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The Roth IRA - America's Next New Tax Break


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  • 1. The Roth IRA in 2010 –America‟s New Next Tax BreakEdward R. Doughty, CFP® <First and last name> is a Registered Representative with and, Securities offered through LPL Financial, Member FINRA/SIPC.
  • 2. What experts are saying… “The Roth IRA is the single best gift Congress has ever presented to the American taxpayer.” 1
  • 3. 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.” 2
  • 4. What the experts are saying… “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.” 3
  • 5. 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.” 4
  • 6. What the experts are saying… “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.” 5
  • 7. What the experts are saying… 6
  • 8. IRA basics Regularly-taxed Traditional IRA Roth IRA account You pay income tax, You may get a tax You pay income tax, and then make your deduction, essentially and then make your contribution with post-tax letting you deposit contribution with dollars pre-tax dollars post-tax dollars Your principal may be subject to taxes on Any growth of principal is Any growth of principal is dividends and capital gains tax-deferred* tax-free* as it grows You pay capital gains or You pay income tax on the You pay no further ordinary income tax on your entire amount of taxes on qualified gain at withdrawal your withdrawal withdrawals * Principal is subject to market fluctuation and may lose value. 7
  • 9. Traditional IRA deductibility rules Traditional IRA deductibility limits for 2009Tax filing Active Modified adjusted Deductionstatus participant status gross income allowed Individual is not active No limit Full deductionSingle or $55k or less Full deductionhead of Individual is active More than $55k but less than $65k Partial deductionhousehold $65k or more No deduction Individual is not active and No limit Full deduction individual’s spouse is not active $89k or less Full deductionMarried Individual is active More than $89k but less than $109k Partial deduction- filing $109k or more No deductionjointly $166k or less Full deduction Individual is not active and More than $166k but less than Partial deduction individual’s spouse is active $176k $176k or more No deduction 8
  • 10. 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) 9
  • 11. The Parity Principle Traditional IRA Roth IRA After-tax contribution ($4,000) ($3,000) Growth rate 8% 8% Time invested 30 30 (years) Nest egg $453,133 $339,850 10
  • 12. The Parity Principle 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 11
  • 13. Tax rates at historic lows Highest Highest Year tax-rate Year tax-rate (single) (single) 1950 91% 1971 70% 1951 91% 1972-78 70% 1952-53 92% 1979-80 70% 1954-63 91% 1981 69.125% 1964 77% 1982 50% 1965-67 70% 1983 50% 1968 75.25% 1984 50% 1969 77% 1985 50% 1970 71.75% 1986 50% Source: 12
  • 14. 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” 13
  • 15. 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? 14
  • 16. The Roth IRA Versus a Traditional IRA Tax bracket Amount A Roth IRA worth $100,000 is equal to a 20% $125,000 Traditional IRA worth…? 28% $138,890 33% $149,250 35% $153,850 Where else does a Roth IRA win? 15
  • 17. Unique benefits: no RMDsUnlike traditional IRAs, no Required Minimum Distributions (RMDs) 16
  • 18. 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 17
  • 19. 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 18
  • 20. Unique benefits: Access to withdrawalsRoth IRAContributions can be withdrawn at any time without penalty tax orincome taxHave income tax-free and penalty-tax-free withdrawals of earningsafter five years if you are age 59½ or in the following circumstances:death, disability, or for a first-time home purchase up to $10,000One of the penalty-tax-free, but not income-tax-free withdrawalsbefore age 59½ can be for higher education expenses 19
  • 21. Unique benefits: Social Security taxation 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 taxedKaye Thomas. Guide to Roth IRA: Tax on Social Security. Fairmark Press Tax Guide for Investors. 20
  • 22. Unique benefits: Access to withdrawalsHow much of your Social Security income is taxable? What‟s included in the calculation? – All wages – 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 How much of your Social Security is taxable? – If married filing jointly and AGI is: Under $32,000: 0% taxable $32,000 - $43,999: 50% taxable Greater than $44,000: 85% taxable 21
  • 23. Roth IRA advantages Qualifying distributions are tax-free  Greater flexibility - Access contributions at any time tax-free Account value is effectively bigger – especially if tax rates go up  Social Security taxation - Tax-free bonds are included No Required Minimum Distributions - Qualifying Roth IRA distributions are during life excluded No age limit on contributions with earned income Diversify tax risk 22
  • 24. 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 23
  • 25. Roth IRA income limits for 2009 contributions Filing Full status Phased out No contribution contribution Single $105,000 - $104,999 or less $120,000 or more filers $120,000 Joint $166,000 - $165,999 or less $176,000 or more filers $176,000 24
  • 26. Roth IRA annual contribution limits Total contribution Year Standard contribution including catch up provision 2007 $4,000 $5,000 2008 $5,000 $6,000 2009 $5,000 $6,000 25
  • 27. Current Roth IRA conversion limits Filing status No conversion Single filers $100,000 or more Joint filers $100,000 or more 26
  • 28. 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.” 27
  • 29. 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. 28
  • 30. 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: 29
  • 31. 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 30
  • 32. Traditional IRA vs. Roth IRA – Income Assumptions Traditional IRA contains only deductible contributions. Qualified Roth IRA distributions taken after five-year holding period. Traditional IRA Roth IRA $250,000 $250,000 @ 7.2% Growth @ 7.2% $500,000 Balance after 10 years $500,000 $25,000 Annual withdrawals $25,000 -$7,500 30% income tax - 0% $17,500 Spendable $25,000 Tax paid over 20 Years Tax paid over 20 years $150,000 $0 31
  • 33. Traditional IRA vs. Roth IRA – Income Social Security taxation 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 Roth IRA $25,000 Annual withdrawals $25,000 $25,000 Added to SS $0 provisional income $18,700 Annual taxable SS $0 Social Security benefits added Social Security benefits added to the taxable income to the taxable income over 20 years over 20 years $374,000 $0 32
  • 34. Traditional IRA vs. Roth IRA–Income Heirs – lump sum distribution Traditional IRA Roth IRA $250,000 $250,000 @ 7.2% Growth @ 7.2% $500,000 Balance $500,000 after 10 years $500,000 To heirs $500,000 - $150,000 30% income tax - 0% Income tax (30%) $350,000 Spendable $500,000 Tax paid Tax paid $150,000 $0 33
  • 35. Traditional IRA vs. Roth IRA – Income Heirs stretching distribution 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 Roth IRA $250,000 $250,000 @ 7.2% Growth @ 7.2% $500,000 Balance after $500,000 10 years $500,000 To heirs $500,000 @ 7.2% Growth @ 7.2% $2.04 million Balance after $2.04 million 34 years - $612,748 30% income tax - $0% Tax paid Tax paid $612,748 $0 34
  • 36. Traditional IRA vs. Roth IRA Traditional IRA Tax Roth IRA Tax Owner’s tax $150,000 on income $0 (over 20 years) Additional $374,000 $0 SS taxable (over 20 years) Heir’s tax $150,000 $0 on lump sum distribution $612,748 Tax on stretched $0 distributions Assuming qualified Roth distributions 35
  • 37. Roth IRA – FAQsTax rates in the future are unpredictable.How can I know if converting will benefit me?Just as you use diversification to deal with theuncertainty of your investments, it can be a good ideato have at least some money in Roth IRAs to diversifyyour exposure to income taxes. 36
  • 38. 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. 37
  • 39. Roth IRA – FAQsDoes Congress have the ability to remove taxadvantages 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 withoutsome transition or grandfathering the rules. What‟smore likely is that Congress will simply raise incometax rates, putting the burden on wage earners andretirees pulling money from regular IRAs and 401(k)s.”-Source: Money Magazine “Retire Without Taxes” October 2008 38
  • 40. Roth IRA – FAQsIs converting in 2010 right for you?Contact your financial professional for moreinformation on the Roth IRA. 39
  • 41. DisclosureThis presentation was prepared by TransAmerica.The opinions voiced in this material are for general information only and are not intended to providespecific advice or recommendations for any individual. To determine which investment(s) may beappropriate for you, consult your financial advisor prior to investing. All performance referenced ishistorical and is no guarantee of future results. All indicies are unmanaged and cannot be investedinto directly.Please consult your tax advisor for tax-related questions. Tracking # 586018 40
  • 42. Questions & AnswersThank you for attending! Not FDIC/NCUA Insured Not Bank/Credit Union Guaranteed May Lose Value Not Insured by any Federal Government Agency Not a Bank Deposit A Registered Investment Advisor Member FINRA/SIPC