Welcome to Pay Now or Pay Later - Is a Roth IRA conversion right for you? My name is (insert) and I’m a (title) at (name of firm). I am delighted that you are here today to learn about Roth IRA conversions and the opportunities that are currently available. I will explain why converting to a Roth IRA and paying the taxes now, can help you create a tax-free income stream in retirement.
There are many reasons to be to be excited about Roth IRAs today. First of all, the adjusted gross income (AGI) limits that disallowed Roth conversions for investors with income over $100,000, have been eliminated in 2010. Starting in 2010, anyone can convert to a Roth IRA regardless of how much income they earn. Some other highlights that I will discuss are the potentially low cost conversion opportunity today, as a result of the market downturn, locking in today’s relatively low tax rates and the potential to take advantage of special tax treatment if a Roth IRA conversion is completed in 2010. But before I get into detail about the opportunity for conversion today, lets take a look at the agenda.
Today we will answer the following questions: What is a Roth IRA? Why convert to a Roth IRA? Why convert now?
OK, let’s start with what a Roth IRA is.
Let’s do a quick refresher on IRAs. There are two primary types of IRAs, Roth IRAs and Traditional IRAs. There are significant differences between them, namely in the timing of when taxes are due. Very simply, With a Roth IRA : Contributions are on an after-tax basis which means that there are not tax benefits for making the contribution initially, however earnings grow free of federal taxes. What this means to you is that when you reach retirement and begin withdrawing money, you won’t pay taxes on any earnings. With a traditional IRA : Depending on certain factors, IRA contributions may be tax deductible up front and earnings grow tax deferred of federal taxes. When you reach retirement and begin withdrawing money, taxes must be paid on any earnings. And the tax is at ordinary income levels, not capital gains rates. So as you can see, one of the main difference between IRAs and Roth IRAs is when taxes are due. Lets move on to the next section.
Now we will look at why to potentially consider converting to a Roth IRA from an IRA (or other type of retirement account).
Before I move any further, I just want to point out that vTraditional IRAs are not the only types of accounts that can be converted to a Roth IRA. In fact, employer-sponsored retirement plans like: 401(k) Plans* 403 (b) Plans* SEP IRAs* Simple IRAs /401(K)s May also be eligible for conversion. However in order to be eligible to roll over your employer sponsored retirement account, you must have had a qualified “triggering event” such as separation of service or attainment of age 59½.
Lets move on to …why convert to a Roth IRA? In helping answer the logical question, should you convert to a Roth IRA? It’s helpful to think about four key reasons to consider Roth conversions based on the current environment. A Roth IRA provides: 1. Tax-free withdrawals. 2. Tax-free stretch, which I will describe in a minute. 3. Tax diversification in retirement. 4. Unique benefits, which I will also outline. I will now cover each one of these points in more detail starting with tax-free withdrawals.
To demonstrate the benefit of tax-free withdrawals, I’d like to provide you with an example. Janet is 45 years old and she recently converted a $100,000 Traditional IRA to a Roth IRA. Let’s say she paid taxes out of pocket, and before and after retirement, Janet is in the 35% tax bracket and receives an average return of 8%. Janet will retire at age 65 and she will need income for 25 years in retirement. Now, let’s compare the difference between a Traditional and Roth IRA: Keep in mind that upon conversion to a Roth IRA, taxes would be due. Therefore, to compare apples to apples, a “side account” was established for the Traditional IRA to account for the opportunity cost of paying for the taxes of the Roth out of pocket. The “side account” assumes an after tax account. As you can see, the Roth IRA has a greater benefit in this example. Janet would receive an annual after-tax benefit of $37,418 for the IRA and $43,663 for the Roth IRA, which breaks down to a monthly after tax amount of $3,113 for the IRA and $3,639 for the Roth. The factors that contributed to the Roth IRA being beneficial to Janet, in this example, was that she is in a higher tax bracket both before and after retirement, and because she could afford to pay the conversion taxes out of pocket. All situations are different. It is important to consult a financial professional to see if conversion is right for you. Does anyone have any questions? (Take time for audience responses then continue)
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 IRAs, the beneficiary of the Roth IRA can stretch the IRA by taking only the required minimum distribution each year over his or her life expectancy. However, unlike the traditional IRA, the Roth IRA permits the undistributed amount to continue to be invested and potentially grow tax free, as opposed to merely tax-deferred, over the beneficiary’s lifetime. Now, let’s look at the second key benefit of a Roth IRA: the tax-free stretch, and I’d like to use an example to explain it to you. Bill is 70-years old and his daughter, Judy, is 30-years old. His goal is to use his IRA to help fund his retirement and still have his daughter inherit what’s left. If left in the IRA, at age 70½, Bill will begin to take RMDs (Required Minimum Distributions) as mandated by law. Bill’s current tax rate is 35%, which he anticipates his tax rate to be at retirement. If Bill converts the IRA to a Roth, he would pay a conversion tax of $35,000 out of pocket. Let’s take a look at the difference of what Judy would inherit when Bill passes away.
Sixteen years later, when Bill is age 86, he dies and his daughter, Judy, at age 46, stretched the IRA and reinvested all after-tax distributions. Here you can see a significant difference in converting a traditional IRA to a Roth IRA. (Read from slide) You can see how a tax-free stretch and a Roth IRA can help in planning for people’s future and their beneficiaries’ well being because of the power of tax free distributions.
Another benefit of a Roth IRA is tax diversification in retirement, and to appreciate this, there are a few key questions to consider: What other investments grow “tax free”? What other strategies allow a taxable investment to be converted to a tax free investment? Do you expect to be in a higher income tax bracket when retired? If so, a tax-free investment, such as a Roth IRA, may have great appeal. Do you believe income tax rates will go up and continue to rise during your retirement? If so, the tax-free benefits of a Roth IRA may be particularly attractive. Roth’s have a unique characteristic in that they grow tax free and when the funds are withdrawn, they provide tax free income.
Let’s explore the benefit of tax diversification in retirement a bit more. For income-tax planning, having a tax-free investment source, such as a Roth IRA, can help supplement other taxable sources of income. In addition, having tax free income can help keep investors in a lower tax bracket. Here is an example. An elderly married couple had unexpected home expenses in 2008. Their taxable income is just under $79,300, which keeps them in the 15% tax bracket. If they withdraw additional money from their IRA, or recognize income from other sources, they may be elevated to the next tax bracket at 25%. Tell me, is anyone ever looking to pay more in taxes? However, if the elderly couple instead access their Roth IRA account to pay for unexpected home expenses, they would stay at the 15% tax bracket. The Roth tax-free income would not affect their tax-bracket at all. The key message is that with a Roth IRA, you can build your tax-free Roth assets and have more flexibility to manage your retirement taxes.
There are other unique benefits of Roth IRAs. Traditional IRA owners must begin taking distributions by April 1st after they turn 70½. Roth IRA owners have no such requirement! So money in a Roth IRA can grow tax-deferred longer, potentially giving you and your heirs more assets. If you are age 70½ and have earned income, you are eligible to still contribute to a Roth IRA. In contrast, contributions to a Traditional IRA are not allowed after age 70½. Are there any questions before we continue? (Take a minute or two for responses.) Great, now that we have covered the basics of why investors may consider a Roth IRA in general, now let’s consider an essential question, why convert to a Roth IRA now ?
Why convert now...
There is timely news to share with you on Roth IRA conversions: for the first time, starting in 2010, higher-income individuals with adjusted gross income (AGI) of more than $100,000 are eligible to convert to a Roth IRA. In addition, the current market may provide: A low-cost conversion opportunity. The ability to lock in today’s low tax rates. Special tax treatment for 2010 and 2011. These are the key reasons to consider converting to a Roth IRA now! Let’s look at these reasons in more detail.
What do I mean by a low-cost conversion opportunity? Well, a side benefit of the down market is that it may allow you pay less in taxes. Let’s look at the low-cost conversion opportunity a little closer with this example. Donna’s IRA was worth $100,000 a few years ago. Thanks to the down market it’s now worth $70,000 and Donna decides to convert the IRA and pay taxes on the conversion while it’s “cheap to do so” because the account is worth less. Let’s say Donna’s IRA subsequently grows from $70,000 to $95,000. If this happens, the $25,000 growth is tax free. This example shows the opportunity of converting now while an IRA value is low.
But many of you might be wondering, what happens if the market goes down more. The good news is that a converted Roth IRA can be “recharacterized” back to a traditional IRA up to October 15 th of the year following the year of the conversion. In other words, you can “undo” the conversion. It’s as if the conversion never took place. And after 30 days, you can convert to a Roth IRA again. Let’s look at our example again. Donna converts an $70,000 IRA in January 2010 and it’s now worth $50,000. If it’s recharacterized by October 15, 2010, Donna can avoid $70,000 of income for 2010. The government basically gives Donna, and all investors, a “do-over.” Here’s what the benefit of “recharacterizing” an IRA can mean to you: if you convert to a Roth IRA and the market goes up, then you save on taxes…If you convert to a Roth IRA and the market goes down further, you can “undo” or recharacterize the Roth. How many investments allow you to do that ?
Another reason for you to consider a Roth conversion is the opportunity to lock in today’s low tax rates. At various times over the decades, the top marginal tax rate has been 50%, 70% and even 90%. For the past 50 years, there have only been 5 years, from 1988 to 1992, where the top tax rate was less than the current 35%. This is why you may be interested in locking in today’s relatively low tax rates by converting to a Roth IRA now.
Let’s look a little more at the potential benefit of locking in today’s low tax rates. Think about the current budget deficits and costs of bailouts and stimulus packages; then ask yourself if you think income taxes will go up. What do you think? (Ask audience to vote) If you believe taxes are likely to go up, you may want to convert to a Roth IRA and pay taxes now rather than wait until taxes are higher and the value of your IRA may be lower. What’s more, converting to a Roth IRA may provide you with a degree of certainty in an uncertain world since many financial experts believe that taxes are likely to rise in the future.
Another compelling reason for you to consider converting to a Roth IRA now is the special tax treatment for 2010 and 2011. The amount converted to a Roth IRA will be included as ordinary income for the year in which the account was converted. For conversion in 2010 only, taxpayers can elect to defer half of their tax liability to 2011 and the other half to 2012. The Roth IRA can grow and be distributed tax free as long as distributions are not taken within five years of the first contribution or conversion, and not until after age 59½.
Certainly a Roth IRA conversion might not be right for everyone. Some of the key factors for you to think about are your investment time horizon, your age, your current and future tax brackets, your view on whether taxes will rise and the available assets to pay the tax that results from an IRA conversion. There are a few more factors to consider: Investment time frame – typically the longer the time horizon before needing the funds, the more beneficial it is to convert to a Roth because you would have more time to make up for the cost of taxes on the conversion. Tax bracket at the time of conversion -- Beyond the &quot;out-of-pocket&quot; consideration, will the &quot;added income&quot; of assets from a traditional IRA (as you switch them to a Roth IRA) move you into a new, artificially high tax bracket? If it does, this of course increases your overall tax burden. Converting from a regular tax-deductible IRA to a Roth IRA may not make sense if you are already in a low income tax bracket, or if you expect to drop into a much lower income tax bracket after you retire, because you will have to pay income tax on the conversion at your current high rate. Upon conversion there will be taxes due. It is important to pay taxes from other resources rather than from the IRA because penalties may apply and a significant portion of the account will reduce the amount of money working for you in retirement. Are there any questions before we move on? (Take a minute or two for responses) Again, everyone’s situation is different, so it is important to consult a qualified professional to determine if a Roth IRA conversion is right for you.
Because there are a lot of factors that go into deciding if a Roth conversion makes sense for you, there are tools available that may provide the information needed to make an informed decision. John Hancock Mutual Funds will be introducing a new Roth conversion tool that will help you determine if a Roth Conversion is right for you. These tools, however, should not replace the expertise of a qualified professional to help to determine if a Roth conversion is in your best interest.
Hopefully, after this workshop, you feel better informed about Roth IRA conversions. I encourage you to utilize the resources at John Hancock. This includes “Is a Roth Conversion Right For You?” Thought Paper, the 10 Common IRA Mistakes brochure and a wide range of retirement education resources at www.jhfunds.com.
December 8, 2009 Thank you very much for your time. Remember everybody’s situation is different. If you would like to sit down and have me explain anything further, or if you would like help to determine if conversion may be right for you, please contact me at ___________.
Transcript of "Roth Conversion"
Presenter’s Name Presenter’s Title Is a Roth IRA conversion right for you?
The Roth IRA opportunity <ul><li>Lower account values may make conversions attractive today </li></ul><ul><li>Lock in today’s low tax rates </li></ul><ul><li>Take advantage of special tax treatment for 2010 & 2011 </li></ul>In 2010, Adjusted Gross Income (AGI) limits on Roth IRA conversions are eliminated
What is a Roth IRA? Why convert to a Roth IRA? Why convert now ? Agenda
What is a Roth IRA? Why convert to a Roth IRA? Why convert now ? Agenda
What is a Roth IRA? <ul><li>Roth IRA </li></ul><ul><li>Contributions are on an after-tax basis </li></ul><ul><li>Earnings grow free of Federal taxes </li></ul><ul><li>When an investor reaches retirement and begins withdrawing money, there are no taxes to pay on the earnings </li></ul><ul><li>Traditional IRA </li></ul><ul><li>Contributions may be tax deductible </li></ul><ul><li>Earnings grow tax deferred Federal taxes </li></ul><ul><li>When an investor reaches retirement and begins withdrawing money, taxes must be paid on any earnings </li></ul>Two primary types of IRAs: Roth and Traditional. Great differences in income limits and tax advantages
What is a Roth IRA? Why convert to a Roth IRA? Why convert now ? Agenda
Potential conversion opportunities <ul><li>Traditional IRAs </li></ul><ul><li>401(k) Plans * </li></ul><ul><li>403(b) Plans * </li></ul><ul><li>SEP IRAs * </li></ul><ul><li>Simple IRAs/401(k)s * </li></ul>* In order to be eligible to roll over your employer sponsored retirement account, you must have had a qualified “triggering event” such as separation of service or attainment of age 59½
Why convert to a Roth IRA? <ul><li>Tax-free withdrawals </li></ul><ul><li>Tax-free stretch </li></ul><ul><li>Tax diversification in retirement </li></ul><ul><li>Other unique benefits of Roth IRAs </li></ul>
1. Power of tax-free withdrawals <ul><li>Janet is 45-years old </li></ul><ul><li>She will retire at age 65 </li></ul><ul><li>Converted $100,000 IRA (Paid taxes out of pocket) </li></ul><ul><li>35% tax bracket before and after retirement </li></ul><ul><li>8% rate of return before and after retirement </li></ul><ul><li>Needs income for 25 years </li></ul>* To account for the ‘opportunity cost’ of paying for the taxes on the Roth out of pocket, a “side account” was established under the Traditional IRA. The side account illustrates how the sum paid in taxes might have grown if it was invested at a consistent rate of 4% $3,639 $3,118 Monthly after-tax income $43,663 $37,418 Annual after-tax income $43,663 N/A Yearly income from Roth IRA N/A $9,037 Side account income * N/A $28,381 income from IRA Distribution Phase $466,097 $562,565 Estimated balance at retirement (before taxes) N/A $96,468 Estimated side account balance * $466,097 $466,097 Estimated balance Roth IRA Traditional IRA Accumulation Phase
2. Tax-free stretch <ul><li>Assumptions </li></ul><ul><li>Bill is 70 years old and does not need the money to fund his retirement </li></ul><ul><li>His daughter Judy is 30 years old </li></ul><ul><li>At 70½ will take RMDs if the account stays in IRA </li></ul><ul><li>Current tax rate is 35% </li></ul><ul><li>Anticipated tax rate at retirement is 35% </li></ul><ul><li>Pay conversion tax of $35,000 out of pocket </li></ul><ul><li>7% rate of return </li></ul>Example: Bill has a $100,000 IRA; wants his daughter to inherit
2. Tax-free stretch Bill dies at age 86 $1,025,853 * $1,578,843 Total lifetime distributions if IRA is not converted Total lifetime distributions if IRA is converted Judy stretches the IRA over her lifetime *The required minimum distributions (RMDs) from the IRA were reinvested back into a side account to show a more accurate comparison. The stretch IRA example assumes that tax laws and IRS rules remain constant for the life of the IRA; but tax rules and rates are subject to change at anytime.
3. Tax diversification in retirement <ul><li>What other investments grow “tax free”? </li></ul><ul><li>What other strategies allow a taxable investment to be converted into a tax-free investment? </li></ul><ul><li>Expect to be in a higher income-tax bracket when retired? </li></ul><ul><li>Believe income tax rates will go up? </li></ul>A few questions to ponder
3. Tax diversification in retirement <ul><li>Keep taxable income within lower tax bracket </li></ul><ul><li>In 2009, a married couple filing jointly with standard deduction could have income as high as $79,300 and still be in the 15% tax bracket </li></ul>Build your tax-free Roth assets and have more flexibility to manage retirement taxes Tax-free income in retirement may help keep you in a lower tax bracket while retired
4. Other unique Roth IRAs benefits No Required Minimum Distributions Contributions allowed after age 70½
What is a Roth IRA? Why convert to a Roth IRA? Why convert now ? Agenda
Why convert to a Roth IRA now? <ul><li>In addition, the current market provides… </li></ul><ul><li>A low-cost conversion opportunity </li></ul><ul><li>The ability to lock in today’s low tax rates </li></ul><ul><li>Special tax treatment for 2010 and 2011 </li></ul>For the first time, higher-income individuals with adjusted gross income (AGI) of more than $100,000 are eligible!
1. It’s a low-cost conversion opportunity <ul><li>It’s now worth $70,000 </li></ul><ul><li>She decides to convert the IRA while it’s “cheap to do so” </li></ul><ul><li>IRA subsequently grows to $95,000 </li></ul><ul><ul><li>$25,000 growth is tax free </li></ul></ul>Convert now, while IRA value is low Donna contemplated doing a Roth conversion when her IRA was worth $100,000
1. It’s a low-cost conversion opportunity <ul><li>Example </li></ul><ul><li>Donna converts $70,000 IRA in January 2010. Value then drops to $50,000 </li></ul><ul><li>Re-characterize by 10/15/11 and avoid $70,000 of income for 2010 </li></ul>What if the market goes down more? A converted Roth IRA can be “recharacterized” as a traditional IRA up to October 15 th of the year following the year of conversion
2. Lock in today’s low tax rates <ul><li>For decades, the U.S. had a top marginal tax rate as high as 50%, 70% and 90% </li></ul><ul><li>For the past 50 years, there have only been 5 years (1988-1992) where the top rate was less than the current 35% </li></ul>
2. Lock in today’s low tax rates Source: Pension Protection Act of 2006 ? Consider the current budget deficits and costs of bailouts and stimulus packages…do you think that taxes will go up? If you think taxes will go up, consider paying taxes now rather than wait.
3. Special tax treatment for 2010 & 2011 For conversion in 2010 only, taxpayers can elect to defer half of their tax liability to their 2011 tax return and the other half to their 2012 tax return The Roth IRA can grow and be distributed tax free
Conversion considerations <ul><li>Investment time horizon </li></ul><ul><li>Current income-tax brackets </li></ul><ul><li>Anticipated income-tax bracket at retirement </li></ul><ul><li>Available assets to pay the resulting conversion taxes </li></ul>
Coming in November 2009 to jhfunds.com John Hancock Roth IRA conversion decision tool
Let John Hancock help you! <ul><li>Research materials </li></ul><ul><li>Retirement education </li></ul><ul><li>Retirement tools </li></ul>A Roth conversion is based on you as an individual— it is important to discuss with your advisers whether or not it makes sense for you
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