1
© Robert S, Keebler, CPA, MST, AEP (Distinguished) Baker Tilly Virchow Krause, LLP
Presented by:Robert S. Keebler, CPA, MST, AEP (Distinguished)920 739 [email protected]
Planning Opportunities Created by Roth IRA Conversions
2
© Robert S, Keebler, CPA, MST, AEP (Distinguished) Baker Tilly Virchow Krause, LLP
Roth IRAsGeneral Concepts
> 100% of growth is tax-exempt
> No required minimum distributions at age 70½> NOTE: Distributions from Roth IRAs cannot be used to fulfill the RMD
from a traditional IRA
> $100,000 Modified Adjusted Gross Income (MAGI) limitation
> RMDs on Inherited Roth IRAs
> Roth 401(k) plans
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© Robert S, Keebler, CPA, MST, AEP (Distinguished) Baker Tilly Virchow Krause, LLP
> Starting in 2010, the $100,000 Modified Adjusted Gross Income (MAGI) limitation no longer applies> The taxable income recognized on a Roth IRA conversion in
2010 may be spread over the following two tax years (i.e. 2011 and 2012)
> Watch Out for the “Two Year Trap!”
> Married Filing Separately taxpayers can convert to a Roth IRA
Roth IRAsGeneral Concepts
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© Robert S, Keebler, CPA, MST, AEP (Distinguished) Baker Tilly Virchow Krause, LLP
Computation of MAGI - New Rule (Conversions After 12/31/2004)Adjusted Gross Income $XX,XXXLess:
Income from Roth Conversion ($XX,XXX)Required Minimum Distribution (IRAs Only) (XX,XXX) (XX,XXX)
Add-in:Traditional IRA Deduction $X,XXXStudent Loan Interest X,XXXTuition & Fee Deduction X,XXXForeign Income/Housing Exclusion X,XXXForeign Housing Deduction X,XXXExclusion of Interest on U.S. Series EE Savings Bonds X,XXX XX,XXX
Modified Adjusted Gross Income (Must be less than $100,000) $XX,XXX
Roth IRAsGeneral Concepts
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© Robert S, Keebler, CPA, MST, AEP (Distinguished) Baker Tilly Virchow Krause, LLP
Convertible accounts> Traditional IRAs
> 401(k) plans
> Profit sharing plans
> 403(b) annuity plans
> 457 plans
> “Inherited” 401(k) plans (see Notice 2008-30)
Roth IRAsGeneral Concepts
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© Robert S, Keebler, CPA, MST, AEP (Distinguished) Baker Tilly Virchow Krause, LLP
Non-convertible accounts> “Inherited” IRAs
> Education IRAs
Roth IRAsGeneral Concepts
May be rolled into an IRA, Roth IRA, or other qualified plan
(unless, possibly, it is a distribution that (1) is part of a series of equal payments and (2) did not include any 2009
RMD)
Was the distribution a RMD for 2009?
Was the RMD a single or multiple distribution?
IRA or Qualified Plan Distribution
Any distribution may be rolled into a Roth IRA or
other qualified plan, however, only one
distribution may be rolled into a traditional IRA.
Rollovers Under Notice2009-82
Yes
No
Multiple distribution(s)Single distribution
Qualified Plan
IRA
2, 3
1. A distribution that would have been an RMD for the year 2009, but for the suspension of RMDs under 401(a)(9(h)2. Rollovers to Roth IRAs will be taxable3. Roth conversions will be subject to the $100,000 AGI limitation, IRC §408A(c)(3)(B)(i)4. One-rollover-per-year rule, IRC §408(d)(3)5. One or more payments in a series of substantially equal distributions (that include the 2009 RMDs) made at least annually and
expected to last for the life (or life expectancy) of the participant, the joint lives (or joint life expectancy) of the participant and the participant’s designated beneficiary or for a period of at least 100 years.
© 2009 Robert S. Keebler, CPA, MST, AEP (Distinguished) Baker Tilly Virchow Krause, LLPAll Rights [email protected]
Pursuant to the rules of professional conduct set forth in Circular 230, as promulgated by the United States Department of the Treasury, nothing contained in this communication was intended or written to be used by any taxpayer for the purpose of avoiding penalties that may be imposed on the taxpayer by the Internal Revenue Service, and it cannot be used by any taxpayer for such purpose. No one, without our express prior written permission, may use or refer to any tax advice in this communication in promoting, marketing, or recommending a partnership or other entity, investment plan or arrangement to any other party.
For discussion purposes only. This work is intended to provide general information about the tax and other laws applicable to retirement benefits. The author, his firm or anyone forwarding or reproducing this work shall have neither liability nor responsibility to any person or entity with respect to any loss or damage caused, or alleged to be caused, directly or indirectly by the information contained in this work. This work does not represent tax, accounting, or legal advice. The individual taxpayer is advised to and should rely on their own advisors.
4
Educational Information
E-mail [email protected] to be added to our newsletter, for
previous write-ups about the new IRA regulations, for a licensing agreement,
or for information about seminars, CDs or books.
Rollover Relief: The 60-day rollover period is extended so that it ends no earlier than November 30, 2009, for 2009 RMDs or payments that are part of a series of equal payments. Taxpayers have the later of Nov. 30, 2009, or 60 days after the date the distribution was received, to roll over the distribution.
5
1 Stop No Special Relief
8
© Robert S, Keebler, CPA, MST, AEP (Distinguished) Baker Tilly Virchow Krause, LLP
> When a traditional IRA has non-deductible contributions, a portion of the conversion to a Roth IRA will be non-taxable “basis” to the IRA owner
> In determining the non-taxable portion of a Roth IRA conversion, all traditional IRAs and IRA distributions during the year (including outstanding rollovers) must be combined for apportioning “basis”> See IRS Form 8606
Roth IRAsRoth IRA Conversions – Calculation of Taxable Amount
9
© Robert S, Keebler, CPA, MST, AEP (Distinguished) Baker Tilly Virchow Krause, LLP
Current year non-deductible IRA contributions 1,000$ Prior year non-deductible IRA contributions 6,000 Total non-deductible IRA contributions 7,000$
FMV of all IRAs 350,000$ Outstanding rollovers 20,000 Distributions - Roth IRA conversions 100,000 Total value of IRAs, distributions and Roth IRA conversions 470,000$
"Basis" apportionment factor 0.0149
Gross Roth IRA IRA conversion 100,000$ Non-taxable portion (1,489) Taxable Roth IRA conversion 98,511$
Roth IRAsRoth IRA Conversions – Calculation of Taxable AmountBasis Apportionment Factor - Example
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© Robert S, Keebler, CPA, MST, AEP (Distinguished) Baker Tilly Virchow Krause, LLP
The 5-year period for all of a participant’s Roth IRAs begins on January 1 of the first year for which a contribution was made to any Roth IRA owned by that participant.
> Except a surviving spouse gets to treat an inherited Roth IRA as one of her own for purposes of the 5-year rule.
> The 5-year period continues to run with the participant dies.
NOTE: If a participant dies within the 5-year period, distributions to a beneficiary are taxable until the 5-year period ends.
Roth IRAsGeneral Concepts
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© Robert S, Keebler, CPA, MST, AEP (Distinguished) Baker Tilly Virchow Krause, LLP
> Qualified distributions are not subject to income tax
> Non- qualified distributions will be subject to income tax
Roth IRAsTaxation of Distributions
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© Robert S, Keebler, CPA, MST, AEP (Distinguished) Baker Tilly Virchow Krause, LLP
> Basis Can be Withdrawn Tax-Free (FIFO Method)> Distributions are not subject to income tax if they do
not exceed aggregate contributions and/or conversions to the Roth IRA
Roth IRAsTaxation of Distributions
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© Robert S, Keebler, CPA, MST, AEP (Distinguished) Baker Tilly Virchow Krause, LLP
Roth IRA Distribution Rules
Contributions> Regular contributions> Rollover contributions> Rollover from Roth 401(k)s
Earnings
Conversions (First in, first out basis)> Taxable portion of prior conversion> Non-taxable portion of prior conversion
Step 1: (Non-taxable/not subject to 10% penalty)
Step 2: (Non-taxable/potentially subject to 10% penalty)
Step 3: (Taxable/potentially subject to 10% penalty)
Does the taxpayer meet
any of the other statutory
exceptions?
Roth IRA Distribution
Is the taxpayer over age 59½?
Entire distribution is tax-free
No
Yes
© 2009 Prepared by Robert S. Keebler, CPA, MST, AEP (Distinguished) Baker Tilly Virchow Krause, LLPAll Rights [email protected]
Pursuant to the rules of professional conduct set forth in Circular 230, as promulgated by the United States Department of the Treasury, nothing contained in this communication was intended or written to be used by any taxpayer for the purpose of avoiding penalties that may be imposed on the taxpayer by the Internal Revenue Service, and it cannot be used by any taxpayer for such purpose. No one, without our express prior written permission, may use or refer to any tax advice in this communication in promoting, marketing, or recommending a partnership or other entity, investment plan or arrangement to any other party.
For discussion purposes only. This work is intended to provide general information about the tax and other laws applicable to retirement benefits. The author, his firm or anyone forwarding or reproducing this work shall have neither liability nor responsibility to any person or entity with respect to any loss or damage caused, or alleged to be caused, directly or indirectly by the information contained in this work. This work does not represent tax, accounting, or legal advice. The individual taxpayer is advised to and should rely on their own advisors.
Yes
No
3
1. IRC Sec. 408A(d)(2)(A)(i)2. IRC Sec 408A(d)(2)(B)3. IRC Sec. 408A(d)(2)(A)(ii)(iii)(iv)
• Death• Disability• First-time homebuyer expenses (up to $10K)
1 Has the taxpayer met the five-year holding
period test?2
Educational Information
E-mail [email protected] to be added to our newsletter, for
previous write-ups about the new IRA regulations, for a licensing agreement,
or for information about seminars, CDs or books.
No Yes
Roth IRA-Taxability of Distributions STOP
Distribution subject to income tax (only to the extent of amounts not
previously taxed)
STOP Distribution subject to
income tax (only to the extent of amounts not
previously taxed)
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© Robert S, Keebler, CPA, MST, AEP (Distinguished) Baker Tilly Virchow Krause, LLP
> Withdrawals made within five years of conversion if owner under age 59½ and no other exception applies
> Five-year period independent of five-year period for qualified distribution
Roth IRAsTaxation of Distributions Early Withdrawal Tax
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© Robert S, Keebler, CPA, MST, AEP (Distinguished) Baker Tilly Virchow Krause, LLP
> If attributable to a regular contribution: applicable to amounts includible in gross income
> If attributable to a rollover contribution: applicable to amounts that were included in gross income at rollover
Roth IRAsTaxation of Distributions Early Withdrawal Tax for Non-Qualified Distributions
17
© Robert S, Keebler, CPA, MST, AEP (Distinguished) Baker Tilly Virchow Krause, LLP
> The calculation of the amount of a non-qualified Roth IRA distribution subject to the 10% early withdrawal tax is determined as follows:
Gross non-qualified Roth IRA distribution
- First-time homebuyer expenses
- Prior year Roth IRA contributions
Gross non-qualified Roth IRA distribution subject to 10% tax
- Taxable portion of prior year Roth IRA conversions > 5 years
- Non-taxable portion of prior year Roth IRA conversions
Net non-qualified Roth IRA distribution subject to 10% tax
Roth IRAsRoth IRA Distributions – 10% Early Withdrawal TaxOrdering Rule - General
Is the taxpayer over age 59½?
Does the taxpayer have only contributory or
conversion IRAs?
Follow the “ordering rules” (as outlined in Form
8606 instructions)
Roth IRA -Application of 10% Early
Withdrawal PenaltyYes
No
No
Comingled Roth IRA
Yes
© 2009 Prepared by Robert S. Keebler, CPA, MST, AEP (Distinguished) Baker Tilly Virchow Krause, LLPAll Rights [email protected]
Pursuant to the rules of professional conduct set forth in Circular 230, as promulgated by the United States Department of the Treasury, nothing contained in this communication was intended or written to be used by any taxpayer for the purpose of avoiding penalties that may be imposed on the taxpayer by the Internal Revenue Service, and it cannot be used by any taxpayer for such purpose. No one, without our express prior written permission, may use or refer to any tax advice in this communication in promoting, marketing, or recommending a partnership or other entity, investment plan or arrangement to any other party.
For discussion purposes only. This work is intended to provide general information about the tax and other laws applicable to retirement benefits. The author, his firm or anyone forwarding or reproducing this work shall have neither liability nor responsibility to any person or entity with respect to any loss or damage caused, or alleged to be caused, directly or indirectly by the information contained in this work. This work does not represent tax, accounting, or legal advice. The individual taxpayer is advised to and should rely on their own advisors.
STOP No 10% Penalty
(“Qualified distribution”)
Did the distribution occur within five years
of conversion?
Is the distribution greater than prior contributions (i.e.
“basis”)?
Penalty only applies to earnings
No
Educational Information
E-mail [email protected] to be added to our newsletter, for
previous write-ups about the new IRA regulations, for a licensing agreement,
or for information about seminars, CDs or books.
100% conversion Roth IRA
100% contributory Roth IRA
STOPNo 10% Penalty
(return of non-deductible contributions)
Penalty applies to prior conversion
amounts and earnings1
Penalty applies unless excluded under one of the following exceptions of IRC Sec. 72(t)1.Death2.Disability3.Series of substantially equal periodic payments4.Medical expenses greater than 7.5% AGI5.Health insurance premiums for unemployed individuals6.Higher education expenses7.First-time homebuyer expenses (up to $10K)
1
Yes1 Penalty only applies to
earnings 1
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© Robert S, Keebler, CPA, MST, AEP (Distinguished) Baker Tilly Virchow Krause, LLP
(1) Taxpayers have special favorable tax attributes including charitable deduction carry-forwards, investment tax credits, high basis non-deductible traditional IRAs, etc.
(2) Suspension of the minimum distribution rules at age 70½ provides a considerable advantage to the Roth IRA holder.
(3) Taxpayers benefit from paying income tax before estate tax (when a Roth IRA election is made) compared to the income tax deduction obtained when a traditional IRA is subject to estate tax.
Roth IRAsNine Reasons Why to Convert to a Roth IRA
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© Robert S, Keebler, CPA, MST, AEP (Distinguished) Baker Tilly Virchow Krause, LLP
(4) Taxpayers who can pay the income tax on the IRA from non IRA funds benefit greatly from the Roth
IRA because of the ability to enjoy greater tax-free yields.
(5) Taxpayers who need to use IRA assets to fund their Unified Credit bypass trust are well advised to
consider making a Roth IRA election for that portion of their overall IRA funds.
(6) Future distributions to beneficiaries are generally tax-free.
Roth IRAsNine Reasons Why to Convert to a Roth IRA
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© Robert S, Keebler, CPA, MST, AEP (Distinguished) Baker Tilly Virchow Krause, LLP
(7) Because federal tax brackets are more favorable for married couples filing joint returns than for single individuals, Roth IRA distributions won’t cause an increase in tax rates for the surviving spouse when one spouse is deceased because the distributions are tax-free.> Important pre-mortem planning opportunity
(8) Suspension of required minimum distributions (RMDs) provides for additional tax-free compounded growth
(9) Ability to recharacterize a Roth IRA conversion is a significant tactical advantage because if provides the taxpayer the benefit of 20/20 hindsight (by allowing the taxpayer to specifically choose which conversions to keep)
Roth IRAsNine Reasons Why to Convert to a Roth IRA
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© Robert S, Keebler, CPA, MST, AEP (Distinguished) Baker Tilly Virchow Krause, LLP
Estate Tax First Income Tax FirstTraditional IRA Roth IRA
IRA Balance 2,500,000$ 2,500,000$ Less: Federal & State Income Taxes @ 40% - (1,000,000) Subtotal 2,500,000$ 1,500,000$ Less: Federal Estate Tax @ 45% (1,125,000) (675,000) Less: State Estate Tax @ 10% (250,000) (150,000) Subtotal 1,125,000$ 675,000$
IRA Balance 2,500,000$ Less: IRC §691(c) Deduction* (1,125,000) Subtotal 1,375,000$ Less: Federal & State Income Taxes @ 40% (550,000)
Net Wealth to Family 575,000$ 675,000$
Roth IRAsAdvantage of Paying Income Tax on a Roth IRA Conversion Before Incurring an Estate Tax
PROOF: ($2,500,000 - $1,500,000) x 10% state estate tax = $100,000 NOTE: Under IRC §691(c), a deduction is allowed ONLY for federal estate taxes paid.
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© Robert S, Keebler, CPA, MST, AEP (Distinguished) Baker Tilly Virchow Krause, LLP
Conversion Period Recharacterization Period
1/1/2009 – First day conversion can take place
2009
12/31/2009 – Last day conversion can take place
4/15/2010 – Normal filing
date for 2009 tax return
10/15/2010 – Latest filing date
for 2009 tax return / last day to recharacterize
2009 Roth IRA conversion
12/31/2010
2010
Roth IRAsRoth IRA Conversion Timeline
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© Robert S, Keebler, CPA, MST, AEP (Distinguished) Baker Tilly Virchow Krause, LLP
> In 2009, the $100,000 AGI limitation is still in effect
> For taxpayers who are below the $100,000 AGI threshold, serious consideration should be given to converting in 2009 because income tax rates are expected to increase as early as 2010
> For those taxpayers above the $100,000 AGI threshold, consideration should be given to harvesting losses (whether ordinary or capital) so as to lower income> Oil & gas investments
> Defined Benefit Plans
> Capital Loss Planning
Roth IRAsSpecial Conversion Opportunity in 2009
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© Robert S, Keebler, CPA, MST, AEP (Distinguished) Baker Tilly Virchow Krause, LLP
> In 2010, there will be a “tsunami” of income tax planning as a result of the repeal of the $100,000 AGI limitation on Roth IRA conversions
> Consequently, planners need to begin now in gathering the necessary resources to handle the additional workload of analyzing Roth IRA conversions> Income tax and cash flow studies
> Comprehensive Roth IRA conversion software
> Comprehensive written materials explaining Roth IRA conversions and how a conversion will affect the client
Roth IRAsReadying for the Conversion Planning “Tsunami” in 2010
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© Robert S, Keebler, CPA, MST, AEP (Distinguished) Baker Tilly Virchow Krause, LLP
Advanced Roth IRA Planning
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© Robert S, Keebler, CPA, MST, AEP (Distinguished) Baker Tilly Virchow Krause, LLP
Advanced Roth IRA PlanningUnderstanding the Mechanics
In simplest terms, a traditional IRA will produce the same after-tax result as a Roth IRA provided that:> The annual growth rates are the same
> The tax rate in the conversion year is the same as the tax rate during the
withdrawal years (i.e. A x B x C = D; A x C x B = D)
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© Robert S, Keebler, CPA, MST, AEP (Distinguished) Baker Tilly Virchow Krause, LLP
Traditional IRA Roth IRA2009 Account Balance 100,000$ 100,000$ Less: Income Taxes @ 40% - (40,000) Net Balance 100,000$ 60,000$
Growth Until Death 300.00% 300.00%
Account Balance @ Death 300,000$ 180,000$ Less: Income Taxes @ 40% (120,000) - Net Account Balance to Family 180,000$ 180,000$
Advanced Roth IRA PlanningUnderstanding the Mechanics
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© Robert S, Keebler, CPA, MST, AEP (Distinguished) Baker Tilly Virchow Krause, LLP
Critical decision factors> Tax rate differential (year of conversion vs. withdrawal years)
> Use of “outside funds” to pay the income tax liability
> Need for IRA funds to meet annual living expenses
> Time horizon
Advanced Roth IRA PlanningUnderstanding the Mechanics
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© Robert S, Keebler, CPA, MST, AEP (Distinguished) Baker Tilly Virchow Krause, LLP
The key to successful Roth IRA conversions is to keep as much of the conversion income as possible in the current marginal tax bracket
> However, there are times when it may make sense to convert more and go into higher tax brackets
Advanced Roth IRA PlanningUnderstanding the Mechanics
Tax Rate Differential
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© Robert S, Keebler, CPA, MST, AEP (Distinguished) Baker Tilly Virchow Krause, LLP
Single Married
Filing Jointly Head of Household
10% $8,350 $16,700 $11,950
15% $33,950 $67,900 $45,500
25% $82,250 $137,050 $117,450
28% $171,550 $208,850 $190,200
33% $372,950 $372,950 $372,950
35% > $372,950 > $372,950 > $372,950
2009 Tax Brackets
Advanced Roth IRA PlanningUnderstanding the Mechanics
Tax Rate Differential
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© Robert S, Keebler, CPA, MST, AEP (Distinguished) Baker Tilly Virchow Krause, LLP
10% tax bracket
15% tax bracket
25% tax bracket
28% tax bracket
33% tax bracket
35% tax bracket
Current taxable income
Target Roth IRA conversion amount
Optimum Roth IRA conversion amount
Advanced Roth IRA PlanningUnderstanding the Mechanics
Tax Rate Differential
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© Robert S, Keebler, CPA, MST, AEP (Distinguished) Baker Tilly Virchow Krause, LLP
Advanced Roth IRA PlanningUnderstanding the Mathematical MechanicsTax Rate Differential – Example #1 (50 Year Old)
ASSUMPTIONSIRA Owner's Age 50
IRA Balance 1,000,000$ Outside Account Balance 400,000$
Yield Rate 2.00%Growth Rate 6.00%Total Return (Pre-Tax) 8.00%Less: Income Tax on Yield @ 40% -0.80%Less: Income Tax on Growth @ 20%* -0.60%Total Return (After-Tax) 6.60%
Tax Rate - Current Year 40.00%Tax Rate - Future Years 40.00%
* Assumes 50% annual turnover on growth
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© Robert S, Keebler, CPA, MST, AEP (Distinguished) Baker Tilly Virchow Krause, LLP
Advanced Roth IRA PlanningUnderstanding the Mathematical MechanicsTax Rate Differential – Example #2 (50 Year Old)
ASSUMPTIONSIRA Owner's Age 50
IRA Balance 1,000,000$ Outside Account Balance 400,000$
Yield Rate 2.00%Growth Rate 6.00%Total Return (Pre-Tax) 8.00%Less: Income Tax on Yield @ 40% -0.80%Less: Income Tax on Growth @ 20%* -0.60%Total Return (After-Tax) 6.60%
Tax Rate - Current Year 40.00%Tax Rate - Future Years 30.00%
* Assumes 50% annual turnover on growth
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© Robert S, Keebler, CPA, MST, AEP (Distinguished) Baker Tilly Virchow Krause, LLP
Advanced Roth IRA PlanningUnderstanding the Mathematical MechanicsTax Rate Differential – Example #3 (50 Year Old)
ASSUMPTIONSIRA Owner's Age 50
IRA Balance 1,000,000$ Outside Account Balance 400,000$
Yield Rate 2.00%Growth Rate 6.00%Total Return (Pre-Tax) 8.00%Less: Income Tax on Yield @ 40% -0.80%Less: Income Tax on Growth @ 20%* -0.60%Total Return (After-Tax) 6.60%
Tax Rate - Current Year 30.00%Tax Rate - Future Years 40.00%
* Assumes 50% annual turnover on growth
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© Robert S, Keebler, CPA, MST, AEP (Distinguished) Baker Tilly Virchow Krause, LLP
Advanced Roth IRA PlanningUnderstanding the Mathematical MechanicsTax Rate Differential – Example #4 (70 Year Old)
ASSUMPTIONSIRA Owner's Age 70
IRA Balance 1,000,000$ Outside Account Balance 400,000$
Yield Rate 2.00%Growth Rate 6.00%Total Return (Pre-Tax) 8.00%Less: Income Tax on Yield @ 40% -0.80%Less: Income Tax on Growth @ 20%* -0.60%Total Return (After-Tax) 6.60%
Tax Rate - Current Year 40.00%Tax Rate - Future Years 40.00%
* Assumes 50% annual turnover on growth
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© Robert S, Keebler, CPA, MST, AEP (Distinguished) Baker Tilly Virchow Krause, LLP
Advanced Roth IRA PlanningUnderstanding the Mathematical MechanicsTax Rate Differential – Example #5 (70 Year Old)
ASSUMPTIONSIRA Owner's Age 70
IRA Balance 1,000,000$ Outside Account Balance 400,000$
Yield Rate 2.00%Growth Rate 6.00%Total Return (Pre-Tax) 8.00%Less: Income Tax on Yield @ 40% -0.80%Less: Income Tax on Growth @ 20%* -0.60%Total Return (After-Tax) 6.60%
Tax Rate - Current Year 40.00%Tax Rate - Future Years 30.00%
* Assumes 50% annual turnover on growth
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© Robert S, Keebler, CPA, MST, AEP (Distinguished) Baker Tilly Virchow Krause, LLP
Advanced Roth IRA PlanningUnderstanding the Mathematical MechanicsTax Rate Differential – Example #6 (70 Year Old)
ASSUMPTIONSIRA Owner's Age 70
IRA Balance 1,000,000$ Outside Account Balance 400,000$
Yield Rate 2.00%Growth Rate 6.00%Total Return (Pre-Tax) 8.00%Less: Income Tax on Yield @ 40% -0.80%Less: Income Tax on Growth @ 20%* -0.60%Total Return (After-Tax) 6.60%
Tax Rate - Current Year 30.00%Tax Rate - Future Years 40.00%
* Assumes 50% annual turnover on growth
39
© Robert S, Keebler, CPA, MST, AEP (Distinguished) Baker Tilly Virchow Krause, LLP
Advanced Roth IRA PlanningUnderstanding the Mathematical MechanicsTax Rate Differential – Example #7 (70 Year Old)
$-
$1,000,000
$2,000,000
$3,000,000
$4,000,000
$5,000,000
$6,000,000
70 71 72 73 74 75 76 77 78 79 80 81 82 83 84 85 86 87 88 89
AgeOption 1 - Traditional IRAOption 2 - Roth IRA Conversion (Pay Tax w/Roth IRA)Option 3 - Roth IRA Conversion (Pay Tax w/Outside Account)
ASSUMPTIONSIRA Owner's Age 70
IRA Balance 1,000,000$ Outside Account Balance 400,000$
Yield Rate 2.00%Growth Rate 6.00%Total Return (Pre-Tax) 8.00%Less: Income Tax on Yield @ 40% -0.80%Less: Income Tax on Growth @ 20%* -0.60%Total Return (After-Tax) 6.60%
Tax Rate - Current Year 30.00%Tax Rate - Future Years 40.00%
* Assumes 50% annual turnover on growth
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© Robert S, Keebler, CPA, MST, AEP (Distinguished) Baker Tilly Virchow Krause, LLP
Advanced Roth IRA PlanningTactical Considerations
> Unused charitable contribution carryovers
> Current year ordinary losses
> Net Operating Loss (NOL) carryovers from prior years
> Alternative Minimum Tax (AMT)
> Credit carryovers
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© Robert S, Keebler, CPA, MST, AEP (Distinguished) Baker Tilly Virchow Krause, LLP
Taxpayers may “recharacterize” (i.e. undo) the Roth IRA conversion in current year or by the filing date of the current year’s tax return> Recharacterization can take place as late as 10/15 in the year
following the year of conversion
Taxpayers may choose to “reconvert” their recharacterization> Reconversion may only take place at the later of the following two dates:
(1) The tax year following the original conversion OR
(2) 30 days after the recharacterization
Advanced Roth IRA PlanningTactical Considerations
Interest Income
- Taxable
Capital Gain Income
-Preferential Rate
-Deferral until sale
Roth IRA and
Insurance
- Tax Free Growth/ Benefits
Real Estate, Oil & Gas and Tax Exempt Bonds
- Tax Preferences
Pension and
IRA Income
- Tax Deferred
Money market
Corporate bonds
US Treasury bonds
AttributesAnnual
income tax on interest
Taxed at highest marginal rates
Equity Securities
AttributesDeferral
until saleReduced
capital gains rate
Step-up basis at death
Real EstateDepreciation
tax shield1031
exchangesDeferral on
growth until sale
Oil & GasLarge up
front IDC deductions
Depletion allowances
Pension plansProfit sharing
plansAnnuities
AttributesGrowth during
lifetimeRMD for IRA
and qualified plans
No step-up
Roth IRATax-free growth during lifetimeNo 70½ RMDTax-free distributions out to beneficiaries life expectancy
Life InsuranceTax-deferred growthTax-exempt payout at death
TAX ASSET CLASSES
Dividend Income
Tax Exempt Interest
Equity securities
AttributesQualified
dividends at LTCG rate
Return of capital dividend
Capital gain dividends
Bonds issued by State and local Governmental entities
AttributesFederal tax
exemptState tax exempt
© 2009 Prepared by Robert S. Keebler, CPA, MST, AEP (Distinguished) Baker Tilly Virchow Krause, LLPAll Rights [email protected]
Pursuant to the rules of professional conduct set forth in Circular 230, as promulgated by the United States Department of the Treasury, nothing contained in this communication was intended or written to be used by any taxpayer for the purpose of avoiding penalties that may be imposed on the taxpayer by the Internal Revenue Service, and it cannot be used by any taxpayer for such purpose. No one, without our express prior written permission, may use or refer to any tax advice in this communication in promoting, marketing, or recommending a partnership or other entity, investment plan or arrangement to any other party.
For discussion purposes only. This work is intended to provide general information about the tax and other laws applicable to retirement benefits. The author, his firm or anyone forwarding or reproducing this work shall have neither liability nor responsibility to any person or entity with respect to any loss or damage caused, or alleged to be caused, directly or indirectly by the information contained in this work. This work does not represent tax, accounting, or legal advice. The individual taxpayer is advised to and should rely on their own advisors.
43
© Robert S, Keebler, CPA, MST, AEP (Distinguished) Baker Tilly Virchow Krause, LLP
> Taxpayers cannot recharacterize a portion of a Roth conversion by “cherry picking” only those stocks that decline in value (IRS Notice 2000-39)
> All gains and losses to the entire Roth IRA, regardless of the actual stock or fund re-characterized, must be pro-rated
Advanced Roth IRA PlanningTactical Considerations“Anti-Cherry Picking” Rule
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© Robert S, Keebler, CPA, MST, AEP (Distinguished) Baker Tilly Virchow Krause, LLP
On January 2, 2009, when John Smith’s IRA was worth $500,000, he converted the entire amount to a Roth IRA. John will owe ordinary income tax on the entire $500,000. The IRA consisted of ABC Fund ($250,000) and XYZ Fund ($250,000). As of April 15, 2010, ABC Fund had declined in value to $100,000, while XYZ Fund had increased in value to $300,000. Thus, the total value of the IRA account declined in value to $400,000.
Even though John would like to re-characterize all of ABC Fund and leave XYZ fund in his Roth IRA, he must allocate the total loss to each fund pro-ratably. Therefore, John may only recharacterize $125,000 (25% x $500,000) of the original conversion amount instead of $250,000, resulting in taxable income of $375,000 ($500,000 - $125,000).
Advanced Roth IRA PlanningTactical Considerations“Anti-Cherry Picking” Rule - Example
Value @ Conversion
Current Value
Relative Percentages
(Current)ABC Fund 250,000$ 100,000$ 25%YYZ Fund 250,000$ 300,000$ 75%Total 500,000$ 400,000$ 100%
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© Robert S, Keebler, CPA, MST, AEP (Distinguished) Baker Tilly Virchow Krause, LLP
Traditional IRAABC Fund: $250,000XYZ Fund: $250,000
Traditional IRA #1ABC Fund: $250,000
Traditional IRA #2XYZ Fund: $250,000
Advanced Roth IRA PlanningTactical ConsiderationsRoth IRA Conversion Segregation Strategy
STEP 1: Create separate IRAs for each asset, asset class or investment sector
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© Robert S, Keebler, CPA, MST, AEP (Distinguished) Baker Tilly Virchow Krause, LLP
Traditional IRA #1ABC Fund: $250,000
Roth IRA #2XYZ Fund: $250,000
Advanced Roth IRA PlanningTactical ConsiderationsRoth IRA Conversion Segregation Strategy
STEP 2: Convert IRAs to separate Roth IRAs
Roth IRA #1ABC Fund: $250,000
Traditional IRA #2XYZ Fund: $250,000
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© Robert S, Keebler, CPA, MST, AEP (Distinguished) Baker Tilly Virchow Krause, LLP
IRSTaxpayerIncome tax liability due on $500,000
conversion amount
April 15, 2010*
* NOTE: Either a tax return or an extension must be filed by this date. Regardless of what is chosen, the tax liability due on the Roth IRA conversion must be remitted by this date in order to avoid late payment penalties and interest.
Advanced Roth IRA PlanningTactical ConsiderationsRoth IRA Conversion Segregation Strategy
STEP 3: Pay income tax on Roth IRA conversion
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© Robert S, Keebler, CPA, MST, AEP (Distinguished) Baker Tilly Virchow Krause, LLP
Roth IRA #1ABC Fund: $100,000
(Current Value)
Roth IRA #2XYZ Fund: $300,000
(Current Value)
Traditional IRA #1ABC Fund: $100,000
(Current Value)
Recharacterization of IRA using the value at the date of conversion
(e.g. $250,000)
October 15, 2010*
* NOTE: October 15, 2010 is the latest date for which a 2009 recharacterization can take place (either by filing extensions or by filing an amended return).
Advanced Roth IRA PlanningTactical ConsiderationsRoth IRA Conversion Segregation Strategy
STEP 4: Recharacterize Roth IRA conversion
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© Robert S, Keebler, CPA, MST, AEP (Distinguished) Baker Tilly Virchow Krause, LLP
October 15, 2010Refund of overpayment on
recharacterization of Roth IRA conversion
Advanced Roth IRA PlanningTactical ConsiderationsRoth IRA Conversion Segregation Strategy
STEP 4: File (or amend) income tax return claiming refund for recharacterization
Taxpayer IRS
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© Robert S, Keebler, CPA, MST, AEP (Distinguished) Baker Tilly Virchow Krause, LLP
Using the facts from the earlier Example, instead of converting his entire IRA into a single Roth IRA, John created two separate Roth IRAs, one for each fund. As of April 15, 2010, ABC Fund had declined in value to $100,000 while XYZ Fund had increased in value to $300,000.
As a result of the poor performance of ABC Fund, John chose to recharacterize the Roth IRA that held ABC Fund before he filed his income tax return. The tax savings from John’s Roth IRA Segregated Conversion Strategy can be summarized on the following slide:
Advanced Roth IRA PlanningTactical ConsiderationsRoth IRA Conversion Segregation Strategy - Example
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© Robert S, Keebler, CPA, MST, AEP (Distinguished) Baker Tilly Virchow Krause, LLP
Without Roth IRA
Segregation
With Roth IRA
Segregation DifferenceValue on Date of Conversion 500,000$ 500,000$ -$ Value of Roth IRA after recharacterization 300,000$ 300,000$ -$ Value of Traditional IRA after recharacterization 100,000$ 100,000$ -$ Ordinary Income Recognized 375,000$ 250,000$ (125,000)$ Ordinary Income Tax @ 28% 105,000$ 70,000$ (35,000)$
Advanced Roth IRA PlanningTactical ConsiderationsRoth IRA Conversion Segregation Strategy - Example
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© Robert S, Keebler, CPA, MST, AEP (Distinguished) Baker Tilly Virchow Krause, LLP
Recharacterization – Comprehensive Example
1/1/10 Action 11/30/10 Action 1/1/11 Action 4/15/11 Action 10/15/11 Action 11/30/11 Action 1/1/12 Action
A $100,000 OriginalConversion
1/1/10
$125,000 Hold $130,000 Hold $130,000 Hold $135,000 Hold $130,000 N/A $130,000 N/A
B $100,000 OriginalConversion
1/1/10
$120,000 Hold $120,000 Hold $120,000 Hold $120,000 Hold $125,000 N/A $130,000 N/A
C $100,000 OriginalConversion
1/1/10
$100,000 Hold $100,000 Hold $95,000 Recharacterize4/15/11
$80,000 Reconvert5/16/11
$85,000 Hold $90,000 Hold
D $100,000 OriginalConversion
1/1/10
$ 75,000 Recharacterize11/30/10
$80,000 Reconvert1/1/11
$85,000 Hold $85,000 Hold $90,000 Hold $95,000 Hold
E $100,000 OriginalConversion
1/1/10
$ 75,000 Recharacterize11/30/10
$90,000 Reconvert1/1/11
$85,000 Hold $90,000 Hold $75,000 Recharacterize11/30/11
$80,000 Reconvert1/1/12
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© Robert S, Keebler, CPA, MST, AEP (Distinguished) Baker Tilly Virchow Krause, LLP
Other Roth IRA Planning Issues
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© Robert S, Keebler, CPA, MST, AEP (Distinguished) Baker Tilly Virchow Krause, LLP
CONVERSION OF INHERITED QUALIFIED PLAN
> Notice 2008-30 – Section II, Q&A 7, allows non-spouse beneficiaries to convert inherited qualified plans to inherited Roth IRAs.
> Plan must allow for such transfers.
Other Roth IRA Planning IssuesRecognizing Losses on Roth IRAs
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© Robert S, Keebler, CPA, MST, AEP (Distinguished) Baker Tilly Virchow Krause, LLP
> Taxpayers are generally allowed to deduct a loss on a Roth IRA in the year that the Roth IRA is fully liquidated> Loss is a miscellaneous itemized deduction subject to the 2% AGI
floor
> Deduction is an add-back for AMT purposes
> In order to recognize the loss, the taxpayer must liquidate all Roth IRAs within the same tax year
Other Roth IRA Planning IssuesRecognizing Losses on Roth IRAs
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© Robert S, Keebler, CPA, MST, AEP (Distinguished) Baker Tilly Virchow Krause, LLP
> 11 U.S.C. §522 > Retirement asset protection
> IRA and Roth IRA limitations
> $1 Million
> Rollover IRA protection> Separate Accounts
> Protection for Business Owners
Other Roth IRA Planning IssuesBankruptcy/Creditor Protection2005 Bankruptcy Act
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© Robert S, Keebler, CPA, MST, AEP (Distinguished) Baker Tilly Virchow Krause, LLP
> Several states have “opt out” provisions that replace the U.S.C. with state law protection> It is important to assess the level of protection each state law provides
IRA owners to determine which set of laws (federal vs. state) to apply in a particular case
Other Roth IRA Planning IssuesBankruptcy/Creditor Protection
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© Robert S, Keebler, CPA, MST, AEP (Distinguished) Baker Tilly Virchow Krause, LLP
Qualified Plan
Traditional IRA
Roth IRA
Bankruptcy and creditor protection may be lost as a result of the following series of transactions
Other Roth IRA Planning IssuesBankruptcy/Creditor Protection
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© Robert S, Keebler, CPA, MST, AEP (Distinguished) Baker Tilly Virchow Krause, LLP
> Basic analysis> Used as a general illustration to show the overall benefits of
converting to a Roth IRA
> Usually only incorporates one to two factors
> Tax rate difference
> Growth rate difference
> Income tax-free distributions after death
> Comprehensive analysis> Used to determine “optimum” conversion amount
> Multi-factorial
> Need to run several models to determine sensitivity points
Other Roth IRA Planning IssuesAnalyzing Roth IRA Conversions
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© Robert S, Keebler, CPA, MST, AEP (Distinguished) Baker Tilly Virchow Krause, LLP
Pursuant to the rules of professional conduct set forth in Circular 230, as promulgated by the United States Department of the Treasury, nothing contained in this communication was intended or written to be used by any taxpayer for the purpose of avoiding penalties that may be imposed on the taxpayer by the Internal Revenue Service, and it cannot be used by any taxpayer for such purpose. No one, without our express prior written permission, may use or refer to any tax advice in this communication in promoting, marketing, or recommending a partnership or other entity, investment plan or arrangement to any other party.
Although effort was taken to ensure the accuracy of these materials, Robert S. Keebler and Baker Tilly Virchow Krause, LLP assume no responsibility or liability for an individual’s reliance on these materials. These materials are being provided for educational and informational purposes only and are in no way to be construed as accounting, financial, tax, legal or other advice. Individual readers must consult their own professional tax and legal advisors.
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© Robert S, Keebler, CPA, MST, AEP (Distinguished) Baker Tilly Virchow Krause, LLP
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