Dashboard Wealth Advisors "Roth Thoughts"

Retirees face the challenge of replacing their working income with a combination of Pension/Social Security income and cash-flow derived from their various other investments. We, at Dashboard Wealth Advisors, break assets down into three basic categories, 1)Pre-Tax, 2) Post-Tax, and 3) No-Tax. Pre-tax assets consist of all Traditional IRA's, Traditional 401k's, SEP-IRA's, and all other vehicles that require the payment of ordinary income tax upon their distribution. Post-tax assets consist of all investment accounts that contain after-tax contributions and require the payment of capital gains taxes on earnings, combined with interest and dividend tax payments where applicable. No-tax monies, however, as the name implies, require absolutely no tax payments upon distribution for the lifetime of the account owner, and oftentimes their direct heirs. These accounts consist of both Roth IRA and Roth 401k assets. The power of tax-free, not tax-deferred, but actually tax-free growth can be staggering. Following are various strategies that we find helpful in exploring with our clients related to these No-tax Roth IRA and Roth 401k assets.

Non-working spouse Roth Conversion Strategy

This concept is based on the fact that high income earners cannot contribute directly to Roth IRA's, but can contribute to traditional IRA's in an after-tax, non-deductible fashion. Oftentimes one spouse has either little or no pre-tax funds in IRA's. As such, a family can contribute the maximum allowable IRA contribution and subsequently convert this amount annually to a Roth IRA. If the individual does not have any other pre-tax IRA's, this annual Roth conversion is 100% exempt from federal income taxation.

Business Owner's Roth Conversion Strategy

This concept is based on the fact that high income earners cannot contribute directly to Roth IRA's, but can contribute to traditional IRA's in an after-tax, non-deductible fashion. However, should an individual then convert IRA assets to Roth assets, there is a calculation to determine the taxable portion of the conversion. Divide the after tax dollars in the IRA by the total IRA balance to get the after tax percentage. Then take the after tax percentage and multiply it by the total distribution amount to determine the amount of the distribution that is tax-free. Additionally, in performing this calculation, the IRS requires the aggregation of all IRA's, but EXCLUDES any and all 401k's. Therefore, if a business owner has a large pre-tax IRA balance, and also has a 401k available at his/her own company, consider rolling the existing pre-tax IRA into their own company's 401k plan. By doing this, the business owner can now contribute the maximum amount to an after-tax non-deductible IRA, and immediately convert it to a Roth IRA annually. As the business owner now has no other pre-tax amounts in his/her IRA's, this Roth conversion would be 100% exempt from taxation.

“Buying” your parent's IRA

This concept is based on the idea of a wealthy adult child gifting assets back to his parents in return for the parents converting their own traditional IRA assets to Roth IRA assets. Once this conversion is done, the primary beneficiary of the Roth IRA assets is changed from the spouse of the parent to either the adult child who gifted the parents the funds, or better yet, the young children of this person. By doing so, the taxes applied to the IRA distributions are at the parent's lower tax bracket rather than the higher tax bracket of the inheriting child.

The "Roth" Retirement Income Bridge

Oftentimes, individual retire before turning 70.5 with significant IRA balances. In these situations, these individuals should consider annual Roth conversions designed to fully maximize their current federal tax bracket. Additionally, in many situations, a sound strategy would be to provide annual living expenses to these families with after-tax assets to minimize current tax brackets while allowing for significant Roth conversions. Knowing that Required Minimum distributions will be significant, a client can use the period from retirement to attainment of age 70.5 to convert Roth IRA assets at tax brackets either the same or lower than post-RMD years.

"Gifting" Roth IRA's,

In situations where the parent's tax bracket is less than the child, consider conversion of Roth IRA's in lieu of or in addition to outright gifting. Keep in mind that this will NOT exclude the asset from one's taxable estate.

The Roth 401k "Misconception"

Roth 401k assets are powerful, but directly contributing to a Roth 401k requires the payment of not only Federal Income Tax, but also State Income Tax. There are numerous states where state income tax is not applied to Roth conversions. As such, we encourage clients to utilize their Employer's traditional 401k, and if adding funds to a Roth is desired, accomplish this through conversions of IRA's to Roth IRA's. This strategy may result in the savings of state income tax on Roth contributions.

Roth Re-characterization Thoughts

Various strategies of executing Roth conversions include separating the Roth IRA before the conversion and converting to separate Roth IRA accounts based on the investment strategy (i.e. US Equities, International Equities, and Fixed Income). Should a re-characterization be required, the account with the worst performance can be re-characterized.

Planned Gifting

High net worth parents should consider gifting to children upwards of $23,000 annually then suggest/require the kids to fully fund their employers' Roth 401k of $18,000, and contribute $5,500 to an outside Roth IRA. This in essence removes funds annually from the parent's estate and provides them to the kids in a no-tax environment for in essence two more generations.

After-tax 401k Rollover to Roth IRA

On September 18th, 2014, the IRS issued IRS Notice 2014-54. This notification allows employees to effectively roll all after-tax funds within their 401k directly into a Roth IRA. When doing so, the associated earnings of the after-tax amount must also be rolled out, but these can then be deposited directly into a traditional IRA. By doing so, all future growth of the after-tax amount is tax-free versus taxed as ordinary income if left within the 401k.

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Unless certain criteria are met, Roth IRA owners must be 59½ or older and have held the IRA for five years before tax-free withdrawals are permitted. Additionally, each converted amount is subject to its own five-year holding period. Converting a traditional IRA into a Roth IRA has tax implications. As federal and state tax rules are subject to frequent changes, you should consult with a qualified tax advisor prior to making any investment decision. The information contained in this report does not purport to be a complete description of the developments referred to in this material. The information has been obtained from sources considered to be reliable, but we do not guarantee that the foregoing material is accurate or complete. Expressions of opinion are as of this date and are subject to change without notice.

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