Investors working with The Cairns Murray Thomson Group of Baird

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1 The Cairns Murray Thomson Group 2 nd Quarter 2015 Planning Points To: Investors working with The Cairns Murray Thomson Group of Baird From: Michael R. Murray, CFP, CRC Vice President Senior Investment Consultant Private Wealth Management Welcome to Planning Points, our quarterly newsletter designed to educate, entertain and Improve Your Financial Planning. IN THIS ISSUE Roth IRA Conversion Strategy Taxation of Social Security Benefits Non-Hardship In-Service Withdrawals Robert W. Baird & Co. Inc. does not offer tax or legal advice. Main: (262) Securities offered through Robert W. Baird & Co. Inc. Toll Free: (800)

2 Quotes of the Quarter: The charm of fishing is that it is the pursuit of what is elusive but attainable, a perpetual series of occasions for hope. John Buchan My movies were the kind they show in prisons and airplanes, because nobody can leave. Burt Reynolds I have called the major crisis of adolescence the identity crisis; it occurs in that period of the life cycle when each youth must forge for himself some central perspective and direction, some working unity, out of the effective remnants of his childhood and the hopes of his anticipated adulthood.. Erik Erikson Robert W. Baird & Co. Inc. does not offer tax or legal advice. Main: (262) Securities offered through Robert W. Baird & Co. Inc. Toll Free: (800)

3 Thank you for your business and please reach out to us with any questions you may have. Summer coming! Sincerely, The Cairns Murray Thomson Group Charles S. Cairns Michael R. Murray, CFP, CRC Gregory J. Thomson, CMT Senior Vice President Vice President Vice President Senior Investment Consultant Senior Investment Consultant Private Investment Manager Private Wealth Management Private Wealth Management Private Wealth Management Dee M. Warpechowski Client Specialist Chris A. Rossman Client Specialist Certified Financial Planner Board of Standards Inc. owns the certification marks CFP, CERTIFIED FINANCIAL PLANNER and federally registered CFP (with flame design) in the U.S., which awards to individuals who successfully complete CFP Board s initial and ongoing certification requirements. Robert W. Baird & Co. Inc. does not offer tax or legal advice. Main: (262) Securities offered through Robert W. Baird & Co. Inc. Toll Free: (800)

4 Private Wealth Management Products & Services Roth IRA Conversion Strategy Contributing to a Traditional IRA and then Converting to a Roth IRA While a change in the Roth conversion laws in January 2010 opened the door for high-income earners to convert a Traditional IRA to a Roth IRA, many are still prevented from making annual contributions directly to a Roth IRA. However, the change in the conversion rules does allow these same taxpayers to contribute to a Traditional IRA and then convert it to a Roth, thereby avoiding the income limitations associated with direct Roth IRA contributions. Roth IRA Contribution Rules The most that can be contributed to either a Roth or Traditional IRA is $5,500 for 2015, plus an extra $1,000 annually for taxpayers age 50 or older (combined limit for both Traditional and Roth IRAs). For Roth IRAs, the maximum contribution is reduced as a taxpayer s Modified Adjusted Gross Income (MAGI) exceeds certain thresholds, according to the table below: Full contribution Limited contribution No contribution MAGI Threshold for Married Taxpayers Filing Jointly MAGI Threshold for Single Taxpayers $0 - $183,000 $0 - $116,000 $183,000 - $193,000 $116,000 - $131,000 Over $193,000 Over $131,000 These eligibility rules apply to just Roth IRA contributions. The only eligibility rule for a Traditional IRA contribution is that you must have earned income, or have a spouse with earned income. This is what creates the planning opportunity. Planning Opportunity Starting in 2010, higher income earners can fund a Roth IRA by making contributions to a Traditional IRA and then converting the account to a Roth IRA 1. In most cases, this IRA contribution would be non-deductible. However, this also means that amount could be converted to a Roth IRA income taxfree (see the section titled The Pro-Rata Rule for more information). Any growth in the account between the contribution and conversion dates would be taxable, but that would likely be minimal if the conversion is done shortly after the contribution is made. As a result, this strategy allows anyone who is working, or their spouse, to essentially fund a Roth IRA through annual Traditional IRA contributions. 1 The IRS could attempt to apply the step transaction doctrine and treat the transaction as a direct Roth contribution. In order to minimize this risk, consider delaying the conversion rather than converting immediately after the contribution. While there is no guaranteed time frame that will avoid step transaction treatment, waiting a minimum of one month is suggested. Robert W. Baird & Co. does not provide tax advice. Please consult with your tax advisor before implementing any strategies Robert W. Baird & Co. Incorporated. Member NYSE & SIPC. First Use: 12/2009, updated 1/2015 Page 1 of 2

5 Roth IRA Conversion Strategy, continued. The Pro-Rata Rule This strategy is very simple when the individual does not have any other Traditional IRAs. However, if they do own any other IRAs with pre-tax balances, the calculation of the taxable portion of the conversion is more complicated. When converting IRA dollars to a Roth IRA, any pre-tax dollars that are converted are taxable at the time of conversion, but after-tax dollars can be converted tax-free. To determine the taxable portion of a Roth IRA conversion, you must aggregate all Traditional IRA balances and then determine the ratio of after-tax dollars to the overall value of all Traditional IRA accounts. This ratio then determines the tax-free portion of a Roth IRA conversion this is known as the Pro-Rata Rule. Balances in qualified plans (401(k)s, 403(b)s, etc.) and accounts owned by a spouse are not included in this calculation, although retirement plans such as SEP IRAs and Simple IRAs are included. After-tax dollars cannot be separated from pre-tax dollars when doing a Roth IRA conversion, even if they are held in a separate Traditional IRA account. Example Assume an individual has an IRA worth $95,000, none of which has ever been taxed. They then contribute $5,000 to a new IRA, but are not eligible to deduct the contribution. They then plan to convert that $5,000 IRA to a Roth, hoping that conversion could be done tax-free. The non-deductible portion of all their Traditional IRAs is 5% of the combined value ($5,000 / $100,000), so 5% of the converted amount is considered tax-free, or $250 (5% x $5,000). The taxpayer would report $4,750 of taxable income in the year of conversion ($5,000 - $250). Who should consider this strategy? This strategy is a way for high-income earners to legitimately get around the MAGI test for Roth IRA contributions. Because of the tax implications of the Pro-Rata Rule, though, it may still not be right for everyone. This idea will work best for those taxpayers who don t already have an IRA with pre-tax dollars. Two groups in particular that can benefit would be: Non-working spouses who have never contributed to a Spousal IRA. If a non-working spouse has never opened an IRA in the past, this may be a good opportunity. In order to contribute to an IRA, you must have earned income, although the Spousal IRA rules allow both spouses to contribute to an IRA even though only one is working. Workers who have spent most of their careers with the same employer. These employees have likely never rolled their retirement account from an employer s plan to an IRA, and therefore wouldn t be impacted by the Pro-Rata Rule. Those with pre-tax IRAs than can be rolled into an employer s plan. A reverse rollover is when an IRA is rolled back into an employer plan. By doing this, the pre-tax assets in the IRA can be moved back to the employer plan, and therefore are excluded from the pro rata calculation. Robert W. Baird & Co. does not provide tax advice. Please consult with your tax advisor before implementing any strategies Robert W. Baird & Co. Incorporated. Member NYSE & SIPC. First Use: 12/2009, updated 1/2015 Page 2 of 2

6 Private Wealth Management Products & Services Taxation of Social Security Benefits The amount of Social Security benefits that are taxable varies based on the taxpayer s level of Modified Adjusted Gross Income (MAGI): For single taxpayers with MAGI below $25,000 (and $32,000 for married couples filing jointly), Social Security benefits are completely tax free. Up to 50% of Social Security retirement benefits may be taxable in years that MAGI is between $25,000 and $34,000 for a single taxpayer, and between $32,000 and $44,000 for a married couple filing jointly. Up to 85% of benefits may be taxable in years that MAGI is in excess of $34,000 for a single taxpayer and in excess of $44,000 for a married couple filing jointly. For purposes of this rule, Modified Adjusted Gross Income is defined as (1) Adjusted Gross Income as it is calculated on a tax return (including all investment income, capital gains, retirement income, etc.) after adding back any deductions for student loan interest, tuition and fees plus (2) tax-exempt interest plus (3) half the Social Security benefits themselves. IRS Instructions to Form 1040 contains a worksheet which will help a recipient of Social Security calculate his or her tax liability. Baird does not offer tax or legal advice. Please consult your tax professional or attorney to discuss specific issues as they pertain to your individual situation Robert W. Baird & Co. Incorporated. Member NYSE & SIPC. First Use: 07/2009, Updated 8/2014. Page 1 of 1

7 Private Wealth Management Products & Services Non-Hardship In-Service Withdrawals Many employer sponsored retirement plans allow participants to access their account balances upon reaching age 59½. You can verify this either in the Summary Plan Description (SPD) provided by your plan or by contacting your benefits department. In-service withdrawals are taxable, unless the assets are rolled over into an IRA. Some of the advantages and disadvantages of this strategy are shown below. Advantages Ability to move out of potentially expensive investments More investment choices in an IRA; not limited to the investments in the plan Distribution exceptions to the 10% penalty Consolidation of IRA accounts and other retirement assets into one account No mandatory 20% withholding on IRA distributions Typically, more beneficiary options Disadvantages Consult with a tax advisor to fully understand any potential tax issues. Baird does not offer tax advice. Loans are not allowed in IRAs Possible additional management expense on investments If you have employer stock, you lose the opportunity for Net Unrealized Appreciation (NUA) strategy in an IRA If you retire at age 55 or older, plans allow for penaltyfree distributions Loss of RMD deferral available in retirement plan if still working 457(b) and 403(b) plans have special distribution rules that may be more beneficial than IRA IRA account opening fees may apply depending on the amount invested. There will also be costs associated with the investments in the account such as loads, expenses or brokerage commissions. Fees for optional services may also apply. Please consider investment expenses of each retirement vehicle before completing an IRA rollover. Generally speaking, ERISA retirement plan assets have unlimited protection from creditors under federal law. State laws vary in the protection of IRA assets in lawsuits. ERISA plans may allow for loans, while IRAs do not. After terminating employment at age 55 or older, participants can take penalty-free withdrawals from an ERISA retirement plan. However, penalty-free withdrawals generally may NOT be made from an IRA until age 59½. Traditional IRA distributions are taxed as ordinary income. Qualified Roth IRA distributions are also federally tax-free provided a Roth account has been open for at least five years and the owner has reached age 59½ or meets other requirements. Both may be subject to a 10% Federal tax penalty if distributions are taken prior to age 59½. Additional important information about rollover IRAs can be found at: Robert W. Baird & Co. Incorporated. Member NYSE & SIPC. Page 1 of 1