Prudent Roth strategies can increase the present value of a family ’ s estimated future after-tax net worth ( FANW ) by six to seven figures .
retirementplanning
BY JIM AMERMAN , CFP ®, AND GLENN FREED , PH . D ., CPA
Evaluating Roth Conversions & 401 ( k ) Recommendations
with a quick Google search , one can find hundreds of articles and rules of thumb about tax-free Roth strategies , which are good candidates , pros and cons , etc . What ’ s harder to find , however , is an arena for debate and agreement on the methodology to determine the optimal , rightsized amount of pre-tax assets ( if any ) to convert to a Roth IRA in any given year — and how to decide if switching to Roth 401 ( k )/ IRA contributions make sense for a specific client .
Prudent Roth strategies can increase the present value of a family ’ s estimated future after-tax net worth ( FANW ) by six to seven figures — and provide insurance against higher future tax rates and exposure to the single filer brackets when a spouse dies prematurely . When recommendations are not competently customized to the client ’ s unique financial situation , however , the benefits can be significantly reduced or the client ’ s family could even be worse off .
Many recommendations do not include a focus on maximizing FANW . You might see efforts to convert to the top of a tax bracket or a focus on the pre-tax break-even ( the more relevant after-tax break-even is always day 1 ). When asked why FANW is being ignored , you may hear , “ Well , we don ’ t know where tax rates will be in the future , and it ’ s good to have tax diversification ” as a reply .
Yes , tax rates can change , but that should not prevent fiduciary level analysis .
The portfolio management industry has a large appetite for rigorous analysis , and its securities markets assumptions are arguably much less reliable than future tax bracket / law predictions . With our sizeable national debt , the potential for tax rates to rise above and beyond the Tax Cuts and Jobs Act expiration levels and millions of boomers retiring , Roth
Prudent Roth strategies can increase the present value of a family ’ s estimated future after-tax net worth ( FANW ) by six to seven figures .
strategies are more important now than ever .
You may be familiar with the popular goal of “ tax diversification ,” but we agree with financial planning guru Michael Kitces ’ opinion ( kitces . com / blog / tax-diversificationroth-optimization-conversion-tax-alpha /) that “… a broad policy of tax diversification will , on average , lag a more proactive approach of Roth optimization .”
Many tax diversification efforts resemble moving a chess piece after checking on the location of only a few of the other pieces rather than examining the entire board .
You may have also noticed the release of more “ quick answer ” Roth conversion and Social Security timing calculators lately . Since they typically ask the user for a best guess on their future tax rates , rather than requesting the crucial inputs and generating careful calculations of future taxes , we feel this is like selling someone a set of tools when their car breaks down instead of sending a qualified mechanic to get the job gets done right .
Although it might be challenging to apply accurate projections for young adults , future estimates for those over 40 are typically more reliable and should be part of a detailed analysis that determines the adviser ’ s guidance . Contrary to the rules of thumb , sometimes an earner in the top bracket would benefit from conversions and Roth 401 ( k ) contributions . Or someone in a low bracket might be better off with traditional 401 ( k )/ IRA contributions . It depends on their financial situation , future goals and estimates , and accurate software output .
A conversion or a switch to Roth 401 ( k )/ IRA contributions might reduce assets under management , but there are still many firms doing the right thing with proactive , precise Roth strategies . If you partner with a tax-savvy specialist who can generate robust projections and answer your questions competently , then your client ’ s family will likely pay much less in lifetime taxes .
Here ’ s a partial list of questions to ask to evaluate a professional ’ s recommendations :
• How did you determine the optimal amount ( if any ) to convert to Roth this year and whether to contribute to Roth 401 ( k )/ Roth IRA or Traditional ? www . calcpa . org JUNE 2023 CALIFORNIA CPA 19