Investments & Retirement Plans

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1 PREPARING FOR THE CHANGES AHEAD. Year End Planning for Year End Planning for Investments & Retirement Plans

2 Td Today s Session Review of Changing Tax Laws Discuss Planning Opportunities Questions & Answers Presented by: Sal Veltri, CPA Partner Plante Moran Financial Advisors 2

3 Tax Provisions i That Could Sunset Ordinary Income Tax Rates Income tax rates were reduced to a bottom rate of 10% and a top rate of 35%. If the tax cuts expire, the bottom rate would increase to 15% and the top rate would rise to 39.6%, and several rates in between would increase as well. Capital Gains Rates Long term capital gains taxes will return to 20% from 15%. Dividends Rates Taxes on qualified dividends were reduced to 15%. A sunset on these provisions means that dividends will be taxed at ordinary rates (up to 39.6%). 3

4 Tax Provisions i That Could Sunset Other Income Tax Provisions The child tax credit would return to $500 from $1,000 per child. Marriage penalty relief the standard deduction for married couples was increased, easing the tax hit on many married couples. This would go away. Personal exemption & itemized deductions may again be phased out. Provisions regarding the alternative minimum tax which has plagued many taxpayers. Estate Tax The federal estate tax was repealed for 2010, but it is scheduled to return to 55% next year with a $1 million exemption. 4

5 What will happen to tax rates? In short, NO ONE knows! Currently, the Bush tax cuts (from 2001 and 2003) are expected to expire as of December 31, 2010, unless Congress renews them. The Obama administration i i has proposed extending several of these tax cuts. In particular, to the middle class (individuals earning less than $200, or families earning less than $250,000). Others are proposing extending the cuts for everyone, perhaps p for 1 or 2 years. The answer is, We need to wait and see However, if nothing is done, personal income taxes will increase for virtually every taxpayer. 5

6 Expiring, Extending, or Somewhere In Between 6

7 Effect on Families & Individuals: Low Income Hypothetical, for example purposes only. Source: 7

8 Effect On Families & Individuals: High Income Hypothetical, for example purposes only. Source: 8

9 What can we do? While uncertainty remains, there are a few things to consider for your retirement plan and investments Considerations Review tax efficiency of portfolio Roth conversion Capital gain recognition Installment sale treatment Maximize retirement plan contributions 9

10 Tax Efficient i Portfolio Management Tax management is a key aspect of portfolio design At PMFA, we: Look at building a portfolio as tax-efficiently as we can Consider tax planning an ongoing process Not just taxable versus municipal (tax-free) bonds Not just a year-end thing Focus on putting tax inefficient investments in tax deferred accounts A hierarchy of investments in tax deferred accounts Actively look for opportunities i to tax-swap Review timing of distributions for tax consequences Consider ways to shelter gain using charitable techniques 10

11 Sample of Tax Efficient Portfolio Construction ti Assumptions $50,000 investment in SP500 Index (yielding 2%, growing 4%) $50,000 in high yield bond fund (yielding 6%) Capital gain and qualified dividend rate of 15% Ordinary income rates are 35% now and in the future Traditional taxable account and traditional IRA 15 year time horizon What a difference tax efficiency can make Ending after tax value if HY is in taxable account: $166,645 Ending after tax value if SP is in taxable account: $190,788 Difference = $24,143 or 2.66% per year Hypothetical, for example purposes only 11

12 Roth Conversion In 2010, the $100, AGI limitation for Roth conversions was lifted, opening the door for everyone to consider a Roth conversion. But, is it right for you? 12

13 A Brief Review: Traditional IRA vs. Roth IRA Tax characterization of contributions Roth IRA Post Tax Tax deferredgrowth inside Yes Yes account Traditional IRA Pre Tax Distributions Generally Tax Free Taxed as Ordinary Income Required minimum None Yes, annually at age 70 ½ distributions Distributions included in income Distributions impact on taxability of Social Security No Does Not Affect Yes Included in AGI No Yes Does Affect 13

14 Roth Conversion Considerations It comes down to tax rates NOW vs. tax rates LATER If you re going to do it, consider Carefully consider recognizing the gain over multiple years as it may be at a higher rate. Do you have cash outside the IRA to pay the tax bill? Estate planning opportunities & charitable intentions Do you have basis in your IRA? Basis in your IRA will reduce your tax bill. Non-deductible IRAs allow you to do a back door Roth conversion with very little to no tax cost. There are many considerations, please consult your PMFA or tax advisor to review implications of your situation. 14

15 Good Candidates for Roth Conversions Low Taxable Income Situation Maximize the 15% (or lower) income tax bracket if client is in a very low bracket due to business operating loss, lower income year, etc. Identify how much can be converted utilizing the lower tax rates. Wealthy, High Net Worth Family High Net Worth Individual likely does not need funds. Always in the highest tax bracket (therefore, rates are likely lower now). Conversion reduces future RMD requirement Preserve assets tax free for future generations, while lowering gross estate by paying the taxes. 15

16 Advantage (Disadvantage) per $1,000 of Conversion Future Tax Rate 5 Years 10 Years 15 Years 20 Years 35% $149 $216 $308 $435 25% $15 $37 $69 $115 15% ($118) ($142) ($171) ($206) Source: Charles Schwab Assumes Current Tax Rate of 25% and Average Annual Return of 6% A Roth Conversion has a slight advantage even if the future tax bracket remains the same. That s because we assume that current taxes will be paid from taxable accounts and the full conversion amount will go into the Roth. 16

17 Capital Gain Recognition Capital gains are expected to go from 15% to 20%. Does that suggest that you should incur gains now to lock-in at the lower rate? Not necessarily. Especially if you have a capital loss carry-forward. However, if you expect to sell anyway in the short to mid term it probably makes sense to incur at a lower rate. Or if you have a low basis position that will be sold. Tax swapping & tax loss harvesting 17

18 Tax Swap Opportunities General Definition: A method of recognizing i capital losses by selling losing positions and purchasing similar investment strategies. Example: $100,000 Investment in Vanguard Index 500. Worth $75,000 today. Sell the fund and buy the Vanguard Total Stock Market Index for $75,000. $25,000 capital loss is recognized to offset current or future gains. Basis is reset at the lower amount. Wash sale rules apply if a loss is recognized and substantially identical securities are purchased within 30 days before or after the sale. (The loss is disallowed.) Losses may offset installment sale, land contracts, or other gains. 18

19 Installment t Sale Treatment t An installment sale or land contract allows you to recognize the gain from a sale over the period in which you receive payments. Should you consider accelerating the gain and paying at 15% in 2010? In many cases, the answer is still no but review your situation in greater detail. Determine the rate of return necessary. Another consideration the Health Care Reform bill does enact Medicare tax of 3.8% on investment income over $250, beginning in That may tip the scales in the other direction suggesting accelerating the tax. 19

20 Maximizing Retirement Plan Opportunities 401(k) contributions Maximizing contributions makes more sense when tax rates are higher. Not only does it provide an immediate tax deduction for high income earners, it also provides more tax deferred space for tax inefficient investments. Roth vs. Traditional 401(k) Contributions Many employers now offer Roth & traditional 401(k) plans. Consider your current tax rate versus tax rate in retirement. Your personal situation and tax rates in place at the time Younger workers not at their earnings peak, or others in a abnormally low tax rate should consider the Roth IRA or 401(k). Non-Deductible IRA Contributions May be converted to Roth IRA 20

21 Maximizing Retirement Contributions for Self Employed Individuals id Maximum contribution (2010) Individual 401K SEP IRA $49,000 $49, K portion $16,500 $0 Catch up (over 50) $ 5,500 $0 401K & catch up is allowed on 100% of your net self employment earnings Employer contribution i 20% 20% 21

22 Examples of SEP vs. Individual 401K Contributions ti Example: $40, net self employment earnings (after ½ of self employment tax deduction) Max SEP: $40,000 x 20% = $8,000 Max individual 401(k): $16, ,500 + $8,000 = $30,000 Example: $270,000 net self employment earnings (after ½ of self employment tax deduction) Max SEP: $49,000 Max individual 401(k): $49,000 Hypothetical, For Example Purposes Only 22

23 Conclusions We are in a period of uncertainty. No one knows exactly what will happen to rates. Every situation is unique, consider discussing your situation with a member of our tax team and a PMFA advisor. Questions & Answers? 23

24 Disclosures Past performance does not guarantee future results. Data sources for peer group comparisons, returns, and standard statistical data are provided by the sources referenced and are based on data obtained from recognized statistical services or other sources believed to be reliable. However, some or all information has not been verified prior to the analysis, and we do not make any representations as to its accuracy or completeness. Any analysis non-factual in nature constitutes only current opinions, which are subject to change. There may be instances when consultant opinions regarding any fundamental or quantitative analysis may not agree. Plante Moran Financial Advisors publishes this presentation to convey general information about our services. Investments mentioned herein may not be appropriate for you. You should consult a representative from Plante Moran Financial Advisors for investment advice regarding your own situation. Plante Moran Financial Advisors is an affiliate of Plante & Moran, PLLC. 24

25 PREPARING FOR THE CHANGES AHEAD. Thank You.

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