Roth IRA Conversions May Trigger a Lawsuit

The strategy of a Roth conversion is premised on the arbitrage, or the difference, of a client’s current and retirement tax brackets. The advantage is paying taxes today and none in retirement’s tomorrows. The additional feature to this conversion strategy eliminates exposure to the provisional income test for Social Security taxation saving benefit taxes because Roth IRAs are not subject to the test.

But keep in mind the client may not have to pay taxes at all with the standard and senior tax deductions (age 65 or older) at $27,400. Many seniors will file the easy form and take both deductions, offsetting any qualified plan income. Because of these tax deductions, many Roth conversions are unnecessary, i.e. the taxes paid triggered by the conversion is a complete waste of money and exposes the agent or investment adviser to arbitration or lawsuit.

This is the next big liability for financial professionals who discuss the tax arbitrage when they shouldn’t be discussing it at all much less executing a trade that will cost most conversion clients unnecessary taxes.

Roth IRA Conversions to Cash Value Life Insurance May Elicit Litigation

Blog 49 “Roth IRA Conversions May Trigger a Lawsuit” addresses the unnecessary tax consequences of Roth IRA conversions. In this blog, addressing the conversion to life insurance is a big wake up call to those insurance agents and advisers that use it. Some investment advisers take a holistic approach to retirement, including the tax consequences now and in retirement. Few of those advisers use cash value life insurance, they generally use mutual funds and/or ETFs. They seem to have a prejudice towards insurance, whether life insurance or annuities.

But many insurance agents who are not licensed for securities use cash value life insurance as their go to option in a Roth conversion. This is an automatic red flag for security attorneys examining mutual fund and ETF conversions to cash value life insurance, the conflict of interest is inherent with a limited life and health license. Keep in mind that having the client surrender a security may be viewed as a security trade by broker/dealers and their attorneys expose your practice to liability.
If all you sell cash value life insurance as the only option in a Roth IRA conversion strategy, you become a prime target for intelligent competitors as well as security attorneys.

Cash Value Life Insurance for Tax Free Income If It’s Done Right

Generally speaking, Roth conversions usually take place between ages 55-65. Cash value life insurance carries an expense charge called the cost of insurance which is predicated on age and health. The cost of insurance begins to increase geometrically during those years by age. Usually clients at that age have some health issues so quoting the top preferred rates on a proposal to boost the internal rate of return is inappropriate most of the time. The cost of insurance is an expensive component and may not be able to overcome an indexed fund's internal expense loads.

The distribution of withdrawals to basis and policy loans of gains must be reviewed every year. The tax issues are a major item during distributions to maintain its tax-free income status. The distribution term “withdrawals” is not the same for cash value life insurance versus a qualified plan. Case in point. The agent letter explained that the client could withdraw tax free annual distributions from their cash value life insurance. The client did just that by requesting in writing taking annual withdrawals. Withdrawals of basis are tax free, but in year five there was very little basis left and so the policy administration treated the annual request for withdrawal according to the client’s letter. At the beginning of the following year, the client received a 1099 for the gain that was withdrawn. This triggered a lawsuit to recover taxes due. The intent of tax-free distributions was not the issue, but how the distribution language was interpreted.

Steve is a syndicated financial columnist, talk show host and popular platform speaker. He is also a nationally recognized videographer, content creator and co-contributor to Advisys, InsMark and LifeSpecs. Steve’s videos and content are distributed to over 280 media outlets and 200,000 Twitter users. To contact him visit