Advisors should do a Net Unrealized Appreciation calculation before they advise clients to convert to a Roth IRA, according to C. James Johnson, a presenter of retirement planning and tax strategies for Allianz Life Financial Services.

“We had fully expected that capital gains would go to at least 20% in 2011, but it stayed at 15% under the 2010 Tax Relief Act. That’s especially positive for advisors working with people who have access to 401(k) money” and who have had company matches in the form of publicly traded corporate stock.

When clients convert to a Roth IRA they have to pay ordinary income on the money converted. However, clients who can do NUA transactions only have to pay ordinary income on the basis of the company stock at the value it was when it was given to them as a 401(k) match. Companies usually try to buy the stock cheaply for such matches, Johnson points out. Any sales of the stock would be taxed at usually significantly lower capital gains rates. 

“In a 15% cap gains environment, this is better than going to Roth, which is all ordinary income,” says Johnson. “So advisors should do this calculation before they do a Roth conversion. After all, there are four words you never want to hear:  ‘You never told me.’”


“Roth is not for everybody,” Johnson adds. “I would venture to guess that for the majority of folks out there if it isn’t triggered by a legacy need or income tax issue, they’re likely not to need it.”

He laid out the four kinds of situations where a Roth conversion makes the most sense.

1. A person who can afford to pay the tax from outside funds. “If you take the money from inside the 401(k) or IRA, you just reduce the amount that’s available for tax-free growth,” he said. “It’s best to get the full rollover.”

2. A client who expects to be in highest tax bracket even after retirement would be a likely candidate, because they would gain the most by paying the taxes now and avoiding them later.

3. A client who potentially will never need these funds because their required minimum distributions at age 70 ½ are high enough to cover all their basic needs and wants, allowing the money to continue to grow tax-free for heirs.

4. If the client expects the money to go to beneficiaries, it’s a way to pass it on without income taxes. A regular IRA would be taxed in the heir’s marginal tax bracket.

Of course, Johnson said in all of these situations, advisors and clients should consult the relevant expert accountants and attorneys.

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