Module 7 Optimal Withdrawal Strategies for Tax … 7 Optimal Withdrawal Strategies for...

1©2015 Pershing LLC. Member FINRA, NYSE, SIPC. For professional use only. Not for distribution to the public. Please see disclosures at end. Proprietary and confidential.

A Comprehensive Modular Program

Module 7 Optimal Withdrawal Strategies for Tax-Advantaged Accounts

Foundational Concepts

Major Activities and Decisions

Advanced Strategies and Implementation

Module 1

The Transition Phase

of Retirement and

Your Business

Module 2

Framework for

Retirement Income

Planning

Module 3

Income Resources and

Budgeting Basics

Module 4

Tapping Into Social

Security

Module 5

Expanding the

Scope of Investments

Module 6

Additional Strategies for

Generating Retirement

Income

Module 7

Optimal Withdrawal

Strategies for Tax-

Advantaged Accounts

Module 8

Identifying Target Clients

and Building a Marketing

Strategy

Module 9

Tying It All Together

©2015 Pershing LLC. Member FINRA, NYSE, SIPC. For professional use only. Not for distribution to the public. Please see disclosures at end. Proprietary and confidential.

Module 7: Optimal Withdrawal Strategies for

Tax-Advantaged Accounts

Income Planning for Clients Nearing Retirement


Overview


Convergent Retirement Plan Solutions, LLC © 2015

General rules concerning

tax-qualified retirement savings

• Diversify tax risk

• Avoid costly IRS penalties

• Leverage special tax options

(when appropriate)

• Extend tax-advantaged duration

Optimization strategies

• Partial Roth IRA conversions

• Pre-59½ penalty-free

withdrawals

• Net unrealized appreciation

(NUA)

• Stretch distribution strategies

and Qualified Longevity Annuity

Contracts (QLACs)


Roth IRA Conversions


Review Your

Client Base

Check for clients who

• Have significant

retirement savings in

tax-qualified plans

• Are concerned about

tax rates increasing

• Would like to delay

withdrawal of tax-

qualified savings by

reducing required

minimum distributions

(RMDs)

• Would like to leave

more tax-qualified

savings to their heirs

Investors have strong interest in Roth IRAs

and their ability to:

• Generate tax-free retirement income if certain

conditions are met

• Diversify tax risk in retirement

• Create a financial legacy for beneficiaries

For many clients who cannot contribute to a

Roth IRA due to income limitations, one or more

partial Roth conversions may be appropriate

Note: Roth IRA conversions are taxable events.

Federal and state taxes may apply.


Avoid Betting on the Direction of Taxes: Diversify Tax Risk

0%

10%

20%

30%

40%

50%

60%

70%

80%

90%

100%

1913 1919 1925 1931 1937 1943 1949 1955 1960 1966 1972 1978 1984 1990 1996 2002 2008 2014 2020 2026 2032 2038 2044 2050

Source: Derived from information published at www.truthandpolitics.org

Top Marginal Federal Tax Rates



http://www.truthandpolitics.org/


Partial Roth IRA Conversions Can Help Diversify Tax Risk

Roth IRA Option Adds Another

Dimension of Diversification

(tax-risk diversification)

Conventional IRA Diversification

Is Two Dimensional

(traditional investment diversification)




• Federal Penalty exceptions

– A variety of penalty exceptions exist

– QRP exceptions are similar to—

but not identical to—the penalty

exceptions for IRA distributions

• Claiming exception

– Distribution code on IRS Form

1099-R may reflect penalty exception

– Often, investors must File IRS Form

5329 to claim penalty exception

Avoid Costly Penalties: Early Withdrawal Penalty (<59½)

General Rule

Taxable withdrawals

from both IRAs and

employer-sponsored

qualified retirement

plans (QRPs) taken

before age 59½ are

generally subject to

a 10% federal early

withdrawal penalty tax




10% Early Distribution Penalty Exceptions IRA QRP

Medical expenses

Health insurance X

Disability

Death

Substantially equal periodic payments *

Separation from service after age 55 X

Higher education expenses X

First-time homebuyer expenses X

IRS levy

Qualified domestic relations order (QDRO)** X

Qualified reservist ***

*Only available after separation from service

**Transfers incident to divorce for IRAs

***401(k) and 403(b) elective deferrals

Avoid Costly Penalties




Substantially Equal Periodic Payments


Review Your

Client Base

Check for clients who

• Are ages 50 to 58

• Want to retire early

or need access to

such funds for any

reason

• Have suffered a

job loss

• Are forced to take

early retirement

The substantially equal periodic

payments penalty exception under

Code Section 72(t)

• Allows penalty-free withdrawals from

IRAs and qualified retirement plans prior

to age 59½

• Provided the client takes substantially

equal payments until the longer of:

– Five years

– Age 59½


Calculated Using Result

Required

Minimum

Distribution

IRS life expectancy tables Variable annual

distribution amount

Annuitization Mortality tables and

interest rate

Fixed annual

distribution amount

Amortization Life expectancy and

interest rate

Fixed annual

distribution amount

Source: IRS Revenue Ruling 2002-62

Three IRS Safe Harbor Methods for Calculating

Substantially Equal Periodic Payments



Substantially Equal Periodic Payments—

Withdrawal Examples

$0

$200

$400

$600

$800

$1,000

$1,200

$1,400

$1,600

$1,800

$2,000

51 52 53 54 55 56 57 58 59

Mo

nth

ly D

istr

ibu

tio

n

Age

RMD Method Amortization Method Annuity Method

Comparing the Three Safe Harbor Methods

This is a hypothetical example. It is not intended to reflect the actual performance of any investment.

Assumptions—No additional contributions. Withdrawal Frequency: Monthly; IRA Owner DOB: 1/1/1965; Spouse Beneficiary DOB: 1/1/1968; Start Date: 2015; RMD Method:

Uniform Lifetime Table; Earnings Assumption for RMD Method: 5%; Interest Rate Assumption for Amortization and Annuity Method: 2.1%




Adjust the IRA or plan balance—

transfer in or out

Adjust the rate of return

assumption (up to 120% of

federal mid-term rate of two

preceding months)

Use an alternative life

expectancy factor

Three Options for “Dialing In”

the Desired Withdrawal Amount




Safe Harbor

Method

Interest Rate Assumption

(Based on Monthly Mid-Term Applicable Federal Tax Rate of 4%)

80% Applicable

Federal Tax Rate

120% Applicable

Federal Tax Rate

RMD method $1,170 $1,184

Amortization method $1,442 $1,585

Annuity method $1,702 $1,857

Assumptions: Beginning IRA balance $500,000 with no additional contributions. IRA Owner DOB 1/1/1960,

monthly distributions, joint life expectancy, spouse beneficiary DOB 1/1/1960.

Modifying Interest Rate Assumptions

This is a hypothetical example. It is not intended to reflect the actual performance of any investment.




Option #1:

Single IRA$400,000

Adjusting the IRA or Plan Balance

• Disadvantages:

– All IRA assets tied up

– Any “unscheduled” IRA distributions will

trigger retroactive 10% early withdrawal

penalty applicable to all distributions

that have been taken

• Target distribution amount:

$1,650/month

• Applicable federal rate: 4%

• Safe harbor: annuity method

• Rate assumption: 3.2%

This is a hypothetical example. It is not intended to reflect the actual performance of any investment. The example assumes a beginning IRA balance of $400,000 with no additional

contributions, the IRA owner’s DOB 1/1/1964 and monthly distributions using the annuity method.




Adjusting the IRA or Plan Balance (Continued)



Option #2:

Split IRA

• Advantages:

– If need arises, client could set up a

second series of penalty-free

substantially equal periodic payments

from IRA (B)

– Discretionary distributions from IRA(B)

will not affect series of substantially

equal periodic payments from IRA(A)

• Target distribution amount:

$1,650/month

• Applicable federal rate: 4%

• Safe harbor: annuity method

• Rate assumption: 4.8%

A

$325,000

B

$175,000

This is a hypothetical example. It is not intended to reflect the actual performance of any investment. The example assumes a beginning IRA balance of $400,000 with no additional

contributions, the IRA owner’s DOB 1/1/1964 and monthly distributions using the annuity method.


Using an Alternative Life Expectancy Factor

Safe Harbor

Method

Life Expectancy Option

Uniform Life

Expectancy Table

Joint Life

Expectancy Table

Single Life

Expectancy Table

RMD method $1,002 $1,120 $1,408

Amortization

method$1,349 $1,465 $1,746

Annuity method $1,780 $1,780 $1,780

Assumptions: Beginning IRA balance $500,000 with no additional contributions, IRA Owner DOB 1/1/1960,

monthly distributions, joint life expectancy, spouse beneficiary DOB 1/1/1963.




Review Your

Client Base

Do you have clients:

• Nearing retirement

age who have

executive-level

positions at public

companies?

• Who have highly

appreciated

company stock in a

former employer’s

plan and are in a

high tax bracket?

• Nearing retirement

who need income

strategies?

Take Advantage of Net Unrealized Appreciation

• The net unrealized appreciation (NUA) tax rule enables

qualified-plan participants the option of electing special NUA

tax treatment on qualifying withdrawals of employer stock

– Distribution must generally qualify as a lump sum distribution*

– At distribution, only the cost basis in the shares is taxed, at ordinary

federal income tax rates

– Federal tax on the appreciation (capital gains) in the shares is deferred until

time of sale

– Upon sale, NUA is taxed at long-term capital gains rate (versus federal

ordinary income tax rates)

– Note: Participants may be subject to the 10% federal penalty for premature

distributions if before age 59½

• NUA tax treatment must be addressed prior to an IRA rollover

– NUA tax treatment is forfeited once employer stock is rolled to an IRA

– Under some circumstances, an IRA rollover can still be a

better choice

*A lump sum distribution is defined as the disbursement of an individual’s entire vested account balance from an employer-sponsored retirement plan within one taxable year as a result of

a “triggering event.” Triggering events are limited to separation from service, attainment of age 59 ½ or death.



Net Unrealized Appreciation: An Example

NUA (Tax Paid With

Outside Assets)

IRA Rollover

Strategy

Investment in shares purchased in company plan(cost basis)

$200,000 $200,000

Market value of shares at distribution $500,000 $500,000

Net unrealized appreciation (market value—cost basis) $300,000 $0

Future account value in 10 years before federal income tax at 5% annual growth rate

$814,447 $814,447

Taxes on initial distribution at 39.6% ordinary income tax rate

$79,200 N/A

Future ordinary federal income taxes at 39.6% at final sale $0 $322,521

Future capital gains tax (20%) and Medicare tax (3.8%) at

final sale$146,238 N/A

Future account value after taxes $589,009 $491,926

Potential increase in wealth due to NUA tax strategy $97,083 N/A


Assumes a 39.6% federal income tax rate and a 20% capital-gain tax rate, plus 3.8% Medicare tax. If the NUA strategy is used, a complete distribution of all assets from the 401(k) plan

must occur in a single tax year. This example is hypothetical and does not depict the performance of any specific stock or NUA treatment. Values fluctuate and when is employer stock

sold, it may be worth more or less than the original cost. This illustration does not take into consideration any state or local taxes.

The greater the appreciation and the higher the client’s federal tax bracket,

the greater the advantage of using the NUA strategy


Investors should consider their individual circumstances before electing a rollover or NUA treatment.



Net Unrealized Appreciation: Key Considerations

Circumstances That Tend to

Favor Rollover

• Intend to liquidate employer

securities in near future

• The ratio of NUA to cost

basis is relatively low

• Concerned about future increases

in capital gains rate

Circumstances That Tend to

Favor NUA Treatment

• Intend to hold employer securities

for a relatively long time

• The ratio of NUA to cost

basis is relatively high

• Higher income tax bracket

(greater disparity between ordinary

tax rate and capital gain rate)


Example

• Participant takes qualifying distribution

of $500,000 worth of employer stock

• At time of distribution, participant pays

ordinary income taxes on $100,000 basis

• At death, stock has appreciated in value

to $800,000

• $400,000 of NUA does not qualify for

stepped-up basis

• $300,000 of post-distribution appreciate

does qualify for stepped-up basis

• Result: Beneficiary inherits $800,000 worth of

stock with a basis of $400,000 (initial basis of

$100,000 plus stepped-up basis of $300,000

from post-distribution appreciation)

Special rules often apply to

beneficiaries of deceased

plan participants who took

distributions of qualifying

employer stock

• NUA treatment (in-plan appreciation

prior to distribution) does not qualify for

a step up in basis (as typically happens

with securities purchased outside of a

qualified plan)

• However, post-distribution appreciation

will typically qualify for basis step up

Net Unrealized Appreciation:

Basis Step-Up Considerations

Beneficiaries of deceased qualified plan participants who receive employer stock as part of a qualified plan distribution are also often eligible for NUA tax treatment on distributions of

qualifying employer stock.



Use a Stretch IRA Distribution Strategy to Help

Retain Assets for Beneficiaries

• A technique for allowing more

IRA assets to remain in an IRA

growing tax deferred—possibly

for generations

• Extends distributions over the

longer life expectancies of

younger beneficiaries

• Reduces the amount that must

be withdrawn annually

• Can be an effective wealth-

transfer strategy

Client’s

Age

Spousal

Beneficiary’s

Age

Distribution

Period/Life

Expectancy

(Yrs.)*

RMD (Initial

Account Value

= $250,000)

70 60+ 27.4 $9,125

70 50 35.1 $7,125

70 40 44.0 $5,114

This example is for illustrative purposes only and is not meant to represent any specific investment. The example assumes a 4% rate of return.

Source: IRS Publication 590, Individual Retirement Arrangements. *Life Expectancy Tables I, II and III.


Note: significant conditions, restrictions, and limitations apply to both the original IRA owner and the beneficiary including, but not necessarily limited to, eligibility requirements,

timing factors and distribution requirements. The beneficiary’s distribution period is potentially very lengthy, and this strategy is based upon current tax law, which could change

during the distribution period and may significantly impact its outcome, including a beneficiary’s ability to maintain estimated distributions. A lengthy distribution period also

exposes investors to significant market and inflation risk as well as ongoing fees, costs and charges that may be applicable during the distribution period.


Use a Stretch IRA Strategy to Help

Retain Assets for Beneficiaries

• Naming a younger non-spouse

as beneficiary can help further

extend the life of the IRA

• Once the owner dies, the

distribution period is extended

based on the longer life

expectancy of the younger

beneficiary

This example is for illustrative purposes only and is not meant to represent any specific investment. The example assumes a 4% rate of return.

Source: IRS Publication 590, Individual Retirement Arrangements. *Life Expectancy Tables I, II and III.


Client’s

Age

Age of

Nonspouse

Beneficiary

Life

Expectancy

(Yrs.)**

RMD (Initial

Account Value

= $250,000)

N.A. 40 43.6 $5,735

N.A. 30 53.3 $4,690

N.A. 20 63.0 $3,968






Stretching the IRA Tax-Advantage

$409,000 $19,824,000$1,149,000

Tom takes minimum

distributions from his

IRA for 10 years

beginning in 2019

Mary rolls over

Tom’s IRA and

receives minimum

distributions for

15 years

Tom and Mary’s granddaughter,

Meagan, begins receiving distributions

in 2044. Meagan takes minimum

distributions from the IRA for the next

53 years

2015 2029 2044 2097

This is a hypothetical example. It is not intended to reflect the actual performance of any investment. No additional contributions are made to the IRA and no distributions other than the

projected RMDs are taken from the IRA. All RMDs are withdrawn from the IRA on 12/31 of the projection year. Life expectancy calculations during Tom and Mary’s life are based on the

Uniform Lifetime Table. Life expectancy calculations for Meagan are based on the Single Life Expectancy Table. Calculated RMDs do not reflect any tax liability. Rates of return used in the

RMD projections are compounded annually and do not represent the performance of any specific security.

There is no guarantee that the selected rate of return can be achieved.



Tom Passes Mary Passes






Year the IRA is

Fully Depleted

Hypothetical

Cumulative IRA

Withdrawals

Tom had named his estate as his primary

beneficiary?2039 $2,358,000

Mary did not elect to treat the IRA as her

own following Tom’s death?2049 $2,583,000

As compared to taking full advantage of

the stretch opportunity…2097 $21,382,000

But, What If…

This is a hypothetical example. It is not intended to reflect the actual performance of any investment. No additional contributions are made to the IRA and no distributions other than the

projected RMDs are taken from the IRA. All RMDs are withdrawn from the IRA on 12/31 of the projection year. Life expectancy calculations during Tom’s life are based on the Uniform

Lifetime Table. Calculated RMDs do not reflect any tax liability. Rates of return used in the RMD projections are compounded annually and do not represent the performance of any specific

security. There is no guarantee that the selected rate of return can be achieved.



Stretching the IRA Tax-Advantage






Additional Stretch Distribution Strategy Considerations

Beneficiary Disclaimers

(Code Sec. 2518)

Potential for the

designated beneficiary

to relinquish beneficial

rights—potentially

allowing for

greater stretch






exposes investors to significant market and inflation risk as well as ongoing fees, costs and charges that may be applicable during thedistribution period.


Additional Stretch Distribution Strategy Considerations (Continued)


Stretching a

Roth IRA

Increase stretch

potential by avoiding

required minimum

distributions at age 70½







Additional Stretch Distribution Strategy Considerations (Continued)


Irrevocable Life

Insurance Trusts

Potentially cost-effective

way to reduce estate

tax liability and increase

value of stretch IRA







Qualified Longevity Annuity Contracts (QLACs)


QLACs

New planning option for

lowering RMDs and

reducing longevity risk



Qualified Longevity Annuity Contracts (QLACs)



A longevity

annuity

contract that

meets

specific IRS

requirements

The maximum amount that

may be allocated to the

purchase of a QLAC is the

lesser of:

• 25% of total tax-qualified

retirement savings or

• $125,000

• Smaller RMDs—

Value of QLAC is not

included in value of IRA

when calculating required

minimum distributions

(RMDs)

• Reduced longevity risk—

QLAC provides a lifetime

income stream beginning

at a specified age

(no later than 85)

How much retirement

savings can be used to

purchase a QLAC?

What are the primary

benefits of purchasing a

QLAC with IRA assets?

What is a

QLAC?


John and Martha: Before and After

John and Martha, both in great health, would like to reduce their IRA required

minimum distributions and take steps to help reduce the likelihood of outliving

their retirement savings. Each has $400,000 in accumulated IRA savings as

they enter their 70½ year.

Both John and Mary decide to invest $100,000 of their IRA savings in a QLAC.

As the charts below illustrate, the impact on their collective RMDs is significant.

John’s 1st Year RMD

Without

QLAC

$400,000

27.4$14,599

With

QLAC

$300,000

27.4$10,949

Martha’s 1st Year RMD

Without

QLAC

$400,000

27.4$14,599

With

QLAC

$300,000

27.4$10,949

Total 1st

Year RMD

Reduction

$7,300




Some Conclusions


Be on the lookout for clients who may benefit

from Roth IRA conversions

Before initiating an IRA rollover from an employer plan,

be sure to ask if any assets are employer securities

Help clients understand tax-saving and

legacy-creating strategies

Take advantage of educational tools and calculators

that can help you engage with clients


Resources

Industry Resources

IRS.gov Understanding Life Insurance Trusts

Rothira.com Spark Institute Summary of QLAC Regulations

Pershing Resources

Rollover IRA Brochure Client Fact Sheets: NUA, 72(t) Distributions and

Stretch IRA Strategy

Traditional and Roth IRA Brochure Pershing Retirement Solutions Brochure

IRA Selector Retirement Calculators (also in the Retirement

Center under Tools in NetX360®)

Additional Resources

MoneyGuidePro™ NaviPlan

Wealth2K® Guided Choice

LifeYield®

Third party sites provided for convenience, Pershing does not endorse these sites or their content.


http://www.irs.gov/

https://www.estateplanning.com/Understanding-Life-Insurance-Trusts

http://www.rothira.com/

http://www.sparkinstitute.org/content-files/summary_of_final_qlac_regulations.pdf

http://www.pershing.com/media/Rollover-IRA-End-Client-Brochure_Pershing.pdf

http://www.pershing.com/media/NUA_Investor_Fact_Sheet.pdf

http://files.pershing.com/media/72-t-distributions.pdf

http://www.pershing.com/media/Stretch_IRA_Strategy_Investor_Fact_Sheet.pdf

http://files.pershing.com/media/Traditional-and-Roth-IRA-End-Client-Brochure_Pershing.pdf

https://www.pershing.com/_global-assets/pdf/retirement-solutions-grow-your-retirement-business-with-pershing.pdf

http://files.pershing.com/media/IRA-Selector.pdf

https://www.advisorrollovernetwork.com/pershingopenaccess/default.aspx

http://www.moneyguidepro.com/Default.aspx

http://www.advicentsolutions.com/products/naviplan/?utm_source=google&utm_medium=cpc&utm_campaign=brand - naviplan&gclid=Cj0KEQjwyMafBRCU7OCRyc2vitsBEiQAKV4H9AXR_fURJHnhEIB8NHr3C4pyex21oRsMtn4TOhZwdEIaAsau8P8HAQ

http://www.incomeforlifemodel.com/

http://www.guidedchoice.com/

http://www.lifeyield.com/


Important Disclosure Information

• This presentation and the information or opinions contained herein has been prepared by Pershing LLC

for informational purposes only without reference to any specific person's investment objectives or

financial situation. The presentation and the information are for reference purposes only and are not

intended to be a recommendation with respect to, or solicitation or offer to buy or sell any particular

security, financial instrument, or investment product, or to participate in any particular trading strategy in

any jurisdiction in which such offer or solicitation, or trading strategy would be illegal. Pershing LLC and its

affiliates do not intend to provide investment advice through this presentation and do not represent that the

securities or services discussed are suitable for any investor. Pershing LLC and its affiliates do not, and

this presentation does not intend to, render tax or legal advice.

• Tax laws are complex and subject to change. The information contained herein is based on current federal

tax laws in effect at the time it was written. Pershing LLC and its affiliates do not provide tax or legal

advice. The presentation and information provided herein were not intended nor written to be used for the

purpose of avoiding tax or penalties that may be imposed on the taxpayer. Individuals are urged to consult

their tax or legal advisors to understand the tax and related consequences of any actions or investments

described herein.

Module 7 Optimal Withdrawal Strategies for Tax … 7 Optimal Withdrawal Strategies for...

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Transcript of Module 7 Optimal Withdrawal Strategies for Tax … 7 Optimal Withdrawal Strategies for...