P L A N N I N G S T R A T E G I E S F O R R E T I R E D E X E C U T I V E S

Transcription

1 P L A N N I N G S T R A T E G I E S F O R R E T I R E D E X E C U T I V E S C O N N E R M C G EE, C F A, C F P O C T O B E R 2017 P R E P A R E D B Y C O N N E R M C G EE, C F A, C F P F I N A N C I A L A D V I S O R, PO R T F O L I O M A N A G E R T HE M I L L M A N G R O U P AT M O R G A N S T A N L E Y W E A L T H M A N A G E M E N T P A R K A V E N U E, 2 3 RD F L O O R, N EW Y O R K, N Y

2 Table of Contents I. EXECUTIVE SUMMARY II. III. IV. BACKGROUND CASE STUDY 1 RETIRED EXECUTIVE Circumstances Wealth Planning Current Strategy Wealth Planning Alternative Strategy Comparisons Implications CASE STUDY 2 INTEGRATING STRATEGY INTO CLIENT PLANNING Circumstances Summary of Strategies and Opportunities to Highlight V. SUMMARY 2

3 Executive Summary Retired executives often face high taxes in retirement due to payouts from corporate benefit plans including 401ks, deferred compensation, stock options and RSUs, pensions and taxable accounts. Many retired executives could save significant taxes by converting pre-tax dollars in their retirement plans into Roth IRAs. While a seemingly counter-intuitive strategy due to the upfront tax outlay, the long term effect of the Roth conversion is to save taxes by transforming tax deferred money into tax free money. o o o The pre-tax plan has a tax liability associated with it, thus the plan s actual value to the retired executive is reduced by his or her tax rate The executive may use funds in a taxable account to pay the Roth conversion tax, which effectively removes the tax liability from the retirement account without reducing the aggregate net of tax value of the executive s assets Each year following the conversion, the executive accrues more net of tax value than would have been possible prior to the conversion Of note: Future tax rate changes will impact this strategy. A tax increase makes the strategy more appealing. A tax decrease makes the strategy less appealing. 3

4 Background Many retired corporate executives are in the enviable position of having significant incomes. This creates tax challenges, as retired executives often face tax rates approaching 50%. Income Sources Basic Pension Executive Pension Deferred Compensation 401k RMDs IRA RMDs RSUs Options Investment Earnings Tax Sources Federal Tax Rate ~40% State and Local Tax Rate ~0-12% Net Investment Income Tax ~3.8% 4

5 Case Study 1 Overview Retired Executive John is a 62yr old retired executive. John s significant pension and investment income place them in the 39.6% federal tax bracket and 10% state and local tax bracket. Thus their combined marginal tax bracket is approximately 50%. Among his various investment accounts, John maintains a $1million retirement account and a $500,000 in a taxable account. He invests these accounts in taxable bonds, earning a pre-tax return of 6%. John and Mary s goals include paying as little as possible in tax and maximizing the legacy left to their children Jack and Susan. Assets $1,000,000 Retirement Account + $500,000 Taxable Account Net Assets After Tax: $1,000,000 (Retirement Account is 50% taxable) Objectives Minimize Taxes Maximize Legacy for Children 5

6 End Account Value End Account Value Case Study 1 Wealth Projections Current Strategy A projection of John and Mary s growth over time shows their retirement account and taxable account growing to $9,703,507 and $2,880,721, respectively by age 100. Accounting for the tax liability on their retirement account, this is a post tax combined value of $7,740,475. $10,000, $7,500, $5,000, $2,500, $- $4,000, $3,000, $2,000, $1,000, Retirement Account (Pre and After Tax) $- 6% growth rate Age Taxable Account 6% growth rate pre-tax ( 3% after-tax) Age For Illustrative Purposes Only Difference due to Pre-tax value 50% tax on Retirement Account distributions After-tax value 6% Pre-Tax Growth Rate 50% Tax rate on Retirement Account Distributions and Taxable Account Earnings Total combined after-tax value of retirement and taxable accounts: Age After-Tax Value $ 1,594,211 $ 2,068,907 $ 2,687,892 $ 3,495,866 $ 4,551,615 $ 5,932,511 $ 7,740,475 For Illustrative Purposes Only 6

7 End Account Value End Account Value Case Study 1 Wealth Projections Current Strategy Accounting for Required Minimum Distributions (RMDs) from the retirement plan will further reduce the projected value of John and Mary s assets. Distributions from the retirement plan are reinvested in the taxable account and earnings are subject to taxes. $3,000, Retirement Account with RMDs $2,000, $1,000, $- $6,000, $4,000, $2,000, $ Age Taxable Account with RMDs Reinvested Age For Illustrative Purposes Only Total combined after-tax value of retirement and taxable accounts: Pre-tax value After-tax value RMDs distributed annually beginning age 70.5 Age After-Tax Value $ 1,594,211 $ 2,061,348 $ 2,651,733 $ 3,393,249 $ 4,318,976 $ 5,468,923 $ 6,893,520 6% Pre-Tax Growth Rate 50% Tax rate on Retirement Account Distributions and Taxable Account Earnings Age 100 value is $847,000 lower due to RMDs For Illustrative Purposes Only 7

8 Case Study 1 Alternative Strategy As an alternative to maintaining their current account structure, John and Mary could convert their retirement account to a Roth IRA and pay the conversion tax using their taxable bond account. They are financially ambivalent today between these two options. Current Structure Alternative Structure $1,000,000 Retirement Account + $500,000 Taxable Account Or Convert Retirement Account to a Roth IRA Pay taxes due on conversion from taxable account $1,000,000 Roth IRA + -$500,000 Income Tax on Conversion Net Assets After Tax: $1,000,000 (Retirement Account is 50% taxable) Net Assets After Tax: $1,000,000 (Roth IRA is 100% tax free) For Illustrative Purposes Only Mary and Jack are financially ambivalent today between these two structures. Both result in the same after-tax value of $1,000,000 8

9 End Account Value Case Study 1 Wealth Projections Strategy Comparisons While financially ambivalent today, each subsequent year the Alternative Strategy (Roth IRA) generates incremental wealth vs. the current strategy. All of the Decker s assets grow at 6% after-tax in the Alternative Strategy, while a significant portion of their assets currently grow at 6% pre-tax and thus have a tax liability. Current Structure Alternative Structure Roth IRA Or $10,000, $7,500, $5,000, $2,500, $ Age Roth account growing 6% after-tax Taxable account growing 6% pre-tax For Illustrative Purposes Only Current Strategy Age After-Tax Value $ 1,594,211 $ 2,061,348 $ 2,651,733 $ 3,393,249 $ 4,318,976 $ 5,468,923 $ 6,893,520 Alternative Strategy (Roth Conversion) Age After-Tax Value $ 1,689,479 $ 2,260,904 $ 3,025,600 $ 4,048,935 $ 5,418,388 $ 7,251,025 $ 9,703,507 Age 100 after-tax value is $2,809,987 higher with the Alternative Strategy For Illustrative Purposes Only 9

10 Case Study 1 - Implications The difference in after-tax wealth which accrues to the Roth conversion strategy is a tax savings due to two factors: A reduction in tax drag on the executive s assets, because the value accruing in the taxable account is effectively moved into the tax free Roth IRA A reduction in tax drag due to the Roth IRA having no Required Minimum Distributions Factors which could impact the long term effectiveness of this strategy include potential tax rate changes and the potential for Roth IRAs to have RMDs. A careful analysis of a retired executive s circumstances and objectives may identify whether this and other opportunities exist to maximize wealth and minimize taxes. 10

11 Case Study 2 Integrating Strategy Into Client Planning - Circumstances Brad a senior executive wants to understand whether retiring at age 62 is feasible. He has accumulated $1,500,000 in a 401K, as well as taxable money, a vacation property and a pension that would provide $400,000 of annual income throughout his and his spouse s lifetime. Brad isn t sure when to take social security. As well he plans to defer distributions from his 401k until RMDs at age 70. Brad has after-tax dollars in his 401k. 11

12 Case Study 2 Summary of Strategies Creating a comprehensive net worth statement for Brad will serve as the basis for a cash flow based financial plan. The plan should incorporate all Brad s assets, cash flows, and financial goals. The plan should identify several planning strategies to include: Strategy #1: Deferring Social Security to age 70 Strategy #2: Rolling a 401k to an IRA and allocating after-tax dollars to a Roth IRA Strategy #3: Pre-RMD Roth conversions in retirement Strategy #4: Reallocating investments to a more efficient portfolio In total, planning recommendations have the potential to increase Brad s ending net worth by $2,267,

13 Case Study 2 Opportunities to Highlight Current Scenario Strategy #1: Defer Social Security to Age 70 Strategy #2: Roll 401k and Allocate After-Tax $ to Roth Strategy #3: Pre RMD Roth Conversions in Retirement Strategy #4: Reallocate to More Efficient Portfolio Recommended Scenario: All Strategies Combined Retire: Age 62 Retire: Age 62 Retire: Age 62 Retire: Age 62 Retire: Age 62 Retire: Age 62 Ending Value (Age 92): $11,680,000 Ending Value Net of Deferred Tax on Qualified Plans: $10,537,000 Strategy: Defer taking social security payments until age 70 Ending Value (Age 92): $11,923,000 Ending Value Net of Deferred Tax on Qualified Plans: $10,619,000 Value add vs. Current: $82,000 Reason for value add: Delaying Social Security to age 70 increases social security payments by 32% Strategy: Convert after-tax $ in a 401k to a Roth IRA Ending Value (Age 92): $11,918,000 Ending Value Net of Deferred Tax on Qualified Plans: $10,813,000 Value add vs. Current: $276,000 Reason for value add: Converting after-tax 401k $ to a Roth IRA allows future growth to be completely tax free Strategy: Annual conversions from retirement plan to Roth IRA of $75,000 from retirement to age 70 Ending Value (Age 92): $13,050,000 Ending Value Net of Deferred Tax on Qualified Plans: $12,391,000 Value add vs. Current: $1,854,000 Reason for value add: Annual Roth conversions of $75,000 from retirement (age 62) until age 70 lower the overall tax rate applied to plan distributions over time and shifts assets to a Roth IRA, which requires no RMDs. Strategy: Reallocate to a more efficient portfolio to boost returns and reduce risk Ending Value (Age 92): $11,945,000 Ending Value Net of Deferred Tax on Qualified Plans: $10,790,000 Value add vs. Current: $253,000 Reason for value add: Reallocating to a portfolio on the efficient frontier reduces risk and increases expected return, thereby improving end values Ending Value (Age 92): $13,447,000 Ending Value Net of Deferred Tax on Qualified Plans: $12,804,000 Value add vs. Current: $2,267,000 For Illustrative Purposes Only 13

14 Summary Corporate Executives face significant taxes in retirement. Identifying and implementing tax savings strategies, including Roth IRA conversions, may meaningfully increase a retired executive s net worth. Integrating these tax savings into a client s financial planning helps to afford an opportunity to highlight your value as a tax advisor by demonstrating the financial impact these strategies may have on a client s net worth. 14

15 Thank You Questions? Conner McGee CFA CFP Financial Advisor The Millman Group at Morgan Stanley Wealth Management 399 Park Avenue, New York, NY (212)

16 Disclaimer THE INFORMATION CONTAINED IN THIS PRESENTATION IS FROM SOURCES B ELIEVED TO BE RELIABLE BUT CANNOT BE RELIED UPON AS FACT. MORGAN STANLEY DOES NOT GIVE TAX ADVICE. PLEASE REFER TAX RELATED QUESTIONS TO THE APPROPRIATE TAX ADVISOR. ALL PROJECTIONS AND CALCULATIONS RELATED TO THE ILLUSTRATED STRATEGI ES ARE GENERAL IN NATURE AND CANNOT BE APPLIED TO ANY ONE PERSON S SPECIFIC CIRCUM STANCES. INDIVIDUALS SHOULD CONSULT WITH THEIR TAX ADVISORS FOR FURTHER I NFORMATION. THIS PRESENTATION DOES NOT REPRESENT THE VIEWS OF MORGAN STANLEY. TH E CASE STUDIES ARE FICTIONAL AND NOT BASED ON REAL PEOPLE. 16

17 Disclosures Asset Allocation does not assure a profit or protect against loss in declining financial markets. Actual results may vary and past performance is no guarantee of future results. Morgan Stanley Smith Barney LLC ( Morgan Stanley ), its affiliates and Morgan Stanley Financial Advisors or Private Wealth Advisors do not provide tax or legal advice. Clients should consult their tax advisor for matters involving taxation and tax planning and their attorney for matters involving trust and estate planning and other legal matters. Morgan Stanley offers a wide array of brokerage and advisory services to its clients, each of which may create a different type of relationship with different obligations to you. Please consult with your Financial Advisor to understand these differences