Introduction To Tax-Efficient Investing (Part 1)

Tax-Efficient Investing Webinar Series
Tax-Aware Investing--It’s The After-Tax
Return That Counts!
Part 1 of 4
Presented by:
Robert S. Keebler, CPA, MST, AEP (Distinguished)
Keebler & Associates, LLP
420 S. Washington St.
Green Bay, WI 54301
Phone: (920) 593-1701
Robert.Keebler@keeblerandassociates.com
Circular 230 Disclosure: To ensure compliance with requirements imposed by the IRS, we inform you that any U.S. federal tax advice contained
in this communication, including attachments, was not written to be used and cannot be used for the purpose of (i) avoiding tax-related penalties
under the Internal Revenue Code or (ii) promoting, marketing or recommending to another party any tax-related matters addressed herein. If you
would like a written opinion upon which you can rely for the purpose of avoiding penalties, please contact us.

Tax Aware Investing
KEY TOPICS
• Tax Structure– Determining the “optimum” mix of taxable
investments, tax-deferred investments and tax-free
investments (i.e. Where should retirement savings be
invested?)
• Tax-Sensitive Asset Allocation – Understanding the impact
that income taxation has on asset allocation and
diversification
• Asset Location – Identifying which assets to place in certain
investment vehicles
• Retirement Distribution Strategies to Last a Lifetime –
Integrating tax structure, tax-sensitive allocation and asset
location to ensure that retirement funds will last a lifetime
2
SM Tax Asset Classes is a service mark of Robert S. Keebler, CPA, MST, AEP and Keebler & Associates, LLP

Tax Structure
Determining the “Optimum” Mix of
Investment Vehicles/Structures

3

TAX ASSET CLASSESSM
Real Estate, Roth IRA
Interest Capital Gain Tax Pension
Dividend Oil & Gas and and
Income Income Exempt and
Income Tax Exempt Insurance
Interest IRA Income
Bonds
- Taxable -Preferential
- Tax Free
Rate - Tax
- Tax Growth/
-Deferral until Deferred
Preferences Benefits
sale

• Money • Equity • Equity • Bonds issued by • Pension plans Real Estate Roth IRA
market securities Securities State and local • Profit sharing • Depreciation • Tax-free
• Corporate Governmental plans tax shield growth during
bonds Attributes Attributes entities • Annuities • 1031 lifetime
• US Treasury • Qualified • Deferral exchanges • No 70½ RMD
bonds dividends at until sale Attributes Attributes • Deferral on • Tax-free
LTCG rate • Reduced • Federal tax • Growth during growth until distributions
Attributes • Return of capital gains exempt lifetime sale out to
• Annual capital rate • State tax exempt • RMD for IRA beneficiaries
income tax dividend • Step-up and qualified Oil & Gas life expectancy
on interest • Capital gain basis at plans • Large up
• Taxed at dividends death • No step-up front IDC Life Insurance
highest deductions • Tax-deferred
marginal • Depletion growth
rates allowances • Tax-exempt
payout at
© 2011 Prepared by Robert S. Keebler, CPA, MST, AEP (Distinguished) death
All Rights Reserved
robert.keebler@keeblerandassociates.com
Pursuant to the rules of professional conduct set forth in Circular 230, as promulgated by the United States Department of the Treasury, nothing contained in this communication was intended or written to be used by any taxpayer for the purpose of avoidi ng
penalties that may be imposed on the taxpayer by the Internal Revenue Service, and it cannot be used by any taxpayer for such purpose. No one, without our express prior written permission, may use or refer to any tax advice in this communication in
promoting, marketing, or recommending a partnership or other entity, investment plan or arrangement to any other party.

For discussion purposes only. This work is intended to provide general information about the tax and other laws applicable to retirement benefits. The author, his firm or anyone forwarding or reproducing this work shall have neither liability nor
responsibility to any person or entity with respect to any loss or damage caused, or alleged to be caused, directly or indirectly by the information contained in this work. This work does not represent tax, accounting, or legal advice. The individual taxpayer
is advised to and should rely on their own advisors.

4

Income Taxation Basics of
Retirement Investments
Three Main Types of Retirement Investment Accounts

• Taxable investment accounts – income generated within the account (i.e.
interest, dividends, capital gains, etc.) are taxed each year to the account
owner
• Tax-deferred investment accounts (e.g. traditional IRAs, traditional qualified
retirement plans, non-qualified annuities, deferred compensation) – income
generated within the account is not taxeduntil distributions are taken from
the account
• Tax-free investment accounts (e.g. Roth IRAs, life insurance) – income
generated within the accountisnever taxed when distributions are made
(provided certain qualifications are met)

© 2011 Keebler & Associates, LLP
Al Rights Reserved. 5

Common Assets in a Client’s Portfolio
• IRA Accounts
• Roth IRA Accounts
• ERISA Plans
• Tax-Deferred Annuities
• Life Insurance
• Stocks, Bonds, Warrants, Options
• Employer NSOs and ISOs
• Employer Deferred Compensation
• Real Estate
• Oil & Gas
• U.S. Savings Bonds


• 2011 Ordinary Income Rates Married
Qualified Married Filing Head of
Single Widow(er) Filing Jointly Separately Household

10% Tax Rate $8,500 $17,000 $17,000 $8,500 $12,150

15% Tax Rate $34,500 $69,000 $69,000 $34,500 $46,250

25% Tax Rate $83,600 $139,350 $139,350 $69,675 $119,400

28% Tax Rate $174,400 $212,300 $212,300 $106,150 $193,350

33% Tax Rate $379,150 $379,150 $379,150 $189,575 $379,150

35% Tax Rate > $379,150 > $379,150 > $379,150 > $189,575 > $379,150

• Capital Gain
– 0% rate if you are in the 10% or 15% bracket
– 15% rate if you are in the 25%, 28%, 33% or 35% bracket

Long-Term
Ordinary Income Capital Gains
2013 & 2013&
2011 & 2012 Beyond1 2011 & 2012 Beyond*
10% 15% 0% 10% / 8%
15% 15% 15% 20% / 18%
25% 28%
*NOTE: In general, the 8% and 18% capital
28% 31% gains rates only apply to long-term capital gains
on property that has been held more than five
33% 36% years at the time of sale.

35% 39.6% For the 18% rate, the property must be
purchased after December 31, 2000.


New 3.8% Medicare “Surtax”
Beginning with the 2013 tax year, a new 3.8% Medicare
“surtax” on net investment income will apply to all
taxpayers whose income exceeds a certain “threshold
amount”. This new “surtax” will, in essence, raise the
marginal income tax rate for affected taxpayers.
• Thus, a taxpayer in the 39.6% tax bracket (i.e. the
highest marginal income tax rate in 2013) would
have a federal marginal rate of 43.4%!


Tax Rate in
Tax Rate in Tax Rate in 2013+
2011 & 2012 2013 (w/surtax)
10% 15% 15%
15% 15% 15%
25% 28% 28%
28% 31% 34.8%
33% 36% 39.8%
35% 39.6% 43.4%
NOTE: The chart above assumes that the 3.8% Medicare surtax would not begin to apply until a
person’s taxable income reaches the 31% tax bracket (based on certain net investment income
and itemized deduction assumptions). However, there are times, though unlikely, when the 3.8%
could apply to a person in a lower tax bracket (i.e. 15%, 28%) or may not apply to a person in
higher tax brackets (31%, 36%, 39.6%).


APPLICATION TO INDIVIDUALS – the new Medicare
surtax is equal to 3.8% times the lesser of the following:
1. “Net investment income”, OR
2. The excess (if any) of –
a. “Modified adjusted gross income” (“MAGI”) for
such taxable year, over the
b. “Threshold amount”



Three critical terms are associated with the 3.8% Medicare
surtax:

• “Net investment income”
• “Threshold amount”
• “Modified adjusted gross income” (“MAGI”)


• “Net investment income” is defined as
interest, dividends, annuities, rents, royalties, income derived from
a passive activity, and net capital gain derived from the disposition
of property (other than property held in an active trade or
business), reduced by deductions properly allocable to such
income.

• Specifically, this does notinclude the following:
1. Income derived from an active trade or business;
2. Distributions from IRAs or their qualified plans;
3. Any income taken into account for self-employment tax purposes;
4. Gain on the sale of an active interest in a partnership or S corporation; or
5. Items which are otherwise excluded or exempt from income under income
tax law, such as interest from tax-exempt bonds, capital gain excluded on
the sale of a principal residence under IRC 121, and veteran’s benefits.


“Threshold amount”is the key factor in determining the “lesser of”
formula for purposes of calculating the surtax.

Threshold amounts
• Single taxpayers - $200,000
• Married, filing jointly taxpayers - $250,000
• Estates/trusts - $11,350 (i.e. top income tax bracket in 2011)


Investment Incentives in the Tax Code
• Qualified dividends
• Long-term capital gains
• Qualified retirement accounts (e.g. 401(k) plan)
• Roth IRAs/Roth 401(k) plans
• Real estate depreciation
• Oil & gas
• Life insurance
• Non-qualified annuities
• Master Limited Partnerships (MLPs)
• Index options

Deductible IRAs, Pension Plan
Incentives and Deferred Compensation
• Deductible contributions
• Tax deferred growth
• Taxable withdrawals
• Net Unrealized Appreciation (NUA)
• Lump-sum averaging
• Aggregation of accounts
• Roth IRA conversions


Roth IRA and Roth 401(K) Incentives
• Non-deductible contributions
• Tax-free growth
• Non-taxable withdrawals for “qualified
distributions”
• Five-year rule & Age 59 ½ Rule


Qualified Dividend Incentives
• Taxation of Interest Income - Ordinary Income
• Taxation of Traditional Dividends- Ordinary
Income
• Taxation of “Qualified Dividends” – Capital
Gains Rate of 15%


Capital Gains Incentives
• Gains Deferred until Property is Sold
• Short-term Gains are Taxed at Ordinary Rates
• Long-term Gainsare Taxed at Lower Tax Rates
• Step-up in Basis at Death
• Gifts to Charity or a Charitable Trust that do
not Trigger Tax


Real Estate Incentives
• Interest Deductions
• Depreciation Tax Shield
• 1031 Tax-free Exchanges
• Step-up in Basis at Death


Oil and Gas Incentives
• Intangible drilling costs (IDCs) provide a large
immediate income tax deduction (up to 85% of the
initial investment)
• Losses, if any, created as a result of IDCs will be ordinary
(thus lowering a taxpayer’s AGI)
• Must be a general partner in the first year
• Possible AMT add-back issues if IDCs exceed 40% of AMTI
• Depletion and other depreciation (including Section 179
expensing) provide for additional deductions during the
term of the investment
• Additional tax credits may be available for certain oil &
gas ventures
• AMT Issues

All Rights Reserved. 21

Life Insurance Incentives
• Tax-Deferred Growth
• Tax-Free Death Benefit
• Tax-Free Basis Distributions First
• Tax-Free Loans
• All Contracts are Treated Separately
• Modified Endowment Restrictions


Nonqualified Annuity Incentives
• Tax-deferred Growth
• Pro-rate Basis Distributions if Annuitized
• All Contracts are Treated Separately


Retirement Assets
How are Distributions Taxed?
Basis Tax-Free Earnings
Loans
IRA(1) Pro rata Method N/A Pro rataMethod
ERISA Plan Pro rata Method N/A Pro rataMethod
Roth IRA(2) Basis First N/A Earnings Follow
Non-qualified Annuity Basis Follows N/A Earnings First
Life Insurance(3) Basis First Available Earnings Follow
Non-Modified Endowment Contract

Life Insurance(4) Earnings First N/A Basis Follows
Modified Endowment Contract

1. All IRAs are combined for the distribution computation
2. All Roth IRAs are combined for the distribution computation
3. Loans available, with interest to the extent of cash surrender
4. Each contract is treated separately for distribution purposes

© Robert S. Keebler, CPA, MST, AEP
All Rights Reserved 24

Annuities and Modified Endowment Contracts
Tax Attributes
Attributes Non-qualified Annuity MEC
During Life
Cash value growth Income tax deferred Same

Lifetime distributions Taxable as income to the extent of Same
growth, followed by recovery of
basis
10% penalty on distribution before 10% penalty on taxable amount Same
age 59 ½ unless an exception applies
Exceptions to 10% penalty Taxpayer’s age 59 ½ or disability, Same without death
owner’s death, series of
substantially equal periodic
payments
Gifts of contract during life Donor pays income tax on any gain No income tax to
in the contract donor or donee
At Death
Death proceeds Amount in excess of basis in the Generally, 100% free from income
contract is taxed as ordinary income tax to the beneficiary
to the beneficiary

Al Rights Reserved.
25

Incentives for Master Limited
Partnerships
• Cash Distributions are often Tax-free
• Depreciation Tax-shield
• Reduction in Basis
• Step-up in Basis at Depth


Incentives for Listed Index Options
• 60% Long-term Capital Gain
• 40% Short-term Capital Gain
• Effective Tax Rate of 23%
– ((15% X 60%) + (35% X 40%))
• “Marked to Market” Taxation at Year End


Blending Tax and Finance
• Asset “Allocation”
• Tax Incentives
• Asset “Location”


Common Problems Blending Tax and
Finance
• Large IRAs and Qualified Plans
• Minimal IRAs and Qualified Plans
• High Turnover Investments


The Mathematics of Wealth
Creation


Traditional IRA/Roth IRA
Key Assumptions
• Beginning Age: 30
• Ending Age: 65 (i.e. retirement)
• Annual Contribution (Age 30 – 49): $5,000
• Annual Contribution (Age 50 – 65): $6,000
• Ordinary Income Tax Rate (@ contribution): 25%
• Ordinary Income Tax Rate (@ distribution): 25%
• Long-Term Capital Gains Tax Rate: 15%
• Annual Income/Growth Rate: 6%


Scenarios
1. Deductible Traditional IRA vs. Taxable Investment Account
(Bond Portfolio)
(Stock Portfolio w/100% Turnover)
4. Non-Deductible Traditional IRA vs. Taxable Investment Account
(Bond Portfolio)
5. Non-Deductible Traditional IRA vs. Taxable Investment Account


Scenarios
6. Non-Deductible Traditional IRA vs. Taxable Investment
Account (Stock Portfolio w/10% Turnover)
7. Roth IRA vs. Taxable Investment Account
(Bond Portfolio)
10. Deductible Traditional IRA vs. Roth IRA
11. Non-Deductible Traditional IRA vs. Roth IRA


Deductible Traditional IRA vs. Taxable
Investment Account (Bond Portfolio)
Total Investment Balance
$700,000
COMMENT: Tax-deferred
$600,000
growth over time allows for
$500,000 more wealth to accumulate.

$400,000

$300,000

$200,000

$100,000

$-
30 31 32 33 34 35 36 37 38 39 40 41 42 43 44 45 46 47 48 49 50 51 52 53 54 55 56 57 58 59 60 61 62 63 64 65

Deductible Traditional IRA Taxable Investment Account


Investment Account (Stock Portfolio
w/100% Turnover)
$700,000
COMMENT: Tax-deferred growth
$600,000
over time allows for more wealth
$500,000
to accumulate, even with lower
capital gains tax rates
$400,000

$300,000

$200,000

$100,000

$-
30 31 32 33 34 35 36 37 38 39 40 41 42 43 44 45 46 47 48 49 50 51 52 53 54 55 56 57 58 59 60 61 62 63 64 65



w/10% Turnover)
$700,000
COMMENT: Tax-deferred growth over
$600,000
time allows for more wealth to
$500,000
accumulate. However, with low turnover
and lower capital gains tax rates, the
$400,000 taxable investment stays pretty close.
$300,000

$200,000

$100,000

$-
30 31 32 33 34 35 36 37 38 39 40 41 42 43 44 45 46 47 48 49 50 51 52 53 54 55 56 57 58 59 60 61 62 63 64 65



Non-Deductible Traditional IRA vs.
Taxable Investment Account (Bond
Portfolio)
$600,000
$500,000 time allows for more wealth to
accumulate. However, without any
$400,000 income tax deduction, the traditional
IRA is not as favorable.
$300,000

$200,000

$100,000

$-
30 31 32 33 34 35 36 37 38 39 40 41 42 43 44 45 46 47 48 49 50 51 52 53 54 55 56 57 58 59 60 61 62 63 64 65

Non-Deductible Traditional IRA Taxable Investment Account


Non-Deductible Traditional IRA vs. Taxable
w/100% Turnover)
$600,000
$500,000 time allows for more wealth to
accumulate. However, without any
$400,000 income tax deduction and lower capital
gains tax rates, the IRA barely breaks
$300,000
even with a taxable investment.
$200,000

$100,000

$-
30 31 32 33 34 35 36 37 38 39 40 41 42 43 44 45 46 47 48 49 50 51 52 53 54 55 56 57 58 59 60 61 62 63 64 65

Taxable Investment Account Non-Deductible Traditional IRA


Non-Deductible Traditional IRA vs. Taxable
Investment Account (Stock Portfolio w/10%
Turnover)
$600,000
COMMENT: Even with tax-deferred
$500,000 growth, the taxable investment is
better over time because of the
$400,000 lower capital gains tax rates.

$300,000

$200,000

$100,000

$-
30 31 32 33 34 35 36 37 38 39 40 41 42 43 44 45 46 47 48 49 50 51 52 53 54 55 56 57 58 59 60 61 62 63 64 65

Taxable Investment Account Non-Deductible Traditional IRA


Roth IRA vs. Taxable Investment Account
(Bond Portfolio)
$700,000
COMMENT: Tax-free growth
$600,000
over time allows for more
$500,000
wealth to accumulate.

$400,000

$300,000

$200,000

$100,000

$-
30 31 32 33 34 35 36 37 38 39 40 41 42 43 44 45 46 47 48 49 50 51 52 53 54 55 56 57 58 59 60 61 62 63 64 65

Roth IRA Taxable Investment Account


$700,000
COMMENT: Tax-free growth over
$600,000
time allows for more wealth to
$500,000
accumulate, even with lower
capital gains tax rates.
$400,000

$300,000

$200,000

$100,000

$-
30 31 32 33 34 35 36 37 38 39 40 41 42 43 44 45 46 47 48 49 50 51 52 53 54 55 56 57 58 59 60 61 62 63 64 65



$700,000
COMMENT: Tax-free growth over time allows
$600,000
for more wealth to accumulate, though low
$500,000
turnover and lower capital gains tax rates
even-up the two investments.
$400,000

$300,000

$200,000

$100,000

$-
30 31 32 33 34 35 36 37 38 39 40 41 42 43 44 45 46 47 48 49 50 51 52 53 54 55 56 57 58 59 60 61 62 63 64 65



Deductible Traditional IRA vs. Roth IRA

$700,000
COMMENT: Assuming tax rates are the
$600,000
same in the contribution years as in
$500,000
the withdrawal years, a deductible
traditional IRA and Roth IRA will come
$400,000 out to be roughly the same. The only
slight difference is due to the after-tax
$300,000
rate of return in the “side fund”.
$200,000

$100,000

$-
30 31 32 33 34 35 36 37 38 39 40 41 42 43 44 45 46 47 48 49 50 51 52 53 54 55 56 57 58 59 60 61 62 63 64 65

Roth IRA Deductible Traditional IRA


Non-Deductible Traditional IRA vs.
Roth IRA
$700,000
COMMENT: Assuming tax rates are the
$600,000
same in the contribution years as in
$500,000
the withdrawal years, a Roth IRA will
come out ahead because there is no
$400,000 reinvestment opportunity with a non-
deductible traditional IRA.
$300,000

$200,000

$100,000

$-
30 31 32 33 34 35 36 37 38 39 40 41 42 43 44 45 46 47 48 49 50 51 52 53 54 55 56 57 58 59 60 61 62 63 64 65

Roth IRA Non-Deductible Traditional IRA


Traditional IRA/Roth IRA
Observations (What Have We Learned?)
• Bonds (or other ordinary income producing assets) should be
placed in IRAs (traditional/Roth) instead of taxable investment
accounts
• Lower turnover equity investments (i.e. long-term capital gain
assets) should be positioned in taxable investment accounts
• Roth IRAs are slightly better than deductible traditional IRAs
and taxable investment accounts with low turnover equity
investments
• Roth IRAs are much better than non-deductible traditional IRAs
and taxable investment accounts with ordinary income
producing assets)


Tax-Deferred Annuity/Life Insurance
Key Assumptions
• Beginning Age: 30
• Ending Age: 65 (i.e. retirement)
• Initial Investment: $50,000
• Ordinary Income Tax Rate: 25%
• Long-Term Capital Gains Tax Rate: 15%
• Annual Income/Growth Rate: 6%
• Annual Yield Rate (Tax-Deferred Annuity): 6%
• Annual Yield Rate (Life Insurance): 6%


Introduction To Tax-Efficient Investing (Part 1)

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