Retirement Plan Update

1. Retirement Plan Update Consumer Group Customer Care

2. Contributing to IRAs • 2009 contribution limits for traditional and Roth IRAs • $5,000 • Beginning in 2009 limit increases $500 annually for inflation • $6,000, 50 or older or • 100% of compensation whichever is less • Roth contributions limited by income exceeding MAGI phase out range • Employer in bankruptcy and • Matching contributions made in company stock AND • Indicted or convicted for transactions leading to bankruptcy • An additional $3,000 can be contributed through 2009 • Contributions may or may not be deductible • Depending on participation in a retirement plan • Income level i.e. it exceeds MAGI phase out range

3. Nondeductible IRA Contributions • Nondeductible contributions if given enough savings horizon can be more advantageous than using a taxable account.

4. More Nondeductible IRA Contributions • Benefit of investing in a nondeductible IRA over a non-IRA investment is that earnings are not taxed until withdrawal. • Downsides • All IRA earnings are taxed as ordinary income • Some of the earnings of non-IRA investment could be taxed at lower capital gains rate • Early withdrawal of earnings is subject to the 10% penalty • To determine tax free distribution amounts • Taxable accounts and nondeductible accounts are aggregated • A distribution will never be entirely tax free • A disadvantage when compared to a Roth IRA

5. Roth IRAs • Contributions are never deductible • Contributions are limited by a MAGI phase out range • Income resulting from a Roth conversion can be ignored in determining the MAGI • Two types of Roth IRA distributions • Qualified which is tax free • Made after the 5 year period beginning on the first day of the first year in which an IRA contribution is made AND one of the following applies • Taxpayer is at least 59-1/2 • Distribution is due to owners death or disability • Up to $10,000 to a qualified first time homebuyer • Nonqualified

6. More on Roth Distributions • Roth distributions are tax free until all of the contributions are distributed. (More favorable than traditional IRA basis recovery. • Non qualified distributions are taxable to the extent they exceed basis. • Subject to 10% penalty if under 59-1/2. • Section 72(t) exceptions apply • Required Minimum Distributions (RMD are not required from a Roth IRA until the owner’s death.

7. Evaluating IRA Options • Nondeductible IRAs vs. Roth IRAs • Roth superior since tax is permanently avoided, not just deferred. • Roth has superior basis recovery rules • RMD rules do not apply until owner’s death • Deductible IRAs vs. Roth IRAs (Which produces more wealth) • Roth superior since tax is permanently avoided, not just deferred. • The assumption that the tax rate at retirement will be lower is not a safe assumption (may favor Roth) • Investment income may be substantial • Other sources may be substantial • The tax rates might increase due to changes in the law • Roth contributions permitted after 70-1/2 • Qualified Roth distributions to heirs tax free • Many variables make number crunching important • Software available for that – CFS Tax Tools and others available online • Google “Roth Conversion Calculators” • Cash Flow limitations • Deductible IRA may win out when the tax savings realized enable a larger contribution

8. Roth IRA Conversions • Why convert to a Roth IRA? • To avoid tax on future IRA earnings • Who can convert to a Roth IRA? • Before 2010 • Taxpayers with traditional, SEP and SIMPLE IRAs • Also qualified plans, 403(b), 457(b) • To avoid 20% withholding, use trustee to trustee transfer • Ability to borrow will be lost • MAGI $100,000 or less in year of IRA distribution if different from the year of Roth deposit • Before considering taxable income from conversion • -RMDs • +Excluded foreign earned income and foreign housing • +Excluded Series EE bond interest used for higher education • +Student loan interest deduction • +Tuition and fees deduction • +Domestic production deduction • Married taxpayer must file MFJ in year of conversion • Conversion triggers taxable income • Each Roth conversion has its own 5 year period for determining qualified distributions • Failed conversion results from MAGI over $100,000 even if caused by audit adjustment • Timely recharacterization can avoid penalties

9. More on Roth IRA Conversions • Who can convert to a Roth IRA? • After 2009 • Taxpayers with traditional, SEP and SIMPLE IRAs • Also qualified plans, 403(b), 457(b) • To avoid 20% withholding, use trustee to trustee transfer • Ability to borrow will be lost • MAGI limitation has been removed • Married taxpayer must file MFJ in year of conversion • Conversions trigger taxable income but • Conversion income is split equally between 2011 and 2012 • Unless taxpayer elects to report the full amount in 2012 • Tax rate picture after 2010 • A major wildcard in deciding - no congressional action, after 2010 tax rates above 15% revert to pre-2001 levels. • The top four brackets will be: • 39.6% instead of 35% • 36% 33% • 31% 28% • 28% 25% • Administration proposal to increase taxes only for those making $250,000 • Proposals on the table to help finance health reform with a surtax on high income taxpayers

10. Deciding Whether to Convert • Conversion is beneficial if • the eventual tax savings when funds are withdrawn • are greater than the tax paid on conversion • To make that decision, taxpayers must project how much tax will be avoided by using the Roth IRA • This involves assumptions about • How much income will be generated in the account (ROI) • When distributions will be taken • Length of time for accumulation • Tax rate at the time of distribution • Some rules of thumb for estimating • The longer one plans to wait before withdrawing funds, the more likely the future tax savings will outweigh the tax on conversion. • If the traditional IRA distributions are expected to be taxed at a lower rate than the tax paid on conversion, paying the tax to convert might be a mistake

11. Roth Conversion Calculator Assumes Capital Gains Rate

12. Roth Conversion Calculator Results

13. A little About Rates of Return • Expected rate of return • The actual rate of return is largely dependent on the type of investments you select. • From January 1970 to December 2008, the average annual compounded rate of return for the S&P 500, including reinvestment of dividends, was approximately 9.7% (source: www.standardandpoors.com). • During this period, the highest 12-month return was 61%, from June 1982 through June 1993. • The lowest 12-month return was -39%, which happened twice, once from September 1973 to September 1974 and again from November 2007 to November 2008. • Savings accounts at a bank may pay as little as 1% or less but care significantly lower risk to loss of principal balances. • It is important to remember that future rates of return can't be predicted with certainty and that investments that pay higher rates of return are generally subject to higher risk and volatility. The actual rate of return on investments can vary widely over time, especially for long-term investments.

14. Good Candidates for Conversion • Individuals with sufficient cash to pay tax on conversion • Selling an asset to raise cash often triggers additional taxable income • Borrowing money incurs interest expense • May be deductible for home equity load • Using IRA funds to pay tax on conversion can be expensive • Additional taxable income and probably 10% penalties • Individuals who will not have large tax liability on conversion • Taxpayers with unused losses and deductions • Taxpayers whose IRAs have not generated significant income • IRA recently established • Declined in value • Taxpayers with substantial basis in traditional IRAs • Wealthy individuals who are planning to transfer their IRAs to beneficiaries, rather than use IRAs for their retirement • Maximize wealth transferred • Beneficiary takes tax free distributions • Taxes paid on conversion reduces taxpayer estate • No RMD after conversion • Taxpayers who intend to withdraw funds from their traditional IRA before age 59-1/2 and can wait 5 years before taking distributions • Have a number of years to go before retirement • Can recoup the dollars lost to taxes due to the conversion

15. Undoing A Roth Conversion • A Roth Conversion can be recharacterized which means it goes back to a traditional IRA • Done by the extended due date of the return for the year of conversion • Whether actually extended or not • Reasons to recharacterize • AGI exceeds $100,000 in conversion year (before 2010) • Value of IRA drops after conversion • Avoids paying tax on subsequent conversion for non existent value • Taxpayer mistakenly funds a traditional IRA • Traditional IRA contribution is recharacterized to a Roth IRA contribution where eligible • Earnings in the traditional are treated as earnings to the Roth and are not considered basis • Has its own 5 year period for qualified distributions • Fine tuning a conversion after year end • When anticipated deductions will more than offset AGI for the year

16. Reconverting After A Recharacterization • Reconversion is restricted • Can’t occur until the later of • The beginning of the year after the year the amount was converted to a Roth, or • The end of the 30 day period beginning on the day the original conversion was recharacterized • Reconverted to early? • Taxable distribution • Maybe subject to premature distribution penalty • 72(t) exceptions apply • Contribution to Roth IRA is an excess contribution subject to 6% penalty

17. 401(k) Plans • 401(k) allows two types of contributions • Elective deferrals (employee) • Up to 100% of compensation or • $16,500 for 2009 • 50+ add $5,500 catch up for 2009 • Employer contributions • Contribute and deduct up to 25% of total compensation • $245,000 for 2009 • Considered a profit sharing contribution • Employee elective deferrals do not count against the 25% contribution limit • Limit on additions to any participant account • 100% of compensation, or • $49,000 • 50+ $49,000 + $5,500, $54,500

18. Roth 401(k) Plans • Combines traditional 401(k) features with Roth IRA features • Contribution limits are the same as for a traditional 401(k) • Contribution limits apply to aggregated 401(k) accounts of all types per individual, traditional, Roth, One-Person • Employee elective deferrals are • Made with after tax dollars • Withdrawals are not subject to income tax subject to the qualified distribution rules • Constitute a separate account from the employer contributions • Employer contributions are • Made with before tax dollars • Go into a separate account • Are taxable on distribution subject to normal distribution rules • Advantages to high income individuals • Roth IRA income limits don’t apply to Roth 401(k) accounts • Can’t do a Roth IRA, you can do a Roth 401(k)

19. One-Person 401(k) Plans • The self employed person is both • An employee and • The employer • Deducts both • Deferral • Contribution • Often maximizes a SE persons deductible retirement plan contribution compared to a SEP or a SIMPLE • Permits larger contribution than a regular profit sharing plan when compensation is below $245,000 or 50+ • Advantages of One-person 401(k) plans • Flexibility in making deferrals and contributions each year • Ability to borrow (Max is lesser of 50%, $50,000) • Drawbacks of One-person 401(k) plans • Elective deferral limit applies to all of a participants • 401(k) • 403(b) • SIMPLE IRA • SARSEP

20. SIMPLE IRA • Savings Incentive Match PLan For Employees is a written salary reduction agreement • Can be established by employer with 100 or fewer employees • Employees of certain related entities must be included in count • Union employees • Leased employees • Non resident alien employees • Can not be established if employer sponsors a qualified plan • Pension • Profit sharing plan • 401(k) • Stock bonus or annuity plan • 403(b) • SEP • Each employee earning at least $5,000 during the preceding year • Employee elects to have employer contribute part of each paycheck • % or $ amount • Employer must make • Matching contributions or • Non-elective contributions • Participation in simple is considered an employer provided pension • Impacts ability to make deductible IRA contributions • Eligible employees • Received at least $5,000 for any 2 prior years • Expected to earn at least $5,000 during the current year

21. More SIMPLE IRA • Plan can be set up using four models • Form 5304-SIMPLE • Employees choose financial institution to receive contributions • Form 5305-SIMPLE • Employer chooses financial institution to receive contributions • Prototype plan sponsored by qualified financial institution • Individually designed plan • Timing • Normally can be established Jan 1 and Oct 1 • If employer (or predecessor employer) already established a SIMPLE • A new SIMPLE can only be effective Jan 1 of the year • A new employer entering the picture after Oct 1 • Can establish SIMPLE between Oct 1 and Dec 31 • A plan year must be a calendar year • Employee notification • Employers must notify employees they are eligible to participate before the 60 day election period begins • They must also be given a plan summary • Must be given 60 days to elect to participate • Normally 60 day period begins on Nov 2 of the previous year • Effective other than Jan 1 • 60 day period must include either • Effective date or • The day before • Notification includes how employer contributions will be determined • Notification pages are contained in the Form 5304-SIMPLE and Form 5305-SIMPLE

22. More SIMPLE IRA • Annual disclosures • Employers must notify eligible employees 60 days before the start of the year • That they can make or change salary reductions • That they can change the financial institution handling their account • Indicating whether the employer contribution will be a matching contribution and the % • Indicate whether the employer contribution will be a nonelective 2% contribution made to all eligible employees • Employee deferrals • Maximum $11,500 • Catch up 50+, $2,500 • Employer contributions • Matching Contribution Formula • Employer matches employer deferral up to max of 3% of compensation • In 2 out of 5 years employer contribution can be 1% of compensation. Other years must be 2% or 3% • Notification of less than 3% contribution required at least 61 days before beginning of planned year. • Maximum $11,500 ($383,333 X .03) • Non Elective Contribution Formula • A 2% contribution to all eligible employees • Maximum $4,900 ($245,000 X .02) • Special rules for Self Employed • Compensation is net SE earnings determined without regard to SIMPLE IRA Contributions • SE persons contribution can be deposited after the end of the year • Employees of SE person deferrals and contributions need to be deposited NLT 30 days after the end of the month involving the compensation • Contributions are deductible if made by the extended due date of the return. • Employer contributions not treated as wages, not subject to withholding • Elective deferrals are subject to FICA and Medicare

23. SEP Plans • A SEP Plan is a written agreement enabling an employer to contribute to IRAs by or on behalf of eligible employees • SEP contributions are deductible to the employer • Excluded from employee income until withdrawn • Plan earned income not taxed until distributed • Setup • IRS Model 5305-SEP • Prototype SEP sponsored by financial institution • Individually designed plan • Timing • Must be adopted by the extended due date of the tax return for the year the plan is to be effective. • Not considered adopted until the separate SEP IRAs are established qualifying employees and • Required disclosures made. • Form 5305—SEP contains the required forms and disclosures if that model is used. • Advantage • Being able to adopt SEPs after year-end and still deduct post-year-end contributions is unique to SEPs

24. More on SEP Plans • Required disclosures • Employer must give • Statement of any contributions made for the year • If made before the end of the year can be on W-2 • Administrator must give each participant within 30 days of the effective date of the amendment • A copy of the amendment • A written explanation of the effects • If employers • Establish a SEP using 5305-SEP • Provide each eligible employee with a copy of the completed 5305-SEP • Other disclosures required in the 5305-SEP. • Not required to file a Form 5500 • Participant requirements • Attained age 21 • Performed service for three of the last five years • Received at least $550 (2009) compensation for the year • Can be less restrictive but not more so

25. And Still More on SEP Plans • Contribution rules • Employer not required to make a contribution in any year unless SEP doc requires it • Contributions must be made pursuant to a written allocation formual • Completed form 5305-SEP satisfies requirement for a written allocation formula • Contributions must be non discriminatory • Uniform relationship to compensation • Contribution Limits • $49,000 or • 25% of compensation • SE Contributions • Based on net SE earnings • $49,000 • 20% net SE Earnings

26. Choosing the Right Retirement Plan • Some questions to ask when deciding which plan is best • How much does the employer want to contribute consistently? • Is the employer willing to commit to contributions every year? • Will employees be allowed to defer salary? • Which employees are targeted to benefit the most in the plan? • What is the employers tolerance of administration and set up costs? • SEPs are the only plan which can be established after year end • Maximizing the business owner’s contributions • For many, maximizing deductible contributions is priority • If simplicity and low cost are important, the choice is geneerally between SEP or SIMPLE • SIMPLE works well when compensation is relatively low • SEP works well when income is higher • SEP/SIMPLE IRA Income break even point • Under 50, net SE income, $73779. Below SIMPLE, above SEP • 50+, net SE income, $89,818. Below SIMPLE, above SEP • If more complexity is tolerable, the One-person 401(k) usually allows for maximum retirement contributions

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