Let’s focus on the taxes that must be paid when these tax strategies are used

3 min read

Matthew Jarvis
Financial Planner, CFP®

Some other day we will discuss the merits of ROTH conversions and Capital Gains harvesting, but for today, let’s focus on the taxes that must be paid when these tax strategies are used.

Setting aside ROTH conversions where the taxes are withheld from the conversion, at some point, the taxes need to be calculated and paid. While the amount due is a fairly straightforward calculation based on the tax return (personally, I use the tax calculator provided by Retirement Tax Services), HOW and WHEN to pay these taxes requires knowing and understanding each client’s thoughts around paying taxes.

Strictly on paper (an illusion that traps many advisors), taxes should always be paid at the last possible moment to avoid penalty. For many clients, this would mean paying on April 15th (or whatever the adjusted filing deadline for that year) OR by the January 15th estimated payment deadline.

However, like so many theories, in reality, this works much differently as almost every client has an aversion to paying taxes. Compounding this aversion will be the tax preparer, who, upon being forced to be the ‘bearer of bad news, will explain to the client, ‘if only your advisor hadn’t recommended this Roth conversion, you wouldn’t owe taxes.’ So what’s the alternative??


Roth conversions

First, we have to set expectations around the ROTH conversion itself:

Mr & Mrs. Client, someday you are going to need a lump sum of money. Hopefully, it is for something fun like buying an RV to travel the country, but maybe it will be for something less fun, like paying for long-term care. In either case, if we take $100k from your IRA all at once, you will get killed in taxes.

“Instead, I recommend we do a small Roth conversion each year, paying a bite-sized amount of taxes each time so that in the future, you have a bucket full of tax-free money. Does that sound ok to you?

Like all scripts I share, this one has been carefully refined through hundreds of clients meetings BUT you still need to adapt it to you and your clients.

Having set the expectation on WHY we are volunteering to pay more in taxes (an expectation that will need to be reset multiple times), I can now ask the client:

“Would you prefer to pay the taxes on this Roth conversion NOW, or in April? The amount you owe will be the same, so it mostly depends if you like to get a refund in April, or if you don’t mind owning?”

MOST clients like getting a refund, in which case we will send in an estimated payment NOW, or if they don’t have non-qualified funds from which to take the payment, we’ll simply have it withheld.

If the client doesn’t mind paying in April, we will set aside funds to cover the taxes and explain to the client, “When you go to do your taxes next year, seeing the bill for this Roth conversion may feel like a punch to the gut, but please remember why we are doing the conversion (bucket full of tax-free money) AND that we have the funds set aside to pay for it.”

You will want to remind the client of all this again in January/February as they start getting ready for doing their tax return. In our office, we typically use our January 1099 Letter for this.

Happy Planning!

But reading is nothing without taking action!
Here is what you should do in order to see results

Action Item

Have a system down to the exact script for each step of the Roth

conversion process.

HOW ABOUT YOU? How do YOU explain the taxes due on a Roth conversion, and what is your system for tracking who owes what?

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