Keep Clients Thinking Positively in Volatile Times

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Keeping a focus on the bright side may not have been easy in recent months, given the market’s tumultuous start to 2016. But in ensuring that clients are grounded and have their eyes on the long term, it’s smart to plan to take advantage of some silver linings in all this market volatility.

First and foremost, in taxable accounts, a good strategy is to harvest portfolio losses when volatility strikes, in order to offset gains elsewhere in the portfolio. Many investors wait until year-end to harvest losses, much in the same way they hastily clean out their closets over the holidays to claim a charitable deduction for the year.

Read more: Panicked Clients? Don’t Tell Them Patience Pays. Prove it

Harvesting throughout the year in response to market declines can maximize the value of this strategy, however. And, quite frankly, when we harvest losses and then invest the sale proceeds in a similar but not identical securities per the IRS’ wash sale rule, we often satisfy clients’ desire to do something in response to the market — all without altering their asset allocation, and while booking valuable losses.


There’s also a way to turn lemons into lemonade in tax-deferred accounts, such as IRAs. What’s more, talking about retirement plans with clients certainly helps to keep them squarely focused on the long term.
During the recent market decline, some of my clients have converted a traditional IRA to a Roth IRA. (Remember, there are income limitations as to who can open a Roth, but anyone can convert a traditional IRA to a Roth IRA.)

And many clients might want a Roth. After all, qualified Roth withdrawals will be tax-free. In addition, because Roth withdrawals don’t count as modified adjusted gross income, they don’t impact a client’s tax thresholds for the 3.8% Medicare surtax or Social Security income taxation. And there are no required minimum distributions. That provides some real planning flexibility, something that can be of particular benefit in extreme markets.

Yet clients often balk at converting a traditional IRA into a Roth because the converted amount is added to their income. So taxes are due. Here’s where the volatile market helps us: When an IRA declines in value, the conversion taxes will not be quite so burdensome. And once in a Roth account, all future appreciation on those converted assets is tax free.

To be clear, not everyone with a traditional IRA account that’s down in value should convert to a Roth. Depending on the size of the conversion, the move to a Roth could increase a client’s taxable income to the point where he or she is bumped into a higher federal income tax bracket.

Also, if you expect a client’s taxable income in retirement will be significantly lower than it is now, the potential future value of a Roth’s tax-free distributions would be reduced or even negated. And, again, the client needs to have enough cash on hand to pay the conversion taxes.

When presenting this conversion strategy to clients, keep in mind that, given the market’s extreme volatility, they might worry about converting their traditional IRA to a Roth, only to see the value of the new Roth account decline. That is, if their $50,000 new Roth account falls to $45,000 over the course of the next few months, they may find themselves wishing they had waited to convert so their conversion tax bill would be even lower.


But fear not. The IRS permits investors to reverse a Roth IRA conversion with a recharacterization. This process must be completed by the last date, including extensions, for filing the prior-year tax return, which is typically on or around Oct. 15.

When recharacterizing the new Roth IRA back to a traditional IRA, it’s as if the conversion never occurred. More amazing still, if you later decide you want to convert the recharacterized traditional IRA back to a Roth, you can do that either in the next tax year after the conversion or 30 days after the recharacterization, whichever is later.

Another strategy we use to manage Roth conversion concerns is investing in multiple new Roth accounts. Often, we choose to spread the converted funds among various asset classes, with the idea that we will recharacterize any account that falls in value. To facilitate any future recharacterization of a Roth account, it’s wise to open a new Roth rather than investing the converted funds in an existing Roth account. In a new Roth, any future losses will be easier to track. 

Also, keep in mind that you don’t have to convert the entire traditional IRA to a Roth; clients can convert any percentage they want. As advisors, however, we need to remain mindful not to convert so much that the clients find themselves in a higher tax bracket. Doing partial conversions over a period of years is a useful strategy we employ to make the overall Roth conversion tax bill more manageable.

The bottom line with these conversions is that the market and tax laws can both be unpredictable. Our job is to attempt to respond to volatility with strategies that benefit our clients — and to plan and manage taxes in a way that affords them the most future flexibility.

For example, we suggest opening a nondeductible IRA to our higher-income clients who still bristle at the 3.8% surtax on passive income in taxable investment accounts. Although future tax-deferred growth was once the only advantage to opening a nondeductible IRA, now those IRA assets also can be sheltered from the 3.8% Medicare surtax in that tax-deferred account.

The IRA contribution limit is just $5,500 for anyone under 50 and $6,500 for anyone over 50, but every little bit helps when it comes to avoiding the 3.8% surtax. You may even consider a backdoor Roth conversion of these nondeductible traditional IRAs.

This is a way for investors who earn too much to open a Roth by opening a traditional IRA first.


Approach this strategy with some caution. Again, we are talking about relatively small amounts. So the same strategy of opening a nondeductible traditional IRA and converting to a Roth would have to be done every year to have a significant impact. And doing this back to back, year after year, could certainly attract the attention of the IRS.

In fact, the president’s latest budget offers some additional insight into how Washington views the backdoor Roth. No surprise, it is listed to be eliminated.

Of course, given that we’re in an election year and there seems to be perpetual gridlock in Washington, it’s unlikely the backdoor Roth will be eliminated this year.

Still, it’s important that we always keep our eyes on how Washington views financial planning loopholes.

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Practice management Financial planning Retirement planning Client strategies