Download Financial Consulting Group, Inc.

Financial
Consulting
Group, Inc.
Wayne C. Bailey, RFC
and
Robert M. Gianchiglia,
MBA, ChFC, CASL
508.854.1070
Getting ready for 2010
Preparing for the Roth conversion
opportunity.
On January 1, 2010, nearly $1.4 trillion in retirement assets
will immediately become eligible to be converted to a Roth
IRA.
Thanks to the Tax Increase Prevention and Reconciliation Act
of 2005 (TIPRA), higher-paid individuals will be able to take
advantage of an opportunity once limited to those taxpayers
with an adjusted gross income of less that $100,000. The
financial advisor’s role in understanding Roth conversion
rules and determining whether and how much of an
individual’s retirement assets should be converted will be
critical.
The Roth conversion Rules
Currently taxpayers can convert traditional IRA’s and
qualified retirement accounts, such as 401(k) accounts, to
a Roth IRA as long as their adjusted gross income is under
$100,000. In 2010 and for all subsequent tax years, the
$100,000 limit is eliminated and all taxpayers will be
permitted to convert their retirement assets to a
Roth IRA.
The amount converted to a Roth IRA will be included as
ordinary income for the year in which the account was
converted. However, for 2010 only, the taxpayers can elect
to defer half of their tax liability to 2011 and the other half
to 2012.
Roth Conversion Considerations
Individuals should discuss with their advisor whether and
how much of their retirement assets should be converted
to a Roth IRA. The factors clients should consider when
converting retirement assets to a Roth include:
Their
investment timeline
Whether they have assets to pay the resulting income
taxes
Their current income tax bracket
Their anticipated income tax bracket in retirement
Whether they believe income tax rates will be lower or
higher in the future.
Whether a Roth conversion makes sense will depend on
some of these factors, and the individual’s specific
financial and estate planning goals and objectives.
Getting ready for 2010
Preparing for the Roth conversion opportunity.
 The current market provides a low-cost
conversion opportunity
 Hedge against increasing income tax rates
 Gross up the value of retirement accounts
 Tax diversification
 Social Security planning
 Tax loss harvesting
 Reduce taxable estate
 Trust planning
 Tax-free stretch
1. The Current Market Provides a Low-Cost
Conversion Opportunity
The current market may give savvy individuals a unique
opportunity to pay taxes at today’s low rates.

Considering many individuals have experienced a loss in
their retirement accounts over the last 18 months, now
may be a perfect time to recognize the income tax liability.

1a. What if the ROTH IRA Continues to Lose Value
After Conversion?
Surprisingly you can ask the IRS for a “do over.”
For example, if an individual converted a traditional IRA to
a Roth IRA in January 2009, he or she will have until
October 15, 2010, to decide whether to take the “do over.”
2. Hedge Against Increasing
Income Tax Rates
For those who believe income tax rates will
eventually increase, now may be the perfect
time to convert retirement assets to a Roth
IRA. For decades, the United States had top
marginal tax rates as high as 50%, 70%,
and 90%. As a matter of fact, for the past
50 years there have been only five years
(1988 to 1992) when the top marginal tax
rate was less that the current 35% rate.
3. Gross Up The Value of
Retirement Accounts
When paying the tax liability for the Roth
conversion, the taxpayer could either use assets
from the IRA or outside of the IRA.
Using IRA assets to pay the conversion tax would
result in a 10% early withdrawal penalty should
the IRA owner be younger than 591/2..
By paying the taxes out of pocket, the IRA owner
is essentially grossing up the value of the IRA that
will then grow tax free.
4. Tax Diversification
By being able to supplement retirement income
with tax free income, retirees increase their
likelihood of keeping themselves in a lower income
tax bracket.
For instance, let’s say a married couple needs
$100,000 of annual income to live in retirement.
For 2009, a married couple filing jointly, with the
personal exemption and taking the standard
deduction, can have up to $86,000 of earnings and
still be in the 15% tax bracket.
5. Social Security Planning
Up to 85% of Social Security benefits are taxable.
When calculating MAGI for Social Security
purposes, the taxpayer needs to include all taxable
and tax-exempt income, and 50% of their Social
Security benefits. Interestingly, although taxexempt income is included in this calculation, Roth
IRA distributions are not.
Therefore, having a Roth IRA to supplement
retirement income will be very important in
managing the taxability of Social Security benefits.
6. Tax Loss Harvesting
Roth conversions can be a useful tool in harvesting
certain tax losses. There are times when a
taxpayer would like to realize income in order to
utilize expiring tax losses and credits. In
particular, taxpayers that have Net Operating Loss
(NOL) carry-forwards, business and other ordinary
losses, charitable contributions carry-forwards,
deductions and exemptions in excess of income,
and nonrefundable tax credits would be wise to
generate income by converting some of their
retirement accounts into a Roth IRA.
7. Reduce Taxable Estate
Individuals with large estates should consider
some of the estate planning benefits of a Roth
conversion. For 2009, a decedent with an estate
larger that $3.5 million will generally be subject to
a 45% federal estate tax. Additionally,
beneficiaries inheriting a taxable retirement
account are normally entitled to take a deduction
against their ordinary income equal to the federal
estate taxes attributable to inherited retirement
assets. This is referred to as an Income in
Respect of Decedent (IRD) deduction.
8. Trust Planning
Trusts are one of the preferred vehicles for
transferring wealth from one generation to the
next.
Distributions of taxable retirement accounts to a
trust would be taxed at the highest marginal
income tax rate of 35% as soon as the income
exceeds $11,150 for 2009. By comparison
individual taxpayers do not pay taxes at the 35%
rate until their income exceeds 372,950.
9. Tax-Free Stretch
One of the more compelling reasons to
convert retirement assets to a Roth IRA is
that the beneficiaries of the IRA can stretch
the account tax free over their lifetime.
Similar to traditional IRA’s, the beneficiary of
the Roth IRA can stretch the IRA by taking
only the minimum required distribution each
year over his or her life expectancy.
9a. Tax Free continued..
For example, a 70 year old with a $100,000 IRA would like
to leave as much as possible to his 40 year old daughter at
his death. Assume he took only his required minimum
distribution at age 701/2 and he and his daughter are in the
35% income tax bracket.
The IRA and “balancing account” grow by 7%, and he
ultimately dies at age 86.
If the daughter stretched the traditional IRA, adding the
“balancing account”, she would receive a total of $983,859
of after-tax distributions over her lifetime. However, had
the Roth been converted prior to the father’s death, the
daughter would receive a total of $1,492,920 of
distributions, or 51% more, over her life-time.
Tax free lifetime investing can be powerful.
Case Study 1
Case Study 2
Case Study 2.. Continued
1%
General
Partner
Client
(via LLC)
Partnership
ASSET
$850,000
Limited
Partner
99%
Client
Charitable
Entity
Creates Income Tax Deduction of
Approximately $637,500 that can be used
over 6 tax years without affecting Control,
Access, or Flexibility.
1%
99%
General
Partner
Client
(via LLC)
Partnership
Limited
Partner
Client
ASSET
$750,000
Charitable
Entity
1%
General
Partner
Partnership
Client
(via LLC)
99%
Limited
Partner
Client
ASSET
$500,000
Charitable
Entity
Creates Income Tax Deduction of
Approximately $375,000 that can be used
over 6 tax years without affecting Control,
Access, or Flexibility.
ROTH IRA
CONVERSION
AND
QUALIFIED RETIREMENT PLANS
Favorable Tax Law Changes







Increased compensation limit for contribution and
benefits.
Increased tax deduction limit for PS Plans to 25%.
Increased salary deferral limit for 401(k)/Simple
Plans.
Added catch-up contributions to 401(k)/Simple
Plans for employees age 50 and over.
Added Roth 401(k) feature (optional) available in
2006.
Increased annual benefit limit for Defined Benefit
Plans.
Pension Protection Act of 2006.
Traditional vs. Roth
Traditional 401(k)
Roth 401(k)
Eligibility
Determined by
Employer
No AGI eligibility
Determined by
Employer
No AGI eligibility
January 1, 2006
2010 Combined
Employee Limit
$16,500 < age 50
$21,500 > age 50
$16,500 < age 50
$21,500 > age 50
Not available. All
distributions are taxed
as ordinary income
If following are met:
5 year holding pd and
* Attainment of 59 ½
* Disability
* Death
Not including Safe Harbor
Match
Tax-Free
Qualified
Distribution*
Written Investment Policy
Statement


An Investment Policy Statement (IPS) is a blueprint
used to design and implement and manage an
investment program
The IPS should contain the following:






Define the Plan’s investment objectives
Define the roles of those responsible for the investments
Describe the criteria and procedures for selecting investment
options and managers
Establish investment procedures, measurement standards and
monitoring procedures
Describe the ways to address investment options that fail to
satisfy the established objectives
The IPS should be reviewed annually and can be
amended to reflect needed changes
401k Plan & ROTH Conversion
1. Make sure Plan Documents allow for
A. “In Service Distribution”
Pre-determined Age: 55 or older
Older Trustee doesn’t want to take same risks as
“younger” Partner / Trustee.
2. Investment Policy Statement Allows for flexible Investment
Options less restrictive; Must be spelled out in the documents.
3. Trustee Authorizes some or all of his/her 401k assets to be
transferred to another investment as a “Rollover IRA.”
4. Traditional IRA may be converted to ROTH IRA under ROTH
conversion rules.
1%
General
Partner
Partnership
Client
(via LLC)
Limited
Partner
99%
Client
ASSET
$500,000
Charitable
Entity
Creates Income Tax Deduction of
Approximately $375,000 that can be used
over 6 tax years without affecting Control,
Access, or Flexibility.