ELITE ADVISOR BEST PRACTICES

Communicating Roth Conversion to Clients: The Three-Box Method

Presenting tax-saving opportunities to your clients may be challenging. But there are simple ways to communicate these opportunities by using Roth conversions as an example.

By Ernest Clark

Key Takeaways:

  • Advisors may communicate tax opportunities to clients by simply repeating the applicable tax law.
  • Advisors are more effective communicating in a way that addresses specific benefits for the individual client.
  • We will explore the process of communicating in a voice that describes specific benefits of Roth conversion opportunities.


At our firm, we are in a position to observe many wealth advisors as they try to explain tax-saving opportunities to their clients. Unfortunately, many advisors merely repeat the tax laws to their clients, instead of explaining them in a language that clients can understand. At the end of the conversation, clients are often confused and do not make a decision about their tax opportunity, no matter how advantageous it could be for them.

Process to Change the Voice

Advisors can communicate more effectively with clients by presenting an explanation that demonstrates their experience with tax opportunities. You can change your approach by following this process:

1. Clearly Define the Benefit of the Tax Opportunity

Often, clients do not understand the possible benefit from the opportunity. As an experienced advisor, you should clearly define the long-term benefit of the opportunity and confirm that the benefit, if achieved, is aligned with your client’s long-term goals.

2. Clearly Define the Cost of the Tax Opportunity

Clients tend to focus on the disadvantage of a tax opportunity. Communicate the cost to your client clearly and early in the conversation. Confirm with your client that he or she understands the cost.

3.Communicate Your Experience with Your Client List

Clients want to hear your experience in this area. The best way to position yourself as an expert is to summarize the effects the opportunity has had on your other clients. Use terms that are simple in order to capture your client’s interest.

4. Provide the Bottom Line

Tell clients that your opinion is based upon your knowledge of their situation and your experience with your other clients.

5. Next Steps

Ask your client to identify the next step. This will open the door for questions so you may guide your client toward making a decision.

Communicating the Roth Conversion Opportunity Using the Three-Box Discussion

We recommend that wealth managers write a script to communicate tax opportunities using the process described in the previous section. The following script is a possible way to communicate the Roth conversion opportunity.

1. Benefit of a Roth Conversion

Explain to your client: “You are allowed to convert a traditional IRA into a Roth IRA so that the future investment growth is tax-free income. There are several advantages to your family, including avoiding future income taxes for you and the heirs of the Roth account, avoiding required minimum distributions at age 70.5, and paying lower estate taxes since the income tax paid at the conversion is removed from your taxable estate.”

2. Cost of the Roth Conversion

Follow with this with: “The cost of the conversion is paying income taxes on 100 percent of the amount transferred into the Roth IRA in the year of the conversion. The good news is you are allowed to convert early in the tax year and make the final decision by the due date of the return, including extensions, which would be October 15. You may undo the transaction before the October 15 filing deadline.”

3. Roth Conversion Experience with Other Clients

Finally, you can add: “The bottom line on a Roth conversion is that if income tax rates and investment earnings are the same, your net after-tax cash flow during retirement will be the same. Based on our experience, clients fit into one of three boxes:

Box 1 is composed of clients who have no income tax due on their income tax return in the year of the conversion. This opportunity occurs when the client has business losses, high itemized deductions or no earned income in the year of the conversion. We would recommend preparing an income tax projection and a conversion if the effective tax rate is acceptable.

Box 3 is composed of clients who are late in life and subject to estate taxes. These clients proceed with a Roth conversion regardless of the amount of the tax because they can reduce their estate taxes. They consider the 50 percent estate tax savings as a 50 percent reduction in the effective income tax rate on the conversion.”

Now is a good time to explain that clients in Boxes 1 and 3 have an easy decision to make. However, it’s not so easy for those in Box 2:

Box 2 is composed of clients who have income tax due and are not late in life,” you could say. “Since the net cash flow after income taxes at retirement is the same with a traditional IRA and a Roth IRA, the client sees no benefit to a conversion. We bring value to these clients by opening several Roth accounts and converting an asset class by itself into each Roth account. The client calculates the income tax due on the tax return and compares it to the effective income tax rate due on the conversion. The effective income tax rate due on the conversion is the income tax due on the conversion divided by the value of the Roth account in the following October. If the client does not like the effective income tax rate, we undo the conversion and redo the asset class at the next available opportunity.”

4. Roth Conversion Bottom Line

Remind such clients of the following: “You are in Box 2. I would recommend a Roth conversion early in the year, and then you can make the final decision by the following October. This will be a win/win for you. If the effective income tax rate is reasonable, you will pay the tax. If you do not like the effective tax rate, we will undo the transaction and try again.”

5. Next Steps

Follow that logic with this: “What do you think about a Roth conversion opportunity for you and your family? Any questions? Would you like me to discuss this with you and your CPA to help you make a final decision?”

Conclusion

Proactive wealth managers are uniquely positioned to bring income tax and estate tax opportunities to their clients because of the deep relationships they develop with them. The wealth manager who quotes the tax law to a client may not guide the client to a decision.

We strongly recommend having a script that allows you to guide a client to a decision. Remember that no decision from a client is still a decision; that is, it is a decision to stay with the current situation.


About the Author

Ernest Clark, CPA/PFS, is a principal and the director of wealth management of BAM Advisor Services, LLC, a comprehensive service provider for independent Registered Investment Advisor firms across the country.