Destin Magazine Winter 2009

Wealth Management

Shut Out from Roth IRAs No Longer

Thanks to some recent tax law changes, high-net-worth individuals who are exploring additional ways to build retirement savings may want to take a closer look at traditional IRAs. In May 2006, the Tax Increase Prevention and Reconciliation Act (TIPRA) revised some of the guidelines covering IRAs. As a result, high-income investors whose earnings level would previously have restricted them to a traditional IRA can now convert those to Roth IRAs tarting in 2010 and reap the long-term tax advantages if they will be in the same or a higher tax bracket in retirement. Because they allow qualified investors to withdraw all contributions and those earnings that meet certain requirements without federal income tax, Roth savings vehicles now appeal to a growing list of investors. Previously, Congress limited Roth conversions to those whose modified adjusted gross income was under $100,000. Under the new rules, however, the conversions will be available to investors at any income level, starting in 2010.

So if you’ve maxed out your 401(k) or 403(b) contributions and don’t qualify to make Roth IRA contributions because of your income level, you still can make nondeductible contributions to a traditional IRA in 2009 and 2010 and then convert it to a Roth IRA in 2010.

Then, when needed during retirement, investors can make withdrawals from the Roth IRA tax-free. Taxes will not be owed on the original nondeductible contributions because they’ve already been paid, although the previous earnings on those contributions will be taxable. Those who convert in 2010 only have the extra incentive of being able to spread the tax liability over the following two years. Thereafter, all future earnings in the Roth IRA will be available for tax-free distributions if certain requirements discussed below are met.

With a traditional IRA, account holders are taxed on both their original contributions and their investment earnings when they start withdrawing money. Essentially, the tax responsibility has been deferred, not eliminated. The tax responsibility for a Roth IRA comes at the front end with nondeductible contributions. One of the advantages to account holders, however, is that they do not have to pay any taxes — even on investment earnings — at the time of withdrawal. And that means that Roth IRAs essentially can make investment income tax-free income.

The opportunity to translate nondeductible contributions into additional savings that could result in a tax-free income stream for retirement is especially attractive for high-net-worth individuals who can afford to pay the conversion taxes without using funds from the account itself. By doing so, an investor can avoid paying taxes on the distribution as well as an early distribution penalty of 10 percent. This assumes that a Roth IRA has been open for at least five

SENIOR VICE PRESIDENT/WEALTH ADVISOR/ INVESTMENT CONSULTANT, BROWN-STRYNAR GROUP, MORGAN STANLEY SMITH BARNEY

years and the investor is at least age 59½. Moreover, because high-net-worth families often have retirement income from other sources, they may not need to tap into their converted Roth IRA for many years, if at all. (Unlike traditional IRAs, there are no mandatory withdrawal rules for Roth IRAs if individuals are 70_.) So investors who choose the conversion option can theoretically shelter their earnings for years — an attractive advantage in estate planning.

Here is a simple example of the potential advantage of doing a Roth conversion: A married couple where both spouses are under age 50 can make nondeductible contributions of up to $10,000 ($5,000 per spouse) to traditional IRAs in 2009 and later. That amounts to $20,000 in additional savings, excluding earnings, in 2009 and 2010. When the couple converts their traditional IRAs to Roth IRAs in 2010, the taxes due will, unless elected otherwise by the client, be paid for in equal installments in 2011 and 2012. All future earnings, however, will accumulate tax-free and all withdrawals from the Roth IRA will be tax-free as well, if the distribution requirements are met (i.e., later than age 59½ and five years after Roth IRA is established). And that’s something all investors can appreciate.

For more information, please contact Mark Strynar at (850) 650-7300.b

NOTE: If you already have a traditional IRA with pre-tax dollars (i.e., deductible contributions, rollovers from qualified plans), you should consult your tax advisor about the aggregation rules that will apply if you convert any traditional IRA assets to a Roth IRA. Tax laws are complex and subject to change. This information is based on current federal tax laws in effect at the time this was written. Morgan Stanley Smith Barney LLC, its affiliates and Morgan Stanley Smith Barney’s Financial Advisors do not provide tax or legal advice. This material was not intended nor written to be used for the purpose of avoiding tax penalties that may be imposed on the taxpayer. Individuals are urged to consult their personal tax or legal advisors to understand the tax and related consequences of any actions or investments described herein. Articles are published for general information purposes and are not an offer or solicitation to sell or buy any securities or commodities. Any particular investment should be analyzed based on its terms and risks as they relate to your specific circumstances and objectives.