COMMITTEE REPORT RETIREMENT BENEFITS To Convert Or Not To Convert? In three years, any taxpayer, regardless of income level, will be able to convert a traditional IRA into a Roth IRA. Question is, will it make sense to do so? T Vincent Travagliato, Nicholas Altieri, and Ian Weinstock, executive directors, and Christopher Leung, associate, Morgan Stanley, New York 54 TRUSTS & ESTATES / trustsandestates.com APRIL 2007
ROTH IRAS BENEFIT OR RISK? We ve built a model to compare performance of a traditional IRA versus a Roth IRA. APRIL 2007 TRUSTS & ESTATES / trustsandestates.com 55
Under our assumptions, a taxpayer is better off if he converts his traditional IRA to a Roth IRA. A CLEAR WINNER INITIAL ACCOUNT VALUES To determine whether to convert a traditional IRA to a Roth IRA, begin with two scenarios, each has an IRA of $1 million and other assets of $350,000 Scenario 2: Scenario 1: Convert; Pay Taxes Account Balances Beginning Balances Do Nothing Out of Taxable Assets IRA $1,000,000 $1,000,000 - Taxable Account $350,00 0 $350,000 (See Note) Roth IRA $0 - $1,000,000 Note: $350,000, plus growth, less tax payments of $175,000 at the end of both 2011 and 2012, reflecting the fact that the taxpayer continues to have use of the funds until the tax payments are made. 56 TRUSTS & ESTATES / trustsandestates.com APRIL 2007
THE WINNER A taxpayer is $2.3 million better off with a Roth IRA, even with taking required minimum distributions Scenario 2: Scenario 1: Convert; Pay Taxes Account Balances Do Nothing Out of Taxable Assets IRA $2,500,000 - Taxable Account $4,700,000 $5,400,000 Roth IRA - $4,100,000 Total $7,200,000 $9,500,000 CHANGE IN APPROACH BETTER STILL Conversion to a Roth IRA yields an even greater result when required minimum distributions are not taken Scenario 2: Scenario 1: Convert; Pay Taxes Account Balances Do Nothing Out of Taxable Assets IRA $2,500,000 - Taxable Account $4,700,000 $200,000 Roth IRA - $10,000,000 Total $7,200,000 $10,200,000 APRIL 2007 TRUSTS & ESTATES / trustsandestates.com 57
THE TRADITIONAL IRA Know the basics Assets in traditional individual retirement accounts (IRAs) grow income tax deferred, and very specific rules govern both the timing and amount of contributions to, and distributions from, IRAs. While distributions can be made anytime during the IRA owner's lifetime, any such distributions will be included in income at that time. Except in limited circumstances, distributions from a traditional IRA made before age 59½ also can subject to a 10 percent penalty for early withdrawal. Once age 59½ is attained, distributions from the traditional IRA can be made without the 10 percent penalty (although they still are subject to income tax). Many IRA owners may prefer delaying distributions to maximize the tax-free growth. But funds cannot stay in a traditional IRA indefinitely. The owner must start receiving distributions by April 1 of the year following the year in which he reaches 70½ years old (the required beginning date or RBD. ) The amount that must be distributed each year is called the required minimum distribution or "RMD." If an RMD is not made or is not large enough, an excise tax of 50 percent is imposed on the amount that should have been distributed. The RMD is figured by dividing the IRA account balance as of the December 31 of the prior year by a number taken from either of two IRS tables (the Uniform Lifetime Table or, if the IRA owner is married and his spouse is more than 10 years younger, the Joint Life and Last Survivor Expectancy Table, which reflects the longer joint life expectancy). When an IRA owner dies, the timing and amount of distributions are based primarily on whether the person (or entity) chosen by the IRA owner to succeed him with respect to the IRA (the designated beneficiary ) is a surviving spouse or someone other than a surviving spouse and, to a certain degree, whether the IRA owner died before or after the RBD. If the designated beneficiary is someone other than the IRA owner s surviving spouse, distributions generally are made over the life expectancy of the beneficiary, based on another table called the Single Life Expectancy Table for Inherited IRAs. The life expectancy of the beneficiary is essentially fixed in the year of the death of the account owner and subsequently reduced by one each year thereafter. If the beneficiary is the IRA owner s spouse, he could treat the IRA as an inherited IRA, which would allow the surviving spouse, if older than the deceased spouse, to defer distributions until the deceased IRA owner s RBD. Distributions would be made for the rest of the spouse s life using the Single Life Table, in which case the spouse s life expectancy would be redetermined annually (rather than fixed in the year of death of the IRA owner and reduced by one each year thereafter, as above in the case of a non-spouse beneficiary.) For an inherited IRA, after the death of the surviving spouse, the first distribution to the succeeding beneficiary is based on the life expectancy of the surviving spouse in his year of death and each year thereafter, the divisor is reduced by one. Alternatively, a spouse-beneficiary can rollover the IRA on the IRA owner s death to his own IRA or similarly treat the IRA as his own. In that case, the survivor can name new beneficiaries and, if he desires, defer payments until his RBD. When the surviving spouse is younger than the deceased IRA owner, this generally allows the maximum possible deferral period ( stretching out the IRA.) Vincent Travagliato, Nicholas Altieri and Ian Weinstock 58 TRUSTS & ESTATES / trustsandestates.com APRIL 2007
$ Millions 12 10 8 6 4 2 AHEAD FROM THE START Conversion is even more attractive when we focus on annual after tax liquidation values Conversion No Conversion 0 40 45 50 55 60 65 70 75 80 85 Age APRIL 2007
SPOTLIGHT Missing! Pablo Picasso s Portrait of Jacqueline, which depicts his second and last wife, was one of two paintings stolen from a granddaughter's Paris home in February. Both paintings are estimated to be worth a total of nearly $66 million. To date, there are about 549 Picasso paintings listed with The Art Loss Register as stolen, missing or looted. Photograph: AP Photos 60 TRUSTS & ESTATES / trustsandestates.com APRIL 2007