To Roth or Not to Roth:

Transcription

1 SAVANT WISE WEALTH JOURNAL To Roth or Not to Roth: Evaluating Your Options This Issue What is a Roth IRA? Is a Roth Conversion Right for You? Roth Conversion Strategies Best Practices for Owning or Converting to a Roth IRA

2 Volume 1 What is a Roth IRA? Funding a Roth IRA There are two ways to fund a Roth IRA: 1) Make annual contributions. 2) Convert your traditional IRA or employer sponsored retirement plan to a Roth IRA. A Roth IRA is a unique saving vehicle that, unlike a traditional tax-deferred IRA or after-tax account, allows your investments to grow tax free. Roth IRAs were established by the Taxpayer Relief Act of 1997 and are named for its chief legislative sponsor, the late Senator William Roth of Delaware. Contributions to a Roth IRA are made with aftertax dollars, and contributions are not deductible on your federal income tax return. However, future qualified withdrawals from your Roth IRA are tax free. In addition, there are fewer restrictions to withdrawing funds from a Roth IRA than a traditional IRA. Distributions from Roth IRAs are considered to come from contributions first and earnings second (Figure 1). If you make a nonqualified distribution from your Roth IRA, the contribution piece will not be taxed or penalized; even if you are under age 59½ (though the earnings would be taxable and may incur a penalty). Also, unlike traditional IRAs, Roth IRAs do not require minimum distributions at age 70½. In contrast to traditional IRAs, you can contribute to Roth IRAs after age 70½ as long as you have taxable compensation. In addition, Roth IRAs have unique estate planning benefits. Roth IRAs can provide heirs with a tax-free asset that continues to grow free of tax over the heir s lifetime. Heirs are required to take annual distributions from a Roth IRA, but these distributions are tax free and are calculated over the heir s lifetime. There are two ways to fund a Roth IRA. You can make annual contributions to a Roth IRA, or you can convert your traditional IRA or employer sponsored retirement plan to a Roth IRA. One additional way you may become an owner of a Roth IRA is by inheriting one as a beneficiary. As mentioned, a beneficiary Roth IRA does require annual minimum distributions. 1

3 Figure 1: Roth IRA Distribution Taxation Distribution of Roth IRA CONTRIBUTIONS Roth IRA Contributions Paid Out WITHIN 5 Years Roth IRA Contributions Paid Out AFTER 5 Years Reason for Distribution Distribution Taxable Subject to 10% Penalty Distribution Taxable Subject to 10% Penalty Any No No No No Distribution of Roth IRA CONVERSIONS Roth IRA Conversions Paid Out WITHIN 5 Years Roth IRA Conversions Paid Out AFTER 5 Years Reason for Distribution Distribution Taxable Subject to 10% Penalty Distribution Taxable Subject to 10% Penalty On or After age 59½ No No No No Before age 59½, see penalty exceptions 1-7 No Yes No No 1. Death No No No No 2. Disability No No No No 3. First time homebuyer ($10,000 limit) No No No No 4. Substantially equal periodic payments 5. Medical expenses above 7½% of AGI 6. Insurance premiums by unemployed No No No No No No No No No No No No 7. Higher education expenses No No No No Distribution of Roth IRA EARNINGS Roth IRA Earnings Paid Out WITHIN 5 Years Roth IRA Earnings Paid Out AFTER 5 Years Reason for Distribution Earnings Taxable Subject to 10% Penalty Earnings Taxable Subject to 10% Penalty On or After age 59½ Yes No No No Before age 59½, see penalty exceptions 1-7 Yes Yes Yes Yes 1. Death Yes No No No 2. Disability Yes No No No 3. First time homebuyer ($10,000 limit) Yes No No No 4. Substantially equal periodic payments 5. Medical expenses above 7½% of AGI 6. Insurance premiums by unemployed Yes No Yes No Yes No Yes No Yes No Yes No 7. Higher education expenses Yes No Yes No The five-year holding period for a Roth IRA begins on January 1 of the tax year in which you make your first Roth IRA contribution. The five-year holding period for Roth conversions begins January 1 of the year in which you convert the funds from a traditional IRA to a Roth IRA Source: To Roth or Not to Roth: Evaluating Your Options

4 Volume 1 Roth Contributions Calculating MAGI Adjusted Gross Income (AGI) + + Deductible IRA contribution + + Excluded foreign earned income and foreign housing costs + + Foreign housing deduction + + Excluded employerprovided adoption assistance + + Excluded Series EE bond interest income used for higher education expenses + + Student loan interest deduction + + Tuition and fees deducation + + Domestic producer s deduction = Modified AGI (MAGI) In 2010, you can contribute the lesser of $5,000 or 100% of your taxable compensation to a Roth IRA. You are also allowed to make an additional $1,000 catch-up contribution if you are over age 50. In addition, your spouse can make spousal Roth IRA contributions based on your earnings if they have little or no earnings of their own. However, contributions to a Roth IRA are based on your modified adjusted gross income (MAGI) for the year and your federal income tax filing status. Figure 2 shows that your ability to contribute to a Roth IRA is phased out as your income increases. Figure 2: Income Limits and Filing Status for Roth Contribution Eligibility in 2010 If your federal filing status is: Single or head of household Married filing jointly or qualifying widow(er) Married filing separately Your Roth IRA contribution is reduced if your MAGI is: More than $105,000 but less than $120,000 More than $167,000 but less than $177,000 More than $0 but less than $10,000 You cannot contribute to a Roth IRA if your MAGI is: $120,000 or more $177,000 or more $10,000 or more Source: IRS Publication 590 at You can make Roth IRA contributions for a specific tax year up until the due date of your federal return for that year (not including extensions). For example, Roth IRA contributions for 2010 are allowed until April 15, Another way to make Roth IRA contributions is through your employer Roth 401(k) plan. Roth 401(k) plans were created by The Economic Growth and Tax Relief Reconciliation Act of 2001 and were available starting in If your employer offers the Roth IRA feature, you can contribute $16,500 per year ($22,000 if age 50 or older) in 2010 regardless of the income limits. Note that you do have the ability to make a Roth IRA contribution and also contribute to a Roth 401(k) plan in the same year. For example, if you are over 50, you can contribute $22,000 to a Roth 401(k) plan and also contribute $6,000 to a Roth IRA as long as you meet the income requirements and have sufficient earnings. It is important to note that total contributions for both traditional and Roth IRAs are $5,000 per year ($6,000 with catch-up) in For example, if you were under age 50 and have already funded a traditional IRA with $4,000 for the year, you would only be able to contribute $1,000 to a Roth IRA. Qualified withdrawals from Roth IRAs are free of both taxes and 3

5 penalties if the distribution is made at least five years after the Roth IRA was established and one of the following applies: Made on or after the date you reach age 59½ Made because you are disabled Made to a beneficiary or to your estate after your death Meet the requirements for firsttime homebuyer expenses (up to a $10,000 lifetime limit) The five-year holding period for a Roth IRA begins on January 1 of the tax year in which you make your first Roth IRA contribution. Each Roth IRA has only one five-year holding period for contributions. For example, if you make a Roth IRA contribution for 2010 on April 15, 2011, your five-year holding period would start on January 1, Additional contributions to your Roth IRA do not require the start of a new five-year holding period. Note, however, Roth conversions have special five-year provisions (Figure 1). Figure 3 can be used to help determine whether or not your Roth IRA distribution is qualified. When does the fiveyear holding period for a Roth IRA begin? The five-year holding period for a Roth IRA begins on January 1 of the tax year in which you make your first Roth IRA contribution. Figure 3: Determine whether or not your Roth IRA distribution is qualified Source: IRS Publication 590 at To Roth or Not to Roth: Evaluating Your Options

6 Volume 1 Penalty Exceptions If you receive a distribution from your Roth IRA that is not considered a qualified distribution, you are required to pay income tax on any earnings (contributions are not taxed as they were funded with after-tax money). Withdrawals are assumed to come from contributions first, then conversions, and finally investment earnings. You may also be required to pay a 10% penalty on nonqualified distributions. You may not have to pay the 10% penalty in the following situations: 1. You have reached age 59½ 2. You are disabled 3. You are the beneficiary of a deceased IRA owner 4. You use the distribution to pay certain qualified firsttime homebuyer amounts 5. The distributions are part of a series of substantially equal payments 6. You have significant unreimbursed medical expenses 7. You are paying medical insurance premiums after losing your job 8. The distributions are not more than your qualified higher education expenses 9. The distribution is due to an IRS levy of the qualified plan 10. The distribution is a qualified reservist distribution 11. The distribution is a qualified disaster recovery assistance distribution 12. The distribution is a qualified recovery assistance distribution Roth Conversions Prior to 2010, Roth conversions were unavailable to taxpayers with modified adjusted gross income (MAGI) greater than $100,000, or individuals married filing separately. However, the Tax Increase Prevention and Reconciliation Act (TIPRA) of 2006 changed those rules starting in TIPRA repealed the AGI limits and income tax filing restrictions on Roth conversions for 2010 and beyond. Now you can convert your traditional IRA to a Roth IRA regardless of your annual income or filing status. Another important change for 2010 is the ability to stretch the income associated with the conversion over two years. If you convert your traditional IRA to a Roth IRA in 2010, you have the option to claim half the income on your 2011 return and half the income on your 2012 return. This feature is only available for Roth conversions completed in A Roth conversion after 2010 requires the tax liability created from the conversion be paid in full in the tax year of the conversion. Conversions from a traditional IRA to a Roth IRA are taxed at ordinary income tax rates, as if you had taken a distribution from your IRA. The difference is you do not incur the 10% early withdrawal penalty, even if you are under age 59½ at the time of the conversion. The five-year holding period applies to Roth conversions as well. However, a new five-year holding period applies to each new conversion completed. The five-year holding period begins January 1 of the year in which you convert the funds from a traditional IRA to a Roth IRA. This five-year holding period may not be the same as the five-year period used to determine whether your withdrawal is a qualified distribution. Example #1: In 2007, you opened your first Roth IRA account by converting a $10,000 traditional IRA to a Roth IRA. You included $10,000 in your taxable income for You made no further contributions. In 2010, at age 55, your Roth IRA is worth $12,000 and you withdraw $10,000. The distribution is not a qualified distribution because five years have not elapsed from the date you first established a Roth IRA. And, because you are making a nonqualified withdrawal within five years of your conversion, the entire $10,000 is subject to a 10 percent premature distribution tax unless you qualify for an exception. This recaptures the early distribution tax you would have paid at the time of the conversion. Example #2: You opened a regular Roth IRA account in 2003 with a contribution of $100, and made no further contributions to the account. In 2007, at age 60, you converted a $100,000 traditional IRA to a Roth IRA. In 2010, you withdraw $50,000 from this Roth IRA. Because you are over age 59½ in 2010, and because more than five years have elapsed from January 1, 2003 (the year you first established any Roth IRA), your withdrawal is a qualified distribution and is totally free of federal income taxes. Even though your withdrawal was within five years of the conversion, no penalty tax applies. 5

7 The new rules for 2010 also apply to employer sponsored retirement plans such as a 401(k) plan. As of 2010, you can roll your 401(k) plan directly to a Roth IRA and pay the tax just like a conversion from a traditional IRA. You can also stretch the income on these conversions completed in 2010 over the 2011 and 2012 tax years. If you have made non-deductible (aftertax) contributions to your traditional IRA, these contributions are not taxed when making a conversion to a Roth IRA. For example, if you are converting your entire traditional IRA worth $100,000 that was funded with $40,000 of non-deductible contributions, you would only owe income tax on $60,000. It is important to note that you can not simply convert only your non-deductible contributions. Instead, the non-deductible contributions are assumed to be a pro-rata portion of all of your IRA accounts (including traditional IRAs, SEP IRAs, and SIMPLE IRAs). New Rules for 2010 As of 2010, you can roll your 401(k) plan directly to a Roth IRA and pay the tax just like a conversion from a traditional IRA. Roth Recharacterizations What if you change your mind? If your tax situation changes, or if your Roth IRA account experiences a significant decline, you may be able to reverse the conversion (if you meet all of the necessary requirements). Such a recission is known as a Roth IRA recharacterization. The deadline for recharacterizing a Roth IRA conversion is the due date of your federal income tax return, including extensions, for the year of the original conversion. But, what if you filed your income tax return on or before April 15 and now want to recharacterize a Roth conversion? In such a case, you would have already paid the conversion tax. By following a special procedure, you are allowed to recharacterize the Roth conversion up until October 15 even if you already filed your income tax return on time and did not obtain a filing extension. Do not confuse the amended return date with the recharacterization due date. An amended return can be filed as late as three years after the original return was filed. However, the deadline for recharacterization of your Roth IRA funds (i.e., for transferring the funds) is the October 15 following your April 15 filing deadline for the prior tax year. For example, if you do a Roth conversion in 2010, you have until October 15, 2011 to un-convert. How long must you wait before you can convert back to a Roth IRA? If you convert funds to a Roth IRA and then switch the funds back to a traditional IRA through a recharacterization, you will have to wait awhile before you can reconvert those funds to a Roth IRA. You cannot convert and reconvert during the same taxable year, or if later, during the 30-day period following a recharacterization. If you reconvert during either of these periods, the conversion will be a failed one. For example, assume you convert a traditional IRA to a Roth IRA in May of On August 6, 2010, you recharacterize that Roth IRA to a traditional IRA. You now want to reconvert to a Roth IRA. You will not be able to effect a reconversion until the later of: January 1, 2011 (the beginning of the year following the year in which the amount was originally converted to the Roth IRA), or September 6, 2010 (the end of the 30-day period following the day on which you recharacterized the Roth IRA to a traditional IRA) Because the later of the two dates is what matters, you will have to wait until at least January 1, 2011, to reconvert. To Roth or Not to Roth: Evaluating Your Options

8 Volume 1 Is a Roth Conversion Right for You? For Converting Creating a tax-free Roth IRA may allow you to enhance the overall tax efficiency of your entire portfolio. Assets with higher expected returns that create a lot of current and ordinary tax exposure can be shielded in the Roth IRA while lower expected return and tax inefficient assets can be held in traditional IRAs and personal accounts. While Roth IRAs are excellent retirement savings vehicles, is a conversion right for you? The answer is a complicated one and depends on your particular situation and goals. Take the quick test shown in Figure 4 to see if a Roth conversion may be beneficial for you. Figure 4: Should you convert to a Roth IRA? Source: Rober S. Keebler, CPA, MST (2010) The Roth IRA Conversion Decision, 7

9 Arguments FOR Converting Converting may make sense if you believe you will be in a higher tax bracket in the future (when you begin taking distributions) than in the year you make the conversion. Qualified distributions from Roth IRAs are tax free. That means in the future you can supplement any taxable income you have with tax-free income that will not impact the taxation of your Social Security benefits or affect any tax benefits that are keyed to your adjusted gross income. You are required to start taking distributions from traditional IRAs when you turn 70½, but withdrawals are not required from Roth IRAs. This can allow your Roth IRA assets to enjoy the benefit of tax-free compounding for a longer period of time. Because you are not required to take distributions, you can potentially leave more dollars free of tax to your heirs, especially if you do not need the Roth IRA assets to fund your retirement. Creating a tax-free Roth IRA may allow you to enhance the overall tax efficiency of your entire portfolio. Assets with higher expected returns that create a lot of current and ordinary tax exposure can be shielded in the Roth IRA while lower expected return and tax inefficient assets can be held in traditional IRAs and personal accounts. Arguments AGAINST Converting If you expect to be in a lower tax bracket in the future, when you will begin taking distributions, converting now may be unwise. You will have to pay federal income tax on all or part of the amount you convert at your current income tax rate. If you will have to use IRA dollars to pay the conversion tax, the benefits of converting to a Roth IRA are substantially reduced. Using IRA dollars to pay the tax reduces the amount of funds in your IRAs, potentially jeopardizing your retirement goals. In addition, the IRA funds used to pay the tax may themselves be subject to federal income tax and possibly a premature distribution penalty tax. If you will need to use the funds before you are eligible for tax-free qualified distributions, any earnings you withdraw will be subject to income tax and penalties. In addition the IRS may recapture all or part of any penalty tax you should have paid when you made the conversion. One of the main reasons to consider contributing to a Roth IRA is that qualified distributions are completely tax-free. However, some experts are skeptical that this will always remain the case, given the uncertain status of Social Security and the projected lost federal revenue attributable to Roth IRAs. Of course, taxing them again would likely cause a tax rebellion! There has occasionally been talk of completely replacing the income tax with a consumption or value-added tax. While the likelihood of politicians completely eliminating the income tax is very slim, this would provide a backdoor method to tax Roth IRAs after all. Although most states follow the federal tax treatment of Roth IRAs, you should check with a tax professional regarding the tax treatment of Roth IRAs in your particular state. X Against Converting One of the main reasons to consider contributing to a Roth IRA is that qualified distributions are completely tax-free. However, some experts are skeptical that this will always remain the case, given the uncertain status of Social Security and the projected lost federal revenue attributable to Roth IRAs. Of course, taxing them again would likely cause a tax rebellion! To Roth or Not to Roth: Evaluating Your Options

10 Volume 1 Special Situations Depending on your overall situation, the loss of income may allow you to do a Roth conversion with little or no tax exposure. If you currently expect to have a tax liability of zero due to losses from a business venture (capital losses do not apply) or from itemized deductions that exceed your taxable income, you may be a prime candidate for a Roth conversion. You may be able to do a Roth conversion to offset these losses/deductions on a dollar-for-dollar basis and not even pay taxes on the conversion. If you are at the opposite end of the spectrum and are currently in the top marginal tax bracket and expect to stay there throughout retirement due to significant projected investment income, business profits, or IRA required minimum distributions, a Roth conversion may be perfect for you. In these current economic times, you might find yourself unemployed. Depending on your overall situation, the loss of income may allow you to do a Roth conversion with little or no tax exposure. Of course, you would want to be extra prudent when deciding to do a conversion to make sure you have ample resources available to fund a potential long-term loss of wages along with the tax liability that a conversion may create. 15 Roth Conversion Caveats 1. On a 2010 Conversion the Income is Split, Not the Tax is the only year that the income on the Roth conversion can be split and the ordinary income reported in 2011 and 2012 (50% each year). Income tax rates are scheduled to automatically increase for many taxpayers starting in Furthermore, many of these same high rate taxpayers may earn additional income from other sources in 2011 and Thus, pushing the conversion taxes out into 2011/2012 may not produce the best tax result. 2. New Roth IRA Accounts Need New Beneficiary Forms - Do not forget to complete new beneficiary forms designating who ultimately gets the money in the Roth IRA account. For all IRAs, the beneficiary designation form is the most important estate-planning document day Rollover Mistakes - Typically a Roth conversion is made by a trustee-to-trustee transfer called a direct rollover. If a custodian does not offer this type of transfer, they will send a check instead. You then have 60 days to place these funds into another qualified retirement account. If the deadline is missed, the funds become taxable, and they are no longer eligible for rollover. If you are under 59 ½ you may also be subject to a 10% early withdrawal penalty. 4. Partial Conversions Involving After-Tax Money: The Pro-rata Rule - If you have after-tax dollars, or basis, in your IRAs, you cannot isolate the after-tax amounts and convert them tax-free while keeping the remaining pre-tax dollars in the traditional IRA. A prorated amount of your basis is included with each dollar converted. The formula for calculating this amount is: Total basis in all IRAs divided by the total value of all IRAs, multiplied by the total amount converted. 5. Rolling to an IRA Mid-Year: Watch that Denominator - This only has impact if you have after-tax monies in a current IRA. As explained above, a prorated amount of basis is included with each dollar converted. Only IRA assets are considered, not 401(k) or profit sharing plan assets. If you roll your 401(k) plan into an IRA in the same year that you do a conversion, you may owe more tax on a conversion due to a smaller prorated basis amount. It is the end of the year IRA balance that determines the denominator for the pro-rata calculation. 9

11 6. RMDs Must be Taken First - If you are 70 ½ or older, you must first take your full Required Minimum Distribution (RMD) before converting all of your IRAs to a Roth IRA. If you are considering a partial conversion, you can do this conversion as a separate transaction in addition to taking the full RMD. The conversion does not reduce the amount of the RMD in the current year. 7. Some Funds are Not Eligible for Conversion or Contribution - The tax code allows only eligible rollover distributions to be converted to Roth IRAs. Items that cannot be converted include RMDs, 72(t) payments, hardship distributions, corrective distributions of excess deferrals, deemed distributions, and dividends from employer securities. 8. Non-Spouse Beneficiaries Cannot Convert Inherited IRAs - Through a direct transfer only, a non-spouse beneficiary can convert a qualified plan to an inherited Roth IRA. However, they cannot convert an inherited IRA to an inherited Roth IRA. Since non-spouse beneficiaries are unable to do a 60-day rollover, the direct transfer method is the only way to accomplish this type of conversion. 9. SIMPLE IRA 25% Penalty - SIMPLE IRAs have a 2-year holding period that is unique to each participant and starts once they have made their first contribution. Funds that leave a SIMPLE IRA in the first two years are treated as taxable distributions that are not eligible for rollover other than to another SIMPLE IRA. Thus, they cannot be converted to a Roth IRA. 10. The 10% Penalty Trap - A 10% penalty typically occurs when funds are withdrawn from an IRA before age 59 ½. The Roth conversion is an exception. However, two traps can still trigger the 10% penalty. If some of the funds withdrawn/withheld are used to pay the conversion tax, or if converted funds are withdrawn within the first five years and the Roth IRA owner is still under age 59 ½, the 10% penalty may apply. 11. Loss of Credits, Exemptions, Deductions and More - Under the tax code, there are many credits, exemptions, deductions, and other tax benefits that get phased out or otherwise eliminated as income increases. We recommend you review which benefits you are currently taking advantage of and at what income level they phase out. While an effective Roth conversion strategy can help you build significant longterm wealth for you and your family, it is important that you are diligent to ensure that you do not run over any tax pothole. The 15 Roth Conversion Caveats list provides the most common mistakes made by taxpayers when converting traditional IRAs to Roth IRAs. 12. Medicare Costs - Medicare Part B premiums are now based on income. A Roth conversion could move you into a higher premium bracket. For example, in 2010, the trigger for higher premiums starts with income over $170,000 for joint taxpayers. 13. Social Security Taxation - If you are currently not being taxed on your Social Security benefits, a Roth conversion may cause these benefits to be included in gross income. Depending on your total taxable income, this could cause anywhere from 50% to 85% of your Social Security to get taxed at ordinary rates resulting in a higher tax bill. 14. Financial Aid Loss - Most schools exclude a parent s retirement assets when considering a college student s eligibility for financial aid but look at income more closely. A Roth conversion can cause a spike in income that may inadvertently result in loss of valuable financial aid. 15. Net Unrealized Appreciation (NUA) - The NUA provision applies when company stock is held in a retirement plan. This provision allows the plan owner to take an in-kind, lump-sum distribution and pay income tax only on the basis of those shares, while any gain would be taxed at long-term capital gain rates when sold. Any NUA rollover to a Roth IRA (in an attempt to avoid capital gain tax on the gain) would first be treated as if it were rolled over into a traditional IRA and then converted to a Roth IRA, making the entire distribution taxable at ordinary income rates. To Roth or Not to Roth: Evaluating Your Options

12 Volume 1 Three Methods for Determining an Effective Roth IRA Conversion Strategy Conversion Strategies We recommend you consider using one of three methods to determine the best Roth conversion strategy: Determining the right Roth conversion strategy can save taxes, increase your retirement lifestyle, and materially increase the wealth you transfer to heirs. 1. PAVE (Portfolio Analysis Value- Enhancing Software) Year Tax Estimates 3. Rule of Thumb/ Common Sense Roth conversion analysis is not a perfect science. This is because there are many variables to consider including those you cannot control or predict like future tax rates and future investment returns. We recommend you consider using one of three methods to determine the best Roth conversion strategy. 1. PAVE (Portfolio Analysis Value- Enhancing Software) - PAVE is Savant s proprietary software that provides directionally sound feedback to help make a good decision regarding the use of Roth IRA conversions and other IRA distribution strategies to achieve your longterm financial goals. The PAVE portfolio analysis process starts by inventorying your current investment balances to project future portfolio balances over the course of your lifetime. On an annual basis, PAVE estimates your taxable portfolio income and combines it with your other sources of income. PAVE then determines the most appropriate withdrawal strategy to meet your living expense needs and income tax liabilities. PAVE accomplishes this by utilizing a sophisticated statistically based value-enhancing algorithm. In addition, PAVE can provide insight as to whether a Roth conversion may make sense for you. Unlike other less sophisticated Roth conversion software systems, PAVE helps you make decisions based on lifetime and even multi-generational cash flow and tax estimates Year Tax Estimates - In many cases converting to a Roth IRA over a 1-3 year time frame with the goal of maintaining your marginal tax rate below a target rate offers a tax-efficient strategy. Volunteering to pay all the tax at a higher marginal tax rate now, only to be in a lower tax bracket in the future when the funds may be needed, is typically not the best solution. Estimating taxable income and deductions over a 1-3 year period can help determine a reasonable 1-3 year conversion strategy. 3. Rule of Thumb/Common Sense - Sometimes just answering some simple questions and discussing your goals and objectives with your financial or tax advisor can clarify whether converting a traditional IRA to a Roth IRA or making annual Roth IRA contributions makes sense. For example, if you are still working and contributing to a 401(k) plan, consider diverting some of your annual 401(k) plan retirement savings to a Roth 401(k) plan if it is available. 11

13 Best Practices for Owning or Converting to a Roth IRA While there is often not a perfect answer when it comes to Roth IRAs, using common sense and making some reasonable estimates regarding the future may allow you to minimize your future tax burden. There are several general conclusions that apply to most, but not all investors. Consider direction of tax rates - Evaluate whether you think your personal income tax rate is headed up or down. Many people think tax rates will be higher in the future. This is because they think the government will need to increase income tax rates to fund the looming budget deficit, Social Security, and healthcare reform. For these individuals that are confident their rate will go up, Roth IRA conversions may make a lot of sense better to pay the tax today at lower rates and benefit from tax-free growth for many years. Other individuals may think that their personal tax rate may actually go down. This may be because they assume they will not earn much in retirement or because they suspect the government will reduce the income tax in the future in favor of a consumption tax. This individual may not be well served to do significant Roth IRA conversions. Moderation - In most cases, it is best to convert some of your traditional IRA to a Roth IRA rather than all of it. This is especially the case if you have a significant IRA balance. You do not want to voluntarily pay income taxes at a higher rate than necessary. Income Tax Diversification - Different types of accounts (e.g., Traditional IRAs, 401(k) plans, Roth IRAs, taxable accounts, etc.) have different tax treatments. Different types of accounts are taxed at different rates, at different times, and under different circumstances. In general, it is optimal to own a variety of these accounts. This way you can fund your annual retirement needs using distributions from a combination of taxable, tax-deferred, and tax-free accounts. The optimal distribution scheme will depend on your personal circumstances, income needs, tax rates, and asset values in retirement. Owning multiple account types provides options. In contrast, having only one bucket may prove unwise. To Roth or Not to Roth: Evaluating Your Options

14 Volume 1 Is a Roth conversion right for you? Optimal Asset Location Owning a combination of tax-free Roth IRAs, taxdeferred traditional IRAs and 401(k) plans, and taxable accounts allows you to more effectively lower taxes. Certain investment asset classes are very tax efficient while others are tax-nasty. More risky asset classes often offer higher long-term rates of return while preservation focused asset classes have lower expected returns. Given that risk, return and tax relationships are somewhat predictable over time, investors who own two or three account types can deliberately locate investments in certain accounts to minimize tax cost. For example, it makes sense to locate the most tax-nasty and highest expected return asset classes in your tax-free Roth IRA like U.S. and international small value stocks. In contrast, taxable accounts should typically hold tax efficient U.S. and international large stocks. Finally, taxdeferred traditional IRAs and 401(k) plans should hold lower expected return and high tax investments. Examples include taxable bonds, REITs, and commodities. Optimal asset location does not affect your overall return, but it does reduce what you pay on April 15th. Is a Roth conversion right for you? The answer to this question depends on many factors, including your current and projected future income tax rates, the length of time you can leave the funds in the Roth IRA without taking withdrawals, your state s tax laws, and how you will pay the income taxes due at the time of the conversion. And don t forget if you make a Roth conversion and it turns out to not be advantageous (for example, the value of your investments declines substantially), IRS rules allow you to undo the conversion. You generally have until your tax return due date (including extensions) to undo, or recharacterize, your conversion. For most taxpayers, this means you have until October 15, 2011, to undo a 2010 Roth conversion. Savant can help you decide whether a Roth conversion is right for you, and whether you should take advantage of the special deferral rule for 2010 conversions. This presentation provides a general overview of Roth IRA rules. It is designed to provide educational and /or general information and is not intended to provide specific legal, accounting, investment, tax or other professional advice. Rather, its intent is to form a basis for further discussion with your legal, accounting, and financial advisor. Savant Capital Management is a Registered Investment Advisor. Savant s marketing material should not be construed by any existing or prospective client as a guarantee that they will experience a certain level of results if they engage the advisor s services and may include lists or rankings published by magazines and other sources which are generally based exclusively on information prepared and submitted by the recognized advisor. Past performance is no guarantee of future results. 13

15 Savant Capital Management Savant Capital Management is an independent, fee-only wealth management firm headquartered in Rockford, IL. Since 1986, Savant has provided integrated investment management, financial planning, and family office services to financially established individuals, trust funds, retirement plans, and non-profit organizations. Savant strives to provide much-needed wisdom and focus in an era of information overload. We offer a personalized, comprehensive, and integrated approach to clients financial needs and help align your assets and decisions to work toward achieving your ideal future. Savant s goal is to provide insight, wisdom, and perspective to clients; to provide direction and confidence regarding your financial decisions. Savant serves you in a manner that we believe is fully transparent. This leads to greater peace of mind, simplicity, and clarity. As a fee-only advisor, Savant does not receive benefits from brokerage services, commissions, or finder s fees. In our opinion, this independence allows Savant to remain impartial. Additionally, Savant does not sell products and thus offers objective fiduciary advice and services that do not create conflicts of interest. We serve only you, our client. To assure that Savant adheres to industry best practices, we became one of the nation s first investment advisors to attain CEFEX Fiduciary Certifications from the Center for Fiduciary Excellence. Team Savant is comprised of highly educated, experienced, understanding, and responsible individuals who remain avidly alert for events, issues, or opportunities that may affect our clients lives. The team understands the intricacies of how financial markets work and is proactive in conveying information to assist you in making decisions to meet your goals. Savant is regularly recognized among the top wealth managers in the United States. In March of 2008, Savant was named the top independent advisor in Chicagoland by Chicago magazine. Recently, Savant was named by Barron s magazine as one of the 100 best independent financial advisors in the United States. Inc. magazine named Savant as the fastest growing Registered Investment Advisor in Illinois. Savant has also been recognized as one of the nation s top 100 financial advisors by Worth magazine each year since 1997 (list discontinued in 2008). Since 2004, Savant has been selected by Medical Economics magazine as one of the 150 best financial advisors for doctors in the nation. In addition, Savant has regularly been included in other prestigious top advisor lists published by Wealth Manager, Financial Advisor, Registered Representative, CPA Wealth Provider, J.K.Lassers, and Family Wealth Alliance. Finally, in 2006, Savant was included in The Wealth Factor A Team Approach, a book profiling ten of the most innovative and respected wealth management firms in the nation. National Recognition Chicago magazine #1 Independent Advisor Barron s Top 100 Financial Advisor Worth Top 100 Wealth Advisor Forbes Top 50 Registered Investment Advisor (RIA) Medical Economics Top 150 Best Financial Advisors for Doctors BusinessWeek Most Experienced RIA List Bloomberg/Wealth Manager Top Dog Inc. Magazine #91 Fastest-Growing Financial Services Company CPA Wealth Provider Ranked as a Top Wealth Manager Financial Advisor A Top-Growing Independent RIA InvestmentNews #39 Largest Wealth Management Firm To Roth or Not to Roth: Evaluating Your Options

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