“Madoff” Your Clients With a Roth IRA Conversion
In 2010 thousands of retirees will get conned by misinformed or unscrupulous salespeople who will talk them into an unsuitable Roth IRA conversion. If you want to become one of those people who, like Bernie Madoff, make themselves rich at the expense of their unsuspecting clients, here is a step-by-step guide:
1) Use a Roth IRA Conversion calculator similar to the one offered by CalcXML. This calculator is perfect, because it leaves no trace; your name does not appear, nor does the name of your client. Throw away the second page to avoid embarrassing questions about your input.
2) Use a lower tax bracket in the pre-retirement, “accumulation” years than the post-retirement, “distribution” years. This printout uses 25% and 33%.
3) Since this client does not have $250,000 of ready cash to pay the taxes for the conversion, use “Option 2,” where the taxes are painlessly paid from the existing IRA funds.
4) Sell a product that has a 25% premium bonus and explain that the bonus will cover the income taxes.
Informed financial professionals can instantly see problems with the above scenario:
1) Ethical financial professionals never use calculators that omit their contact information, the client’s name, assumptions used, pertinent disclosures, and includes a sentence about seeking the advice of an income tax professional.
2) A Roth IRA Conversion calculator that uses “Tax Bracket” fields can be manipulated to deceive the client as I did in the sample printout. As a minimum it should have an input for “Adjusted Gross Income” and use the income tax rates that President Obama proposed for 2010 and beyond. Nobody who has $500,000 added to their income in a single year is in a 25% tax bracket!
3) The software should take all income tax ramifications into account. The sample printout does not take into account the fact that the client is age 56, and would incur an additional $25,000 tax penalty (10% early withdrawal penalty).
4) Taking into account both of above mentioned potential tax issues, the income tax impact for this client is about $250,000 higher than what was disclosed!
5) Products with premium bonuses may help offset current income taxes, however, a premium bonus is never “free.” There is always a cost somewhere, often in the form of lower interest rates.
I recommend the following safeguards to protect consumers from tax penalties and financial institutions and their representatives from potential lawsuits:
1) Insurance companies, marketing organizations, and broker / dealers should train their representatives about a how a Roth IRA conversion will affect a client’s current and future income tax situation, and how to determine whether it is suitable for their client.
2) Insurance agents and registered representatives should insist that a licensed income tax professional review the tax calculations and assumptions of Roth IRA conversions over $100,000. This may save the client tens of thousands of dollars in taxes, and a tax professional’s endorsement may shield against a future lawsuit.
3) File a complaint with the appropriate supervising authority against any insurance agent or securities representative who uses the above unethical approach to Roth IRA conversions.
4) Financial institutions should review all calculations and reports, including the tax professional’s review, before implementing a Roth IRA conversion.
July 8th, 2009 at 5:25 pm
You have good ideas & intentions but too extreme. Keep balanced.
Feedback to your recommendations>
1. I agree
2. I agree
3. I am not going to be a spy and take my time to turn other people in. Have u filed a complaint with various regulatory agencies, law enforcement, sec, finra and FTC about these other companies whose roth conversion anayalysis don’t like?
4. financial insitutions should not try to hold up a request from a consumer and act as some kind of body guard.
give consumers some credit for understanding. How many layers of regulation do u want to have? if this multiplied nothing would ever get done.
July 8th, 2009 at 5:27 pm
CORRECTION: TO # 3
3. I am not going to be a spy and take my time to turn other people in. Have u filed a complaint with various regulatory agencies, law enforcement, sec, finra and FTC about these other companies whose roth conversion analysis YOU don’t like?
July 8th, 2009 at 5:50 pm
#3. Are you saying when someone knowingly uses unethical practices to rollover an IRA, that nothing should be done about it? What if this happens to one of your clients? I believe that any company should be able to create Roth Conversion software, but reps, broker-dealers, and marketing companies should make sure tools they use are accurate.
#4. Perhaps you are right. Consumers need to take responsibilty for their retirement assets and make sure that they deal with knowledgeable, ethical, people.
July 9th, 2009 at 11:28 pm
A. if they knowingly used unethical pratices yes I would take action.
I like the fact that your Roth analysis will include the “Obama proposed new tax rate.
QUESTION: IS NOT THE ANSWER TO ROTH OR NOT TO ROTH ONLY DEPENDENT ON 3 FACTORS?
1.) WHETHER THE CLIENT FEELS THAT HIS TAX RATES WILL BE HIGHER.
2.) THE CLIENT HAS NON-QUALFIED MONEY TO PAY THE CONVERSION TAX?
3.)THE CLIENT STILL HAS A TIME HORIZON OF AT LEAST 5-10 YRS BEFORE INCOME IS REQUIRED?
July 10th, 2009 at 8:08 am
You are correct — keep the concept simple — Roth IRA Conversion is really about paying lower taxes in the long run. Here are a few other ideas:
1) Roth IRA is not an “all or nothing” situtation. Your clients do not have to convert everything in 2010. This is simply an outstanding opportunity to spread taxes over several years.
2) The client can use qualified money to pay the taxes by taking distributions in 2009, 2010, and 2013 to pay the taxes on the 2010 Roth IRA Conversion that are due on April 15, 2012 and 2013.
3) Yes, the client must know that they cannot touch the newly converted Roth IRA for at least five years.
Clients have at least three goals for their retirement assets:
a) income
b) leave money to heirs
c) emergency fund
Roth IRA money is better suited to all three goals — if, as you stated earlier — the client pays less taxes in the long run by doing a Roth IRA conversion.
July 19th, 2009 at 7:30 am
There are two ways to gauge success as an investor. Don’t be fooled by simply gauging success on account balances. We suggest to our clients that they gauge success on buying power. If you truly understand this concept and can slowly convert to a Roth then the client is at a break-even from day one with all factrors being equal. Income planning is about positioning assets. We recommend to our clients to have a Roth IRA as the 10+ year income bucket. I have looked at the premium bonus issue from many angles. My advisce is that if you want to use any bonus to offset taxes then you should declare the conversion at the existing custodian before you transfer to the annuity carrier with a bonus. The bottom line here is that there is no “Silver Bullet” in planning for clients.
July 20th, 2009 at 8:54 am
I agree that there is no silver bullet or one-size-fits-all solution. That is why any planning tool needs to be flexible. It also needs to disclose when doing a conversion in not in the client’s best interest.