Evaluating Roth Conversions & 401(k) Recommendations.

• Author: Amerman, Jim

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 breakeven (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 lax 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 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 (kilces.com/blog/tax-diversilication-roth-optimizalion-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 liming calculators lately. Since they typically ask the user for a best guess on their future lax...