Norquist showed a simple web-based application he developed that makes it easy for advisors to calculate complex conversion scenarios to show the net benefit of conversion.
The tool's strength is that it allows you to dynamically on-the-fly change variables affecting a client's conversion options. The variables include future tax rates, the amount of cash available to pay income taxes incurred on the withdrawal of assets being converted from traditional IRAs or qualified plans, the monthly withdrawals of the IRA owner for living expenses, what you'll earn on a traditional IRA that's not converted, required minimum distributions on the traditional IRA, and the amount left for beneficiaries.
While the software is a one-trick pony and is only good for Roth IRA conversion calculations, the opportunity to advise on Roth IRA conversions justifies the software’s $600 perpetual license fee. I don't believe any of the financial planning applications can make these dynamic calculations and illustrations on the fly, making it a great app to work with live in front of clients.
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At Norquist's session, we had more questions from attendees than we could answer. So Norquist sent me answers to some of the questions we did not have time for. Below are four of the 15 questions he sent me answers for. To see the rest of the Q&A, please join Advisors4Advisors.
Q: Does the five-year rule apply to distributions made from Roth Conversions after age 59½?
A: No. The five-year rule that applies specifically to Roth IRA conversion assets is only pertinent in situations where an individual under age 59½ takes a distribution of conversion assets within five years of the conversion transaction.
Q: Can an individual with a 401(k) plan convert even if he is still employed? Must the plan allow for in-service distributions? If allowed, can this be converted directly into a Roth IRA or must it first go into a traditional IRA?
A: A 401(k) participant can potentially take a distribution of 401(k) assets for Roth conversion purposes provided the plan he is covered under contains some type of in-service withdrawal provision. If an individual is able to request an "eligible rollover distribution" from his 401(k) plan, he can elect to roll over (i.e., "convert") the distribution directly to a Roth IRA without first going through a traditional IRA. (If the 401(k) distribution occurred during 2009, the individual would be subject to the $100,000 income restriction on Roth IRA conversions.)
Q: Can you address re-characterization options if the market should go down after the point of conversion?
A: The re-characterization option basically allows you to "rewind" a Roth IRA conversion and treat the transaction as if it never happened. In situations where the market value of your IRA assets declines following a Roth IRA conversion, the re-characterization option can provide you with the opportunity to undo your original conversion, thereby avoiding an income tax liability on the value of the assets at the time of original conversion. It should be noted that you cannot re-convert the same assets until the latter of a) January 1 following the year of original conversion, or b) 30 days following the date of re-characterization.
Q: What about the impact of estate taxes on Roth IRAs as Income in Respect of a Decedent?
A: Both traditional IRA assets and Roth IRA assets are included in a decedent's overall estate when assessing potential estate tax liability. Part of the beauty of Roth IRA conversion is that, by paying taxes up front, an individual is able to reduce the overall value of his or her estate, thereby potentially decreasing the amount of estate tax liability. While it is true that the beneficiaries of deceased traditional IRA holders are potentially eligible to take subsequent tax deductions due to Income in Respect of a Decedent (IRD), some financial planning professionals believe it is often more beneficial to reduce the aggregate estate tax liability rather than depending on recouping taxes over a period of years through the IRD deduction.