While the Roth IRA offers the tremendous advantage of tax-free investments, it has long been the stepchild of Individual Retirement Accounts. Traditional IRAs totaled $3.167 trillion in assets at the end of 2008, according to the Investment Company Institute. Roth IRAs, previously available only to those making less than $100,000, had only $173 billion.
Fund companies are now looking to convert more investors into Roth IRA believers, thanks to a provision in the 2010 Tax Increase Prevention and Reconciliation Act that allows higher earners to invest in them.
Since the new rule went into effect on Jan. 1, 61% of leading fund companies have been taking advantage of the enormous sales opportunity that Roth IRA conversions present by proactively educating investors, according to Corporate Insight.
The tax implications involved in switching to a Roth IRA can appear overwhelmingly complicated to investors, even financial planners. Thus, fund companies are running marketing and advertising campaigns to motivate investors to start the conversation with their advisers, and equipping both with calculators and educational materials.
Dreyfus, Fidelity Investments, OppenheimerFunds, Putnam Investments, T. Rowe Price, Vanguard and Wells Fargo are among those providing online educational tools.
"These important legislative changes create a clear tax-related opportunity for some investors," said Michael Ellison, executive vice president at Corporate Insight. "It's up to mutual fund firms to ensure that clients understand the issue so that they can make the right decision. This new law creates an enormous opportunity for mutual fund firms to educate clients about the benefits of conversion, while potentially increasing the firms' Roth IRA sales."
The main difference between a traditional IRA and a Roth IRA is the tax treatment. Like 401(k)s, traditional IRA taxes are deferred until they are withdrawn in retirement, while Roth IRA taxes are paid upfront and never taxed again federally. There is no mandatory withdrawal date for Roth IRAs, which is ideal for retirees in a higher tax bracket or for those looking to leave a legacy to beneficiaries.
A large number of variables-such as age, current investments, current and future tax rates, marital status and legacy wishes-invariably complicate attempts for cookie-cutter solutions, but a robust online Roth center can both answer and raise new questions by curious investors.
MME took a look at a number of Roth sites at leading mutual fund companies and found most to be a good preparation for an in-depth conversation with a financial adviser or retirement expert. Several firms had standalone sections for Roth questions that included frequently asked questions, audio and video presentations, online calculators and even blogs and chat sessions. Most sites also encouraged investors to talk to an adviser, especially if the Roth evaluators determined that the investor might be a good candidate for a Roth IRA.
"Clients like to see things for themselves, not just talk to advisers," said Marc Isaacson, director of retail sales at Dreyfus. "They like to play with the numbers and see what converting a percentage of their IRA would do."
Isaacson noted that the Dreyfus Roth IRA calculator offers sliding bars so investors can readily see the tax results of various investment combinations and variables.
"It's easy to use," he said. "They can do it on their own or call us and have us walk them through it. The idea is to take them from using a generic tool to having a very specific conversation."
Isaacson said an investor's decision to move their assets to a Roth IRA or partially convert depends on what they are trying to accomplish. In many cases, a Roth conversion will leave investors with significantly more assets in retirement.
Easy-to-use websites can also be very beneficial for third-party intermediaries and financial planners who are trying to explain these products to clients.
"Putnam values our relationships with our intermediaries and financial advisers, and if we can deliver value to them through the use of education, resources, tools and literature, it can deepen that relationship," said William Cass, senior vice president of Putnam Retail Management. "Our new Roth IRA Conversion Evaluator provides a quick and visual analysis to stimulate a thoughtful conversation with a financial adviser or tax professional."
Cass said that clients may decide that a Roth conversion just isn't for them, but the conversation can be a starting point that can lead to broader discussions, such as conversations about legacy planning and wealth transfers.
"If you are intending to leave assets for the future or if you have needs for estate planning, it can become a very exciting conversation," Isaacson said.
One of the main questions to consider when contemplating a switch to a Roth IRA is whether an investor wants to pay taxes on their savings now or later. Since taxes on Roth IRAs are paid when you save rather than when you withdraw, a Roth conversion could have significant tax implications.
Big Tax Hit
"It's important to understand the potential tax bill, as that could come as a surprise," Isaacson said. "Our clients are very unsure of their future tax bracket and most seem to think that taxes will rise in the future."
"Asking someone to pay taxes sooner rather than later requires a leap of faith," Cass said.
If an investor already has a substantial amount saved in a traditional IRA, the immediate tax hit can be shocking, as all those deferred taxes are suddenly due. It gets even more complicated if the investor is trying to roll over a 401(k) into a Roth IRA, particularly if they are trying to use their account balance to pay the taxes. Drawing on the principal can trigger penalties in many cases, and it's often better if the investor has some extra cash to pay the taxes, rather than take a loan from their plan.
"The biggest benefit is if you have money outside an IRA to pay for the tax conversion, without damaging your liquidity needs," Isaacson said.
A provision in the new law allows investors to spread this tax burden over two years on Roth conversions made in 2010. Thereafter, taxes may not be deferred.
Isaacson said Dreyfus has seen an increase in traffic on its website, but not many Roth rollovers yet.
"We haven't converted as many IRAs as we expected, because of the big tax consequences, but it has created a lot of dialog and opportunities for providing education," he said. "The educational component is what our clients appreciate. We've found that having this content makes our clients more comfortable and confident."
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