TO ROTH OR NOT TO ROTH _ THAT IS

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					TO ROTH OR NOT TO ROTH,
  THAT IS THE QUESTION
           J. Scott Dillon
      Carruthers & Roth, P.A.
     235 N. Edgeworth Street
      Greensboro, NC 27401
           336.478.1119
          jsd@crlaw.com
    OVERVIEW
   The Rules
      Roth IRA

      Roth 401(k)

   Roth or Pre-Tax Deferrals
   Roth Conversions
PART I


THE RULES
ROTH IRA Basics
   Same contribution limit as traditional
    deductible IRA
       $5,000/yr. or $6,000/yr. with catch up
       Phases out between $105,000 - $120,000 for
        single person or $166,000 - $176,000 for married
        filing jointly in 2009
   This is combined limit for all Roth and pre-tax
    IRAs
   But, Roth contributions can continue past 70-
    1/2
ROTH IRA Basics
   Must keep in separate Roth IRA (can’t
    commingle with pre-tax)
   Not subject to RMDs while owner alive
   Surviving spouse who rolls over not
    subject to RMDs either
   No deduction for contributions but
    qualified distributions are tax-free!
   Partial withdrawals come first from
    principal (relevant only for non-qualified
    distributions)
ROTH 401(k)/403(b) Basics
   Roth deferrals to 401(k)/403(b) plans
    available since 2006
   Plan must also allow traditional pre-tax
    deferrals
   No income ceilings on ability to make Roth
    deferrals
   Employee’s decision to defer as Roth is
    irrevocable (no conversion inside plan)
   Plan must separately account for Roth:
       Year of first deferral, Roth basis, and total Roth
        balance
Roth 401(k)/403(b) Basics
   Otherwise, regular 401(k) rules apply
       Subject to 402(g) limit ($16,500 in 2009/10
        plus $5,500 catch up)
       ADP test applies unless plan is safe harbor
       401(k) distribution restrictions apply (at
        termination or after age 59½)
   Qualified distributions are tax-free!
Qualified Distribution
   Qualified distribution is tax-free/penalty
    free
       Applies to principal and income
   Two requirements for qualified distribution:
       5 year clock runs, and
       Qualified distribution event
          Attain age 59½

          Death

          Disability

          First-time home buyer (IRA only)
Roth 401(k)/403(b) 5 year
clock
   Each plan has separate clock
   Clock starts January 1 of year in which
    first Roth deferral made
   Roth clock tacks in plan-to-plan rollover
   Example: if first deferral occurs in Dec.
    09, qualified distributions can be made
    starting Jan. 1, 2014
Roth IRA 5 year clock
   Each person has 1 Roth IRA clock, regardless
    of number of Roth IRAs
   Clock starts January 1 of year of first Roth
    deferral/conversion
       Example: if first contribution made 4/1/10 for
        2009 tax year, qualified distributions can be
        made starting 1/1/14
   In case of rollover from Roth 401(k), Roth
    401(k) clock does not tack
       New 5 year clock if rollover Roth 401(k) to new
        Roth IRA
Roth rollover possibilities
   Can rollover qualified or non-qualified
    distributions
   Can rollover:
       Roth plan to Roth plan
       Roth IRA to Roth IRA
       Roth plan to Roth IRA
       Regular IRA to Roth IRA (subject to conversion
        rules)
       Regular plan account to Roth IRA (subject to
        conversion rules)
    PART II


    ROTH OR PRE-TAX DEFERRALS
(should I pay tax on the acorn or the tree?)
    Tax rate issues
   Highest rate today = 35%
   Highest rate in 2011 = 39.6% (barring law
    change)
   Highest rate after 2011 = ?
   High AGI can cause loss of itemized
    deductions
   Social security not taxed if income below
    $25,000 ($32,000 for joint return)
       Taxed at 85% otherwise
3 classes hurt by Roth
   Tax bracket goes down at retirement
   Will need distributions prior to maximizing
    advantage of Roth (will need more than RMD
    amount for living expenses)
   In Roth 401(k), can’t afford to make Roth
    deferral equal to pre-tax deferral due to
    current tax liability; lose company match as
    result
6 classes helped by Roth
   Higher tax bracket at retirement
   Won’t need money as fast as RMD schedule
    demands
   May need money before age 59½
   Deferring as much as you can and would love to
    be able to defer more
   Forced savings for people who don’t save
    anything other than retirement plan/IRA
    contributions
   Reduce taxable estate for estate tax purposes by
    taxes on Roth contributions/conversions
     A Tale of Scott and Howard
   Scott and Howard are age 50
   Each in 40% bracket (federal & state)
   Investment funds grow at 10%/yr
   Defer until age 65 (check results at age 66)
   Available pre-tax salary available to invest
    $36,667
   401(k) deferral (with catch up) - $22,000
   Scott prefers Roth; Howard prefers pre-tax
 Deferral Differences
                    Scott    Howard
                   (Roth)   (pre-tax)
Pre-tax $         $36,667   $36,667

401(k) deferral   $22,000   $22,000

40% tax           $14,667    $5,867

Taxable side        $0       $8,800
fund investment
   Results
Scott’s Roth 401(k) balance at 66    $790,894
Howard’s pre-tax 401(k) balance at 66 $790,894

40% tax on Howard’s 401(k)           $316,358

Howard’s side fund balance at 66     $245,415

Total for Howard                     $719,951

Extra for Scott (10%)                $70,942
Four potential limits to high-income
401(k) participants wanting to defer
more
   402(g) - $16,500 plus $5,500 catch-up
   ADP
   415
   Plan limit
   Example: If ADP limit restricts Scott’s 401(k)
    contribution to $10,000, $10,000 Roth
    deferral = $16,700 pre-tax deferral
   Example: Even if Scott can make full $22,000
    401(k) deferral, deferring as Roth
    contribution means $8,800 less to spend on
    cars, vacations, i-phones, etc.
PART III


ROTH CONVERSIONS
Roth IRA conversions
   Can convert traditional IRA to Roth IRA
       Price: Pay tax now on amount converted
   For 2009 only, modified AGI cannot
    exceed $100,000
       $100,000 limit goes away in 2010
   Options if convert in 2010
       Include in 2010 (35% rate)
       Include ½ in 2011 and ½ in 2012 (?% rate)
Converting non-deductible
IRAs to Roth
   Can convert non-deductible IRA
    contributions to Roth
   No tax on principal upon conversion; taxed
    only on converted IRA value in excess of
    basis
   Warning – all IRAs must be converted pro
    rata
       Can’t choose to convert after-tax IRA but not
        pre-tax IRA
Converting non-deductible
IRAs to Roth
   Example: Howard has $50,000 after-tax
    IRA ($45,000 basis) and $50,000
    regular IRA. If he converts after-tax
    IRA, must pay tax on $27,500
   No 10% early distribution penalty on
    conversion before 59½
Rollover pre-tax plan to Roth
IRA
   Can rollover pre-tax account in qualified
    plan directly to Roth IRA
   Same rules as Roth IRA conversion
       $100,000 income limit in 2009
       Current taxation (2 year deferral option in
        2010)
   Must have distributable event under plan
   Available for participants and beneficiaries
What if I make a mistake?
   After converting, can unconvert
    (recharacterize) all or part of Roth IRA
    back into pre-tax IRA on or before due
    date of tax return for year of conversion
    (as extended)
   After unconverting, you get a “re-do” --can
    reconvert back to Roth IRA in next tax
    year (or after 30 days if longer)
What if I make a mistake?
   Example: Sally converts $100,000 pre-tax IRA
    into Roth in 2010. Extends 2010 tax return.
    IRA drops to $50,000 as of 10/1/11. Sally
    unconverts on 10/1/11 and reconverts on
    1/1/12
   After converting, consider separating asset
    classes (i.e., stocks & bonds) into 2 Roth
    IRAs
       If one drops and other increases, apparently you
        can unconvert only the one that drops
Questions to ask before
converting
   Do I expect tax rate on conversion to be higher
    than rate on distribution?
   Do I have funds available to pay taxes from
    outside of IRA?
   How many years of tax-deferred growth can I
    expect?
       Will my withdrawals exceed RMD amount
        regardless?
   Do I expect to have substantial taxable earnings
    after I start drawing social security?
   What effect will converting have on my tax
    bracket?
IRA comparison
   Larry, Mo, and Curly each:
       Have $500,000 in pre-tax rollover IRA
       Have $200,000 in outside taxable savings
       Are in 40% combined federal/state tax
        bracket
       Are age 65
       Cash out at age 90
       Earn 10%/yr on all investments
       Have no need for plan distributions
IRA comparison
   Larry keeps $ in pre-tax IRA
       Reinvests RMDs in savings (after paying
        taxes). Invests savings after-tax.
   Mo converts to Roth, paying tax from
    pre-tax IRA. No RMDs
       Invests savings after-tax
   Curly converts to Roth, paying tax from
    savings ($0 savings left). No RMDs
  Results
                          Larry         Mo          Curly
      IRA type           Pre-tax       Roth         Roth
Conversion tax paid        N/A          IRA        Savings
       from
Outside savings at 90   2,350,132    $858,374        $0
  Pre-tax IRA at 90     $1,935,736      $0           $0
  Tax on IRA at 90      (774,302)       $0           $0
   Roth IRA at 90          $0        $3,250,412   $5,417,353
       Total            $3,511,566   $4,108,786   5,417,353
     % of Curly           65%          76%          100%
Retired couple; Pre-tax IRA;
Main example
   John and Mary, married couple
       Both age 65, retired
       Social security = $20,000/year
       Taxable investments = $220,000
       Pre-tax IRA = $200,000
       File joint return with standard deduction (2008
        rates)
       Living expenses = $61,200/year + taxes
       Earnings rate = 10%
Retired couple; Pre-tax IRA;
Main example
   Withdraw $25,000/year from IRA
       $5,800 total taxes (all sources)
       $19,200 for remaining living expenses
        ($20,000 S.S. + $22,000 inv. earnings + $19,200 IRA
        = $61,200 needed to live)
   Result: IRA is empty at age 81
   Outside savings carries until just before
    age 90
    Retired couple; Roth IRA
    Conversion
   Same facts as previous example except convert to
    Roth IRA and pay taxes over 2 years from outside
    savings
        Taxes on conversion are $51,000
        Continue drawing $22,000/yr from savings even
         though exceeds earnings
        Annual income taxes are much less
             IRA distributions aren’t taxable
             Neither is social security
   Results
        Outside savings depleted at 83
             At that point, start drawing $41,200 from Roth IRA
        Roth IRA lasts to age 94
After-Death Options
   Beneficiaries can convert inherited pre-
    tax IRA to Roth IRA
   Beneficiaries can rollover inherited pre-
    tax qualified plan to inherited Roth IRA
   RMDs from inherited Roth IRAs same as
    RMD from inherited pre-tax IRAs –
    based on beneficiary’s life expectancy
Beneficiary Example
   Assumptions
       Ben converts $100,000 pre-tax IRA to Roth
        IRA at age 65
       8% annual return before 65 and 6% after
       Combined tax rate of 27.75%
       Ben takes no IRA distributions and dies at
        age 85
       Ben’s 55 year old son, Jerry, is beneficiary
       Jerry receives RMDs only
    Beneficiary Example
         Results
Jerry’s     Total Tax-   Remaining    Total Roth   Advantage over
 Age           free         IRA      IRA Benefit    Tradition IRA
              RMDs        balance

 65        $183,446 $477,225         $660,671        $296,619
 70         329,132      475,564      804,696        360,776
 75         528,318      413,498      941,816        426,990
 80         804,481      244,452     1,048,933       482,105
 85        1,086,191        0        1,086,191       510,964

				
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