the roth ira - america's next new tax break
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<First and last name> is a Registered Representative with and, Securities offered through LPL Financial, Member FINRA/SIPC.
The Roth IRA in 2010 –America‟s New Next Tax Break
Edward R. Doughty, CFP®
1
What experts are saying…
“The Roth IRA is the single best gift
Congress has ever presented to the
American taxpayer.”
2
What the experts are saying…
“By allowing Roth IRAs, they also
created the single most powerful
estate building and wealth transfer
vehicle available today.”
“…By not imposing RMDs
on the owner, they gave the
American taxpayer one of the
greatest income tax „loop-
holes‟ in existence today.”
3
“The advantage of a Roth IRA over a regularly-taxed account is obvious.
Either way you pay income tax up front. But with Roth, you‟re then done paying taxes; with a regular account you‟re just getting started.”
What the experts are saying…
4
What the experts are saying…
“The essence of a Roth IRA
is that you pay tax on the seed,
but reap the harvest tax-free.”
5
“One of the smartest money moves a
young person can make is to invest
in a Roth IRA.
Follow the rules and any money you put
into one of these retirement-savings
accounts grows absolutely tax
free...Plus, an IRA is more flexible than
a 401(k) and other retirement plans
because you can invest it in almost
whatever you want, from stocks …
to bonds and real estate.”
What the experts are saying…
6
What the experts are saying…
7
IRA basics
Regularly-taxed account
Traditional IRA Roth IRA
You pay income tax,
and then make your
contribution with post-tax
dollars
You may get a tax
deduction, essentially
letting you deposit
pre-tax dollars
You pay income tax,
and then make your
contribution with
post-tax dollars
Your principal may be
subject to taxes on
dividends and capital gains
as it grows
Any growth of principal is
tax-deferred*
Any growth of principal is
tax-free*
You pay capital gains or
ordinary income tax on your
gain at withdrawal
You pay income tax on the
entire amount of
your withdrawal
You pay no further
taxes on qualified
withdrawals
* Principal is subject to market fluctuation and may lose value.
8
Traditional IRA deductibility rules
Active participant status
Modified adjusted gross income
Tax filing status
Deduction allowed
Individual is active More than $89k but less than $109k
$89k or less
No limit
Married
- filing
jointly
$109k or more
Individual is not active and
individual’s spouse is active
More than $166k but less than
$176k
$166k or less
$176k or more
Partial deduction
Full deduction
Full deduction
No deduction
Partial deduction
Full deduction
No deduction
Individual is not active and
individual’s spouse is not active
Traditional IRA deductibility limits for 2009
Individual is active
Individual is not active
More than $55k but less than $65k
$55k or less
No limit
$65k or more
Partial deduction
Full deduction
Full deduction
No deduction
Single or
head of
household
9
The Parity Principle
Traditional IRA Roth IRA
Taxable income $50,000 $50,000
Contribution ($4,000) ($4,000)
Tax rate 25% 25%
After-tax contribution ($4,000) ($3,000)
10
Traditional IRA Roth IRA
After-tax contribution ($4,000) ($3,000)
Growth rate 8% 8%
Time invested(years)
30 30
Nest egg $453,133 $339,850
The Parity Principle
11
Traditional IRA Roth IRA
Nest egg $453,133 $339,850
Tax rate 25% 25%
Tax due ($113,283) ---
After-tax nest egg $339,850 $339,850
The Parity Principle
12
Tax rates at historic lows
1970
1969
1968
1965-67
1964
1954-63
1952-53
1951
1950
Year
71.75%
77%
75.25%
70%
77%
91%
92%
91%
91%
Highest tax-rate (single)
1986
1985
1984
1983
1982
1981
1979-80
1972-78
1971
Year
50%
50%
50%
50%
50%
69.125%
70%
70%
70%
Highest tax-rate (single)
Source:http://www.ntu.org/main/page.php?PageID=19
13
Current tax rates are low
“The current income tax rates are the lowest they’ve been
since World War II …Under current policy, federal
spending will rise to 32% of GDP by 2050, compared
with a current level of 19%. There is no way to fund that
spending without significant increases in tax rates.”
- David Wyss, Chief Economist at Standard & Poor‟s
Source: Pioneer Investments, “Worth the Wait: New Roth 401(k) Reshapes the Retirement Plan Landscape”
14
The Roth IRA versus a Traditional IRA
Do you expect that your personal tax
rates will be higher or lower in the future?
How much Is a $100,000 Roth IRA worth?
15
A Roth IRA worth
$100,000 is equal to a
Traditional IRA worth…?
Where else does a Roth IRA win?
Tax bracket Amount
20% $125,000
28% $138,890
33% $149,250
35% $153,850
The Roth IRA Versus a Traditional IRA
16
Unique benefits: no RMDs
Unlike traditional IRAs, no Required Minimum Distributions (RMDs)
17
Unique benefits: Estate planning
No RMDs gives Roth IRAs a distinct advantage in estate planning
Tax on conversion is “pre-paying” taxes…a gift for heirs
(without owing any gift taxes)
– “Pre-paying” taxes by converting also reduces the size of your taxable estate
– Withdrawals may be tax-free for heirs
Minimum withdrawal rules will apply to heirs
18
Unique benefits: No age limits
Unlike Traditional IRAs, no age limits
– 8 or 85: start at any age, as long as income is being earned
19
Unique benefits: Access to withdrawals
Contributions can be withdrawn at any time without penalty tax or
income tax
Have income tax-free and penalty-tax-free withdrawals of earnings
after five years if you are age 59½ or in the following circumstances:
death, disability, or for a first-time home purchase up to $10,000
One of the penalty-tax-free, but not income-tax-free withdrawals
before age 59½ can be for higher education expenses
Roth IRA
20
Unique benefits: Social Security taxation
Kaye Thomas. Guide to Roth IRA: Tax on Social Security. Fairmark Press Tax Guide for Investors.
http://www.fairmark.com/rothira/socsec.htm
Qualified Roth IRA distributions do not affect SS taxation
Tax-exempt income that is included:
– Tax-exempt interest
– Series EE bond income
– Exclude income earned
abroad
Traditional IRA distributions can increase the amount of Social Security benefits that are taxed
21
Unique benefits: Access to withdrawals
What‟s included in the calculation?
How much of your Social Security income is taxable?
– All wages
How much of your Social Security is taxable?
– Any taxable or tax-free interest
– Distributions from pensions and traditional plans like IRAs and 401(k)s
– Half of your Social Security income
– Other taxable income
– If married filing jointly and AGI is:
Under $32,000: 0% taxable
$32,000 - $43,999: 50% taxable
Greater than $44,000: 85% taxable
22
Roth IRA advantages
Qualifying distributions are tax-free
Account value is effectively bigger – especially if tax rates go up
No Required Minimum Distributions during life
No age limit on contributions with earned income
Diversify tax risk
Greater flexibility
- Access contributions at any time tax-free
Social Security taxation
- Tax-free bonds are included
- Qualifying Roth IRA distributions are excluded
23
Roth IRA disadvantages
All contributions are non-deductible
The perceived tax benefit may never be realized, i.e., one might
not live to retirement or much beyond, in which case, the tax
structure of a Roth only serves to reduce an estate that may not
have been subject to tax.
If contributions are made while in a higher tax bracket than when
withdrawals are made, a Traditional IRA may result in lower taxes.
If converting to a Roth IRA, you may lose growth potential of
the money paid in taxes
24
Roth IRA income limits for 2009 contributions
Full contribution
Phased out No contribution
$104,999 or less$105,000 -
$120,000$120,000 or more
$165,999 or less$166,000 -
$176,000$176,000 or more
Joint
filers
Filing status
Single
filers
25
Roth IRA annual contribution limits
Year Standard contribution
Total contribution
including catch up
provision
2007 $4,000 $5,000
2008 $5,000 $6,000
2009 $5,000 $6,000
26
Current Roth IRA conversion limits
Filing status No conversion
Single filers
Joint filers
$100,000 or more
$100,000 or more
27
What the experts are saying…
“The May 17, 2006 tax act, the Tax Increase
Prevention and Reconciliation Act (TIPRA),
presents wealthy Americans with an outstanding
lifetime-and-beyond tax break…
In 2010, wealthy Americans will be granted a
wonderful, new opportunity. They will, for the first
time, qualify for a Roth IRA conversion,
regardless of their income.”
28
Convert in 2010
No income limits for conversions of a Traditional IRA to a Roth IRA in 2010
– Limits on income levels for contributions and annual contribution amounts
remain in place
Beneficiary IRAs or inherited IRAs from a person other than your
spouse cannot be converted
If you‟re otherwise eligible, you can convert part of a Traditional IRA to
a Roth IRA. But you can’t convert only the nontaxable part.
29
Tax implication
Upon conversion, Traditional IRA assets are taxed as ordinary income
But for 2010 conversions, these taxes can be paid evenly over two years
(2011 and 2012)
Please note: Pre-tax contributions vs. nondeductible Traditional IRA contributions
Converting an annuity?
- The Fair Market Value (or Actuarial Present Value) is used to determine the tax on
conversion
Source: http://www.nysscpa.org/cpajournal/2007/507/essentials/p48.htm
30
Conversion tax in perspective
The tax on conversion is not an extra tax that you must pay to get the benefits
of a Roth IRA
Instead it is the payment of tax on the pre-tax growth that has already
accrued in the IRA
31
Traditional IRA vs. Roth IRA – Income
$250,000
@ 7.2%
$500,000
$25,000
-$7,500
Tax paid over 20 Years
$150,000
Traditional IRA
$17,500
$250,000
@ 7.2%
$500,000
$25,000
- 0%
Tax paid over 20 years
$0
Roth IRA
$25,000
Balance after 10 years
Growth
Annual withdrawals
30% income tax
Spendable
Assumptions
Traditional IRA contains only deductible contributions.
Qualified Roth IRA distributions taken after five-year holding period.
32
Social Security benefits added
to the taxable income
over 20 years
$374,000
Traditional IRA Roth IRA
Added to SS
provisional income
Annual taxable SS
Assumptions
Married and filing jointly with $22,000 Social Security benefit.
$20,000 of additional taxable income.
Traditional IRA contains only deductible contributions.
Roth IRA distributions taken after five-year holding period.
Traditional IRA vs. Roth IRA – Income
$25,000
$18,700
$25,000
Social Security benefits added
to the taxable income
over 20 years
$0
$25,000
$0
$0
Annual withdrawals
Social Security taxation
33
Heirs – lump sum distribution
Traditional IRA vs. Roth IRA–Income
$250,000
@ 7.2%
$500,000
$500,000
- $150,000Income tax (30%)
Tax paid
$150,000
Traditional IRA
$350,000
$250,000
@ 7.2%
$500,000
$500,000
- 0%
Roth IRA
$500,000
Growth
To heirs
30% income tax
Spendable
Tax paid
$0
Balance
after 10 years
34
$500,000
@ 7.2%
$2.04 million
- $0%
Assumptions
Heir inherits $500,000 at age 50 and lives to age 84, with an assumed
growth rate of 7.2% while taking out IRS required distributions, total
beneficiary distributions equal $2.04 million.
Traditional IRA vs. Roth IRA – Income
$250,000
@ 7.2%
$500,000
$500,000
@ 7.2%
$2.04 million
- $612,748
Tax paid
$612,748
Traditional IRA
$250,000
@ 7.2%
$500,000
Roth IRA
Growth
To heirs
Growth
Balance after
34 years
Tax paid
$0
Balance after
10 years
30% income tax
Heirs stretching distribution
35
Traditional IRA Tax Roth IRA Tax
Traditional IRA vs. Roth IRA
$0
$0
$0
$0
$150,000
$150,000
$374,000
$612,748
Additional
SS taxable
(over 20 years)
Heir’s tax
on lump sum
distribution
Owner’s tax
on income
(over 20 years)
Tax on stretched
distributions
Assuming qualified Roth distributions
36
Roth IRA – FAQs
Tax rates in the future are unpredictable.
How can I know if converting will benefit me?
Just as you use diversification to deal with the
uncertainty of your investments, it can be a good idea
to have at least some money in Roth IRAs to diversify
your exposure to income taxes.
37
Roth IRA – FAQs
What if the value of my IRA significantly
increases or decreases when I convert?
If the value goes up, the tax on conversion would have
been calculated on a lower value. This is just one of
the advantages of converting!
If the value goes down, you can “recharacterize” the
Roth IRA back to a Traditional IRA. This must be done
by the due date, including extensions, for filing your
income tax return.
38
Roth IRA – FAQs
Does Congress have the ability to remove tax
advantages of the Roth IRA in the future?
Tax rules can be changed by Congress at any time.
However, “…outright reneging on the promise of tax-
free Roth withdrawals seems unlikely, at least without
some transition or grandfathering the rules. What‟s
more likely is that Congress will simply raise income
tax rates, putting the burden on wage earners and
retirees pulling money from regular IRAs and 401(k)s.”
-Source: Money Magazine “Retire Without Taxes” October 2008
39
Roth IRA – FAQs
Is converting in 2010 right for you?
Contact your financial professional for more
information on the Roth IRA.
40
Disclosure
This presentation was prepared by TransAmerica.
The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendations for any individual. To determine which investment(s) may be appropriate for you, consult your financial advisor prior to investing. All performance referenced is historical and is no guarantee of future results. All indicies are unmanaged and cannot be invested into directly.
Please consult your tax advisor for tax-related questions.
Tracking # 586018
A Registered Investment Advisor Member FINRA/SIPC
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