Managing taxes in retirement

Transcription

1 Managing taxes in retirement

2 Agenda The up- and down-side of tax-deferred saving Manage taxes by reducing Required Minimum Distributions (RMDs) Overcoming the retirement tax cliff with Roth conversions Considerations for affluent households 2

3 Trillion 0903c02a81208d35 U.S. retirement assets Estimated retirement asset growth over time, $ trillions Private DB assets Public DB assets DC assets IRA assets Annuities outside of retirement accounts $3.0T $5.4T $7.9T $8.6T $1.9T 2017 $45 $40 $35 Long term mutual funds outside of retirement accounts $5.9T 2017 retirements assets $32.7T $30 $25 $20 $15 $10 $5 $ Source: ICI, Cerulli, J.P. Morgan Asset Management analysis. Long Term Mutual Funds excludes money market funds.

4 Due to increased income and more tax-deferred wealth, tax planning in retirement is more important than ever Income has increased substantially over time in households age 65+ Mix of retirement sources for households approaching retirement Social Security DB plans DC & IRA assets Other assets Net housing wealth 1.6x 100% 80% 60% 40% 8% 82% 10% 18% 8% 8% 9% 25% 22% 23% 23% 11% 15% 11% 31% 36% 15% 14% 49% 19% 18% 64% 58% % 0% 41% 15% 28% 14% Bottom Second Third Fourth Top $93,500* $294,000* $543,000* $904,000* $2,000,000* Real adjusted gross income 4 Source: IRS, 2014 dollars, ages determined by householder *Approximate average level of augmented wealth in 2006 for augmented wealth quintile, which includes estimates of Social Security and DB benefits as assets Note: Households with the top and bottom 1 percent of wealth are excluded. Social Security wealth is estimated as the present discounted value (PDV) of the stream of Social Security benefits. Net housing wealth is the value of the home less mortgages. DB pension wealth is estimated as the PDV of the stream of DB benefits. Retirement assets include DC plan assets (401(k), 403(b), 457, thrift, and other DC plans) and IRAs (traditional, Roth, SEP, SAR-SEP, and SIMPLE). DB pension and retirement assets are derived from work in both the private-sector and the government sector. Source: Investment Company Institute tabulation derived from Gustman, Steinmeier, and Tabatabai (2009) using Health and Retirement Study (HRS) data

5 Spending Consider proactive tax management strategies 25 KEEP A BIGGER SLICE Tax-advantaged accounts can shelter income-producing investments from current income taxation and result in greater longterm growth than taxable accounts. Actively managing your tax picture in retirement may help you keep even more of your taxdeferred wealth. 5 Source: J.P. Morgan Asset Management. Assumes $5,500 after-tax contributions at the beginning of each year for 30 years and 6.0% annual investment return that is assumed to be subject to ordinary income taxes (capital gains and qualified dividends are not considered in this analysis). Tax-deferred account balance is taken as lump sum and taxed at the 15%, 25% and 33% federal tax rate, respectively, at time of withdrawal. Taxable account contributions are after tax and assume a 33% federal tax rate during accumulation. This hypothetical illustration is not indicative of any specific investment and does not reflect the impact of fees or expenses. This chart is shown for illustrative purposes only. Past performance is no guarantee of future results.

6 Agenda The up- and down-side of tax-deferred saving Manage taxes by reducing Required Minimum Distributions (RMDs) Overcoming the retirement tax cliff with Roth conversions Considerations for affluent households 6

7 The charitable IRA rollover is now permanent Qualified Charitable Distributions ( IRA charitable rollovers ) allow RMDs to be transferred to charity and are not included in owner s taxable income Donor must be age 70½ Annual $100,000 cap IRA Direct transfer Charitable organization* Transfer from Traditional/Roth IRAs only Transfer prioritizes deferred taxable income first No tax deduction on transfer but removes amount from AGI 7 Consolidated Appropriations Act of 2016 *Not applicable to supporting organizations, donor advised funds or private foundations

8 After-tax contributions to 401(k) plans Make additional after-tax contributions to leverage tax-deferred growth and diversify retirement accounts PRE-RETIREMENT $53,000 limit Employer may make additional after-tax contributions* RETIREMENT Rollover after-tax amounts to Roth POST-RETIREMENT +$6,000 age 50+ limit Rollover pre-tax amounts to Traditional $ $18,000 Annual pre-tax contribution limit $ 401(k) Traditional IRA Roth IRA 8 *Subject to plan provisions Contributions limits as of 2016 IRS Notice

9 Qualified Longevity Annuity Contracts (QLAC) Delay taxes with a QLAC and secure a stream of income for later retirement years Distributions must commence by age 85 Retirement account One-time 25% or $125,000 max withdrawal from retirement account Invested into a QLAC product Transfer is not a taxable event QLAC (Qualified Longevity Annuity Contract) Distributions subject to tax Growth is tax-deferred Provides annual income to owner for life or period certain 9 Internal Revenue Bulletin:

10 NUA strategy for Employer Stock Option Plans Minimize RMDs and receive favorable tax treatment for retirement assets on net unrealized appreciation (NUA) 401(k) ASSETS NEW ACCOUNTS Mutual fund Rollover Not a taxable event IRA pay ordinary income on distributions Company stock cost basis In kind distribution Pay ordinary income tax on cost basis at time of distribution Brokerage account pay capital gains tax when stock is later sold 26 CFR

11 Increase in MAGI may impact taxes in retirement Large RMDs, excess withdrawals and Roth conversions may trigger 3.8% Medicare Surtax and increase Medicare premiums Income thresholds: Single: $200,000 Married: $250,000 Sandra s MAGI: $170,000 $200,000 income threshold Net investment income Capital gains Interest Royalties & rents Annuity distributions Current MAGI: Includes $30,000 in investment income $40k $30k Trigger: Roth IRA conversion of $40,000 $140k How surtax applies The lesser of net investment income or amount above threshold New MAGI: $210,000 Subject to Medicare Surtax: $10,000 Roth Conversion MAGI (Capital gains) MAGI 11 Modified Adjusted Gross Income (MAGI) is AGI plus certain deductions added back such as foreign earned income, tax-exempt interest, taxable IRA contributions and Social Security payments.

12 Agenda The up- and down-side of tax-deferred saving Manage taxes by reducing Required Minimum Distributions (RMDs) Overcoming the retirement tax cliff with Roth conversions Considerations for affluent households 12

13 Saving Evaluate a Roth at different life stages 18 THINK OPPORTUNISTICALLY Effectively managing taxes over a lifetime requires a careful balance of your current income tax picture and building income tax diversification. Consider: 1. Contributing to a Roth early in your career and shifting as your income increases. 2. Roth 401(k) contributions in peak earning years if wealth is concentrated in tax-deferred accounts. 3. Proactive Roth conversions in lower income retirement years if RMDs are likely to push you into a higher tax bracket. 13 *If eligible to make a deductible contribution (based on your MAGI). The illustration reflects savings options into Traditional and Roth IRA accounts, as well as into pre-tax retirement and Roth 401(k) accounts. RMD = Required Minimum Distribution. RMDs are calculated every year based on the account value and the owner s life expectancy using IRS actuarial data. IRA owners must begin taking RMDs no later than April 1 following the year the owner turns age 70½. For owners of employer-based qualified plans, RMDs must begin at age 70½ or when the owner retires, whichever is later. Owners of Roth IRAs are not required to take RMDs; however, RMDs are required in Roth 401(k) accounts. Any employer contribution will be applied to the participant s pre-tax retirement account for both Traditional and Roth 401(k) plans, and subsequent distributions will be subject to tax. The above example is for illustrative purposes only. Source: J.P. Morgan Asset Management

14 Tax bracket Tax bracket Tax bracket The retirement tax experience: Past, present and (possibly) future Tax experience for defined benefit participants Pension distributions Social Security benefits RMDs Age 62 Age 70 ½ Tax experience for defined contribution participants RMDs Withdrawals from taxable accounts Social Security benefits Age 62 Age 70 ½ Hypothetical tax experience incorporating pre-70 ½ retirement withdrawals Proactive Roth conversions Withdrawals from taxable accounts Social Security benefits RMDs Age 62 Age 70 ½ 14 For illustrative purposes only. Source: J.P. Morgan Asset Management

15 Current taxable income Leverage the wiggle room within an individual s top income tax bracket The more space below the top of the bracket, the more opportunity for a Roth conversion 28% Top marginal income tax bracket 25% 15% Yes Yes No 15 For illustrative purposes only

16 Case studies: Meet the million dollar household families RMD Couple Taxable Couple Roth Couple Married couple, same age, retire at age 60 $1 million portfolio, 50/50 split between taxable account and IRA/401(k) Invested 30/70 in equity/fixed income, 5.2% estimated annual return Begin claiming Social Security at age 66 (full retirement age) Maximum wage earners from Social Security perspective Initial spending need: $75,000, grown by 1.5% Draw from taxable assets first Wait until age 70 ½ when RMDs begin Withdraw amount from tax-deferred account within existing tax rate from age N/A Reinvest excess withdrawal in taxable account Convert excess withdrawal into Roth IRA and taxable account 16 For illustration purposes only. Investors should ensure to seek all necessary legal, regulatory and tax advice on the consequences of an investment in the product(s).

17 Withdrawal amount Portfolio value The RMD Couple: Tap taxable assets first, then RMDs at age 70½ Sources of income in retirement Spending need Total federal taxes Social Security benefits Taxable portfolio (end of year) Taxable withdrawal Tax-deferred portfolio (end of year) RMD Tax-deferred withdrawal $200,000 $1,600,000 $180,000 $160,000 $140,000 $120,000 $1,400,000 $1,200,000 $1,000,000 $100,000 $800,000 $80,000 $60,000 $40,000 $20,000 $600,000 $400,000 $200,000 $ Age $0 17 Source: J.P. Morgan Asset Management

18 Adjusted gross income Tax implication: With RMD approach, marginal tax rate jumps to 15% at 70½ Components of AGI Taxable Social Security Benefits Ordinary Investment Income Tax-Deferred Withdrawal Tax rate $200,000 $150,000 15% $100,000 10% $50,000 $ Age Standard Deduction 18 Note: Does not include capital gains income since it is taxed differently Source: J.P. Morgan Asset Management

19 Case studies: Meet the million dollar household families RMD Couple Taxable Couple Roth Couple Married couple, same age, retire at age 60 $1 million portfolio, 50/50 split between taxable account and IRA/401(k) Invested 30/70 in equity/fixed income, 5.2% estimated annual return Begin claiming Social Security at age 66 (full retirement age) Maximum wage earners from Social Security perspective Initial spending need: $75,000, grown by 1.5% Draw from taxable assets first Wait until age 70 ½ when RMDs begin Withdraw amount from tax-deferred account within existing tax rate from age N/A Reinvest excess withdrawal in taxable account Convert excess withdrawal into Roth IRA and taxable account 19 For illustration purposes only. Investors should ensure to seek all necessary legal, regulatory and tax advice on the consequences of an investment in the product(s).

20 Withdrawal amount Portfolio value The Roth Couple: Tap retirement assets and make Roth IRA conversions with excess withdrawals Sources of income in retirement Spending need Taxable portfolio (end of year) Tax-deferred portfolio (end of year) Roth portfolio (end of year) Total federal taxes Taxable withdrawal RMD Roth withdrawal Social Security benefits Tax-deferred withdrawal $200,000 $1,600,000 $180,000 $1,400,000 $160,000 $140,000 $1,200,000 $120,000 $1,000,000 $100,000 $800,000 $80,000 $60,000 $40,000 $20,000 $600,000 $400,000 $200,000 $ Age $0 20 Source: J.P. Morgan Asset Management

21 Adjusted gross income Tax implications: Tax rate stays at 10% throughout most of retirement Components of AGI Taxable Social Security Benefits Ordinary Investment Income Tax-Deferred Withdrawal Tax rate $200,000 $150,000 15% $100,000 10% $50,000 $ Age Standard Deduction 21 Note: Does not include capital gains income since it is taxed differently Source: J.P. Morgan Asset Management

22 Million dollar household summaries: Overall tax, wealth and RMD implications The RMD Approach The Taxable Account Approach The Roth Conversion Approach Total ending wealth*: $1,573,387 Taxable portfolio: $1,079,944 Tax-deferred*: $493,443 Roth: N/A $1,589,777 $1,311,015 $278,762 N/A $1,907,073 $157,192 $196,162 $1,553,719 Total RMDs: $1,335,490 $743,734 $520,255 Ordinary income taxes: $293k $241k $53k 22 *Represents final portfolio after average effective federal taxes Source: J.P. Morgan Asset Management

23 Agenda The up- and down-side of tax-deferred saving Manage taxes by reducing Required Minimum Distributions (RMDs) Overcoming the retirement tax cliff with Roth conversions Considerations for affluent households 23

24 Factors that can make or break the Roth conversion strategy A Roth conversion strategy may be available to affluent/hnw clients depending on certain factors: Make: the building blocks Break: factors to consider Marginal tax bracket Longevity Time before RMDs begin (age 70 ½) Portfolio returns Mix of account types Legacy planning 24 For illustrative purposes only

25 Case studies: Meet the $6mm households John & Jane Doe The HNW household Married couple, same age, retire at age 60 John & Jane DeLay Retire later Married couple, same age, retire at age 65 John & Jane Elsewhere Mix of accounts Married couple, same age, retire at age 60 $6 million portfolios, split 50/50 between taxable account and IRA/401(k) $6 million portfolios, split 50/50 between taxable account and IRA/401(k) $6 million portfolio, split 20/80 and 80/20 between taxable account and IRA/401(k) Begin claiming Social Security at age 66 (full retirement age) Maximum wage earners from Social Security perspective Initial spending need: $240,000, grown by 1.5% Draw from taxable assets first 25

26 Withdrawal amount Portfolio value Roth approach: Tap retirement assets and make Roth IRA conversions with excess withdrawals Sources of income in retirement Social Security Benefits Taxable Withdrawal RMD Tax-Deferred Withdrawal ROTH Withdrawal Federal Taxes Paid from RMD Additional Federal Taxes Spending Need Taxable Portfolio (End Of Year) Tax-Deferred Portfolio (End Of Year) ROTH Portfolio (End Of Year) $600,000 $5mm $500,000 $4mm $400,000 $300,000 $200,000 $3mm $2mm $100,000 $1mm $ Age $0mm 26 Note: Does not include capital gains income since it is taxed differently Source: J.P. Morgan Asset Management

27 Adjusted gross income Roth approach: Leverage top tax bracket early to save taxes later $1,000,000 Taxable Social Security Benefits Investment Income Tax-Deferred Withdrawal $900,000 $800,000 $700,000 33% $600,000 $500,000 28% $400,000 $300,000 $200,000 $100,000 25% 15% 10% $ Age 27 Note: Does not include capital gains income since it is taxed differently Source: J.P. Morgan Asset Management

28 Roth conversion helps to reduce taxes and increase ending wealth Taxes Ending wealth AMT Medicare surtax Capital gains Ordinary income $162k $88k $181k $45k $62k $185k 44% 56% 6% greater wealth RMD approach $5.40mm $2.08mm 14% tax savings $1.87mm 30% 32% RMD RMD approach $2.51mm Roth approach Roth $2.16mm Taxable Tax-deferred Roth 38% Roth approach $5.74mm 28 Source: J.P. Morgan Asset Management

29 Minimize RMDs and taxes with a Roth 401k Income Savings 401(k) ROTH Traditional Age 70 ½ Rollover to Roth IRA No RMDs required Taxable RMDs begin 29

30 Diversify taxes in retirement with a Roth 401(k) account Including a Roth 401(k) among retirement accounts can better diversify taxes even with the RMD approach 50 / 50 Roth approach Taxable / tax-deferred 50 / 25 / 25 RMD approach Taxable / tax-deferred / Roth AMT Medicare surtax Capital gains Ordinary income $62k $45k $185k $1.87mm $95k 58% tax savings $812k 50 / / 25 / 25 $2.16mm $907k 30 Source: J.P. Morgan Asset Management

31 31 Questions?

32 32 Appendix

33 Tax planning for retirement assets Ways to mitigate taxes by minimizing RMDs Roth IRA conversions/roth 401(k) contributions Qualified IRA charitable distributions After-tax contributions to 401(k) plans Qualified Longevity Annuity Contract (QLAC) opportunities Employee Stock Ownership Plans (ESOPs) 33

34 % change in Roth approach vs RMD approach The Roth conversion sweet spot for affluent/hnw clients The benefits of a Roth conversion strategy diminish as portfolio values increase in a 50/50 mix retirement account 16% 14% 13.9% 14.1% % decrease in Taxes % increase in End Portfolio 12% 10% 10.2% 9.2% 9.8% 8% 6% 4% 4.2% 6.4% 5.6% 6.4% 4.5% 5.9% 5.3% 2% 2.1% 2.0% 0% $3 million $4 million $5 million $6 million Net worth $7 million $8 million $9 million 34 Source: J.P. Morgan Asset Management

35 Withdrawal amount Portfolio value RMD approach: Tap taxable assets first and wait until age 70 ½ for RMDs from tax-deferred assets Sources of income in retirement Social Security Benefits Taxable Withdrawal RMD Tax-Deferred Withdrawal Federal Taxes Paid from RMD Additional Federal Taxes Spending need Taxable Portfolio (End Of Year) Tax-Deferred Portfolio (End Of Year) $600,000 $6mm $500,000 $5mm $400,000 $4mm $300,000 $3mm $200,000 $2mm $100,000 $1mm $ Age $0mm 35 Note: Does not include capital gains income since it is taxed differently Source: J.P. Morgan Asset Management

36 Adjusted gross income RMD approach: Income tax rate jumps 2 brackets at age 70 ½ $1,000,000 Taxable Social Security Benefits Investment Income Tax-Deferred Withdrawal $900,000 $800,000 $700,000 33% $600,000 $500,000 $400,000 28% $300,000 25% $200,000 $100,000 $ Age 15% 10% 36 Note: Does not include capital gains income since it is taxed differently Source: J.P. Morgan Asset Management

37 37 J.P. Morgan Asset Management Index definitions & disclosures

38 38 J.P. Morgan Asset Management Disclosures