Advanced IRA Planning

Advanced IRA Planning Presented by: Robert S. Keebler, CPA, MST, AEP 420 South Washington Street Green Bay, WI 54301 1 Agenda Tax consequences of large IRAs Roth conversions Life insurance Stretch IRA planning IRAs payable to trusts 2 1

The Possibly Devastating Tax Consequences of Large IRAs 3 Bracket Management Poor Bracket Management Scenario $800,000 $700,000 $600,000 $500,000 $400,000 $300,000 $200,000 $100,000 $ Taxable Income and RMD Taxable Income IRA Distributions 39.6% Bracket 35% Bracket 33% Bracket *Taken from a product created by for the AICPA called the Tax Rate Evaluator: A Graphical Calculator for Tax Planning After ATRA (PTX1307M). It is available at www.cpa2biz.com or by calling 1 888 777 7077. 4 2

Bracket Management Poor Bracket Management Scenario Taxable Income per Bracket $800,000.00 $700,000.00 $600,000.00 $500,000.00 $400,000.00 $300,000.00 $200,000.00 $100,000.00 $ 10.00% 15.00% 25.00% 28.00% 33.00% 35.00% 39.60% *Taken from a product created by for the AICPA called the Tax Rate Evaluator: A Graphical Calculator for Tax Planning After ATRA (PTX1307M). It is available at www.cpa2biz.com or by calling 1 888 777 7077. 5 Bracket Management Bracket Management Example Married Filing Jointly Taxpayer 5 Year Projection In 2013: $150,000 Wages $50,000 Long Term Capital Gains $20,000 Itemized Deductions In 2015: RMDs on a $5,000,000 IRA start 2% Inflation Rate 6 3

Bracket Management Bracket Management Example INCOME 2013 2014 2015 2016 2017 Wages $150,000 $153,000 $156,060 $159,181 $162,365 Long Term Capital Gains 50,000 51,000 52,020 53,060 54,122 IRA Distributions 210,880 226,438 243,133 Subtotal $200,000 $204,000 $418,960 $438,679 $459,620 Adjusted Gross Income $200,000 $204,000 $418,960 $438,679 $459,620 Itemized Deductions $ 20,000 $ 20,400 $ 17,239 $ 17,064 $ 16,860 Net Personal Exemptions 7,800 8,000 328 Taxable Income $ 27,800 $ 28,400 $ 17,567 $ 17,064 $ 16,860 Regular Income Tax $29,908 $30,490 $98,442 $104,438 $110,727 Alternative Minimum Tax 3,821 4,116 4,542 Net Inv. Income Tax 1,977 2,016 2,057 TOTAL INCOME TAX $29,908 $30,490 $104,240 $110,570 $117,326 *Taken from a product created by for the AICPA called the Tax Rate Evaluator: A Graphical Calculator for Tax Planning After ATRA (PTX1307M). It is available at www.cpa2biz.com or by calling 1 888 777 7077. 7 Bracket Management Bracket Management Example 2013 2014 2015 2016 2017 MARGINAL INCOME TAX RATE 25.00% 25.00% 33.00% 33.00% 33.00% MARGINAL CAPITAL GAINS RATE 15.00% 15.00% 15.00% 15.00% 15.00% CURRENTLY SUBJECT TO NIIT No No Yes Yes Yes MARGINAL INC. RATE if NIIT APPLIES 25.00% 25.00% 36.80% 36.80% 36.80% MARGINAL CAP GAIN RATE WITH NIIT 15.00% 15.00% 18.80% 18.80% 18.80% AVERAGE RATE 14.95% 14.95% 24.88% 25.21% 25.53% DISTANCE TO NEXT TAX BRACKET $50,850 $47,450 $48,607 $28,384 $7,240 DISTANCE TO FOLLOWING BRACKET 226,150 222,750 Max Max Max AMOUNT ABOVE 39.6% BRACKET *Taken from a product created by for the AICPA called the Tax Rate Evaluator: A Graphical Calculator for Tax Planning After ATRA (PTX1307M). It is available at www.cpa2biz.com or by calling 1 888 777 7077. 8 4

Bracket Management Bracket Management Example 2013 2014 2015 2016 2017 DISTANCE TO PEP/PEASE $100,000 $96,000 $ 118,960 Over $ 138,679 Over $ 159,620 Over TAX COST OF PEP/PEASE $ $ $ 3,775 $ 4,145 $ 4,418 RATE IMPACT OF PEP/PEASE 0.00% 0.00% 0.94% 0.98% 1.00% % OF ITEMIZED DEDUCTIONS LOST 0.00% 0.00% 17.15% 19.60% 22.12% 2013 2014 2015 2016 2017 MAGI LESS THRESHOLD (A) $ $ $168,960 $188,679 $209,620 NET INVESTMENT INCOME (B) 50,000 51,000 52,020 53,060 54,122 LESSOR OF A OR B $ $ $52,020 $53,060 $54,122 NIIT @ 3.8% $ $ $1,977 $2,016 $2,057 DISTANCE TO 3.8% NIIT 50,000 46,000 Over Over Over AMOUNT OVER THRESHOLD N/A N/A 168,960 188,679 209,620 *Taken from a product created by for the AICPA called the Tax Rate Evaluator: A Graphical Calculator for Tax Planning After ATRA (PTX1307M). It is available at www.cpa2biz.com or by calling 1 888 777 7077. 9 Bracket Management Bracket Management Example 2013 2014 2015 2016 2017 REGULAR INCOME TAX $ 29,908 $ 30,490 $ 98,442 $ 104,438 $ 110,727 TENTATIVE MINIMUM TAX 28,742 29,516 102,264 108,554 115,269 ALTERNATIVE TAX DUE $ $ $ 3,821 $ 4,116 $ 4,542 DISTANCE UNTIL AMT APPLIES $ 4,163 $ 3,479 Applies Applies Applies 2013 2014 2015 2016 2017 CAPITAL GAINS TAXED AT 0% $ $ $ $ $ CAPITAL GAINS TAXED AT 15% $ 50,000 $51,000 $52,020 $53,060 $54,122 CAPITAL GAINS TAXED AT 20% $ $ $ $ $ DISTANCE TO NEXT CAPITAL GAINS BRACKET $277,800 $274,400 $48,607 $28,384 $7,240 MARGINAL CAPITAL GAINS RATE 15.00% 15.00% 15.00% 15.00% 15.00% *Taken from a product created by for the AICPA called the Tax Rate Evaluator: A Graphical Calculator for Tax Planning After ATRA (PTX1307M). It is available at www.cpa2biz.com or by calling 1 888 777 7077. 10 5

11 Convertible accounts Roth IRAs General Concepts Non convertible accounts Traditional IRAs Inherited IRAs 401(k) plans Education IRAs Profit sharing plans 403(b) annuity plans 457 plans (b) Inherited 401(k) plans (see Notice 2008 30) 12 6

Reasons to Convert to a Roth IRA 1) Suspension of RMDs provides a considerable advantage for individuals who do not require RMDs for living expenses. 2) Federal tax brackets compress when the first spouse passes and the surviving spouse begins filing Single thereby making RMDs more painful. 3) Tax rates very well might increase in the near future. 4) Conversion reduces the account owners overall estate, thereby lowering the effect of higher estate tax rates. 5) Post death distributions to beneficiaries are tax free. 13 Conversion Types Strategic conversions Take advantage of a client s long term wealth transfer objectives Tactical conversions Take advantage of short term client specific income tax attributes that are set to expire (e.g., low tax rates, tax credits, charitable contribution carryovers, NOL carryovers, etc.) Opportunistic conversions Take advantage of short term stock market volatility, sector rotation and rotation in asset classes Hedging conversions Take advantage of projected future events that will result 14 7

Taxation of Roth IRA Conversions When a traditional IRA has non deductible contributions, a portion of the conversion to a Roth IRA will be non taxable basis to the IRA owner In determining the non taxable portion of a Roth IRA conversion, all traditional IRAs and IRA distributions during the year (including outstanding rollovers) must be combined for apportioning basis See IRS Form 8606 15 Taxation of Roth IRA Conversions Basic Apportionment Formula 16 8

Mathematics of Roth IRA Conversions In simplest terms, a traditional IRA will produce the same after tax result as a Roth IRA provided that: The annual growth rates are the same The tax rate in the conversion year is the same as the tax rate during the withdrawal years (i.e. A x B x C = D; A x C x B = D) 17 Mathematics of Roth IRA Conversions 18 9

Mathematics of Roth IRA Conversions Critical decision factors: Tax rate differential (year of conversion vs. withdrawal years) Use of outside funds to pay the income tax liability Need for IRA funds to meet annual living expenses Time horizon 19 Mathematics of Roth IRA Conversions The key to successful Roth IRA conversions is to keep as much of the conversion income as possible in the current marginal tax bracket However, there are times when it may make sense to convert more and go into higher tax brackets Also, in additional to brackets, it s important to consider the 3.8% NIIT, the AMT, & PEP/PEASE. Also, healthcare premium subsides or Medicare premiums will be effected by income 20 10

Possible Target Conversion Amount 10% tax bracket Current taxable income 15% tax bracket Mathematics of Roth IRA Conversions 25% tax bracket 3.8% Surtax 28% tax bracket 21 PEP/ PEASE 33% tax bracket 35% tax bracket 39.6% tax bracket Life Insurance 22 11

Life Insurance IRA ILIT Strategy Inherited IRA Tax Spiral ISSUE: Perhaps the single biggest issue with an inherited IRA is that the IRA owner s estate oftentimes needs to utilize the IRA to pay the applicable estate tax liability. The payment of the estate tax using IRA funds, in turn, causes additional income tax to be incurred at higher income tax rates. As a result, between 60% to 80% of IRA could be lost to taxes. (This is known as the Inherited IRA Tax Spiral.) 23 Life Insurance IRA ILIT Strategy Inherited IRA Tax Spiral Net to Family 28.00% Federal and State Estate Tax 50.00% Income Tax 22.00% 24 12

Life Insurance IRA ILIT Strategy Inherited IRA Tax Spiral SOLUTION: Establish an Irrevocable Life Insurance Trust (ILIT) to hold a life insurance policy whereby the death benefit proceeds can be used to provide liquidity to the IRA owner s estate, thereby preserving the inherited IRA. 25 Life Insurance ILIT Reasons for Setting Up an ILIT To provide estate tax liquidity to a decedent s estate without the life insurance proceeds included in the decedent s taxable gross estate. To provide liquidity to a decedent s estate to cover administration expenses and to make cash bequests to heirs. To leverage the grantor s GST exemption/lifetime gift tax exemption amount/annual exclusion gift amount during lifetime 26 13

Life Insurance IRA ILIT Strategy Overview IRA Annual distributions IRA Owner (Insured) Annual gifts to cover life insurance premiums* ILIT (Beneficiary) Payment of premiums Payment of death benefit proceeds at death of insured Life Insurance Company Discretionary distributions of income and principal during the lifetime of the trust s beneficiaries Assets outside of the taxable estates of beneficiaries Children * NOTE: Gifts to the ILIT will use IRA owner s annual gift exclusion and/or lifetime gift exemption. 27 Stretch IRA Planning 28 14

Stretch IRA Planning Inherited IRA Objective: Prolong IRA payments over longest possible period of time, thus increasing wealth transfer to future generations Assumptions IRA Balance: $1,000,000 Pre-Tax Growth Rate: 7.00% After-Tax Growth Rate: 5.50% Age of Roth IRA Beneficiary: 55 Net Wealth to Family $3,516,931 $3,087,269 $5,273,501 $6,143,755 $1,382,890 $1,392,772 $1,807,382 $1,918,006 Year 5 Year 10 Year 20 Year 30 Non-Qualified Designated Beneficiary Qualified Designated Beneficiary 29 Stretch IRA Planning Stretch Out IRAs Inherited IRA Two Strategies Spousal Rollover Inherited IRA Spousal Rollover Advantages Rollover delays RMD until spouse s own RBD Unless there s a significant age differential a spouse often has lower RMDs thereby increasing wealth transfer 30 15

Stretch IRA Planning Stretch Out IRAs Inherited IRA Notice 2007 7 Beginning in 2007, non spousal beneficiaries (e.g. children, grandchildren, friends, etc.) are permitted to roll over a qualified retirement plan (e.g. 401(k)), via a trustee totrustee transfer, into an inherited IRA Designated beneficiary trusts are also permitted to roll over qualified retirement plans to inherited IRAs Notice 2008 30, Section II, Q&A 7 Allows non spouse beneficiaries to convert inherited qualified plans to inherited Roth IRAs. 31 Stretch IRA Planning Stretch Out IRAs Inherited IRA Key Issues in Making the Inherited IRA Work Beneficiary Designation Forms Tax Apportionment Estate Liquidity Disciplined beneficiaries 32 16

IRAs Payable to Trusts 33 Paying IRAs to Trusts Benefits of Utilizing a Trust Spendthrift protection Creditor protection Divorce protection Special needs Investment management Estate planning Dead hand control 34 17

Paying IRAs to Trusts Naming a Trust as Designated Beneficiary IRA An IRA Can Be Payable to a Trust Beneficiary Designation Form Trust IRA distributions over the life expectancy of the oldest beneficiary Spouse Children 35 Paying IRAs to Trust Four Requirements for ALLTrusts 1. Trust is valid under state law Treas. Reg. 1.401(a)(9) 4, Q&A 5(b)(1) 2. Trust is irrevocable upon death of owner Treas. Reg. 1.401(a)(9) 4, Q&A 5(b)(2) 3. Beneficiaries of the trust are identifiable from the trust instrument Treas. Reg. 1.401(a)(9) 4, Q&A 5(b)(3) 4. Documentation requirement is satisfied Treas. Reg. 1.401(a)(9) 4, Q&A 5(b)(4) 36 18

Accumulation Trusts Paying IRAs to Trusts Two Types of Trusts IRA Trust Conduit Trusts IRA Trust Beneficiary *Treas. Reg. 1.401(a)(9) 4, Q&A 5 requirements apply to both types 37 Paying IRAs to Trusts Accumulation vs. Conduit Trust Accumulation IRA distributions are allowed to accumulate Stronger asset protection Key issue in analyzing is to determine which beneficiaries are countable All potential takers must be considered Conduit All distributions from the IRA are immediately distributed to the beneficiary (ies) Very limited asset protection Allows easier identification of beneficiaries Only named recipient of distributions considered Can ignore potential appointees under power of appointment 38 19

Paying IRAs to Trusts Accumulation Trust IRA Example 1 If Grandchildren die before reaching age 30 Trust Sister Age 67 Discretionary Distributions Grandchildren Entire Trust outright upon Grandchildren reaching age 30 Grandchildren Accumulation Trust Sister measuring life for determining required minimum distributions Facts same as PLR 200228025 39 IRA Example 2 Paying IRAs to Trusts Accumulation Trust Trust To Red Cross Discretionary Distributions Child #1 At Child #1 s death Contingent beneficiary must be counted. Non individual contingent beneficiary. No designated beneficiary status. Treas. Reg. 1.401(a)(9) 5 Q&A 7 40 20

Paying IRAs to Trusts Conduit Trust IRA Trust If Grandchildren die before reaching age 30 Example 1 Mother Age 80 Discretionary Distributions, but no less than total withdrawals from IRA Entire Trust outright upon Grandchildren reaching age 30 Child Age 30 Child Age 30 Mother is not countable for determining applicable life expectancy Treas. Reg. 1.401(a)(9) 5 Q&A 7 41 Paying IRAs to Trusts Conduit Trust IRA Trust All distributions from IRA Child #1 To Red Cross At Child #1 s death See Treas. Reg. 1.401(a)(9) 5 Q&A 7 Example 2 42 21

Questions? 43 Thank You 44 22

Required Disclosure Under Circular 230 Pursuant to the rules of professional conduct set forth in Circular 230, as promulgated by the United States Department of the Treasury, nothing contained in this communication was intended or written to be used by any taxpayer for the purpose of avoiding penalties that may be imposed on the taxpayer by the Internal Revenue Service, and it cannot be used by any taxpayer for such purpose. No one, without our express prior written permission, may use or refer to any tax advice in this communication in promoting, marketing, or recommending a partnership or other entity, investment plan or arrangement to any other party. For discussion purposes only. This work is intended to provide general information about the tax and other laws applicable to retirement benefits. The author, his firm or anyone forwarding or reproducing this work shall have neither liability nor responsibility to any person or entity with respect to any loss or damage caused, or alleged to be caused, directly or indirectly by the information contained in this work. This work does not represent tax, accounting, or legal advice. The individual taxpayer is advised to and should rely on their own advisors. 45 Contact Information For information on upcoming seminars and webinars, please visit our website: keeblerandassociates.com/events To be added to our newsletter, please visit keeblerandassociates.com/speaking 46 23

Appendix 47 Taxability of Distributions Seasoning Rule No Is the taxpayer over age 59½? Yes Does the taxpayer meet any of the other statutory exceptions? No FOOTNOTES IRC Sec. 408A(d)(2)(A)(i) IRC Sec 408A(d)(2)(B) IRC Sec. 408A(d)(2)(A)(ii)(iii)(iv) Death Disability First time homebuyer expenses (up to $10,000) Yes Distribution subject to income tax (only to the extent of amounts not previousely taxed) No Has the taxpayer met the five year holding period test? 2 Yes Entire distribution is tax free 48 24

Application of 10% Early Withdrawal Penalty No Penalty 100% Contributory Is the distribution greater than prior contributions (i.e. basis )? No Yes Penalty Box Rule Yes 100% Conversion Is the taxpayer over age 59½? No Is the Roth IRA: (1) 100% contributory (2) 100% conversion (3) Commingled Did the distribution occur within five years of conversion? Penalty applies to earnings (Unless exception applies) No Yes Commingled Follow the ordering rules (see above chart) Penalty applies to conversion and earnings (Unless exception applies) Exceptions to 10% early withdrawal penalty : 1. Death 2. Disability 3. Series of substantially equal periodic payments 4. Medical expenses greater than 7.5% AGI 5. Health insurance premiums for unemployed individuals 6. Higher education expenses 7. First time homebuyer expenses (up to $10K) 49 Application of 10% Early Withdrawal Penalty Gross Distribution Step 1 Net contributions 1 FOOTNOTES: 1. Net contributions is: (a) the sum of all prior Roth IRA contributions reduced by (b) the sum of all prior Roth IRA distributions (i.e. basis first rule) 2. Distributions attributable to prior conversion amounts are determined on a first in, firstout ( FIFO ) basis (e.g. 1998 conversions,1999 conversions, 2000 conversions, etc.) with the taxable portion of each prior year conversion coming out first followed by the non taxable portion Ordering Rules Step 2 Conversion amounts > 5 years 2 (taxable portion) Step 3 Conversion amounts > 5 years 2 (non taxable portion) Step 4 Conversion amounts <= 5 years 2 (taxable portion) Step 5 Conversion amounts <= 5 years 2 (non taxable portion) 10% early withdrawal penalty applies (Unless exception applies) Step 6 Earnings 50 25

Mathematics of Roth IRA Conversions Example #1 50 Year Old IRA Owner 2014 Robert S. Keebler, CPA, MST. 51 Mathematics of Roth IRA Conversions Example #2 50 Year Old IRA Owner 2014 Robert S. Keebler, CPA, MST. 52 26

Mathematics of Roth IRA Conversions Example #3 50 Year Old IRA Owner 2014 Robert S. Keebler, CPA, MST. 53 Mathematics of Roth IRA Conversions Example #4 70 Year Old IRA Owner 2014 Robert S. Keebler, CPA, MST. 54 27

Mathematics of Roth IRA Conversions Example #5 70 Year Old IRA Owner 2014 Robert S. Keebler, CPA, MST. 55 Mathematics of Roth IRA Conversions Example #6 70 Year Old IRA Owner 2014 Robert S. Keebler, CPA, MST. 56 28

Stretch IRA Planning Stretch Out IRAs Inherited IRA Case Study Scenarios Immediate distribution IRA payable to non qualified beneficiary (five year rule) IRA payable to surviving spouse (no spousal rollover) IRA payable to surviving spouse (spousal rollover) IRA payable to child IRA payable to grandchild 57 Stretch IRA Planning Stretch Out IRAs Inherited IRA Case Study Assumptions IRA owner s age 65 Spouse s age 60 Child s age 35 Grandchild s age 10 IRA balance $1,000,000 Brokerage account balance $0 Pre tax growth rate 8% Ordinary income tax rate 40% Capital gains tax rate 20% 58 29

Stretch IRA Planning Stretch Out IRAs Inherited IRA Case Study Summary 59 Stretch IRA Planning Stretch Out IRAs Inherited IRA Case Study Summary Year 10 60 30

Stretch IRA Planning Stretch Out IRAs Inherited IRA Case Study Summary Year 20 61 Stretch IRA Planning Stretch Out IRAs Inherited IRA Case Study Summary Year 30 62 31