of $350,000 is half of the long-term cost of $700,000 in taxes.

For many advisors, understanding the Roth conversion details can be time-consuming. If you are unclear on the implications of a conversion, you should work with a specialist. Errors and omissions involving clients stuck with unnecessary taxes can result in a professional liability suit for financial advisors. Seeking out a specialized tax and conversion strategist is the best way to protect against liability charges.

Dan Deighan, a family wealth specialist, established Deighan Financial Advisors in 1974. As founder and principal, Dan has counseled and advised thousands of clients over the last 35 years while building and developing a nationally recognized financial advisory firm. Learn more by visiting