volume 47 | summer 2020

Determining if a Roth Conversion

Is Right for You

ForewordWe launched Spectrum to share insights from the conversations we have with clients

every day. True to its name, this newsletter includes a range of topics we know clients

face as they assess their financial plans.

The Summer 2020 edition explores several of the questions our clients ask most

often: Which factors should I evaluate when considering a Roth conversion? Does my

business have the right buy/sell provisions in place? How can I close the gender gap

when it comes to financial planning? And what steps can I take to ensure a successful

intergenerational wealth transfer?

We hope you find this issue insightful and inspiring.

It’s a privilege to serve you,

The First Republic Private Wealth Management team

Contentssummer 2020

page 2 Determining if a Roth Conversion Is Right for You

page 6 Prepare for the Unexpected — Reviewing Your Buy/Sell Agreement

page 10 Closing the Gender Gap on Money Matters

page 13 Values: Shaping Your Legacy With Intention

Determining if a Roth Conversion

Is Right for You

Paul K. MutchAdvanced Planner

The current downturn in the stock market has made many investors uneasy. But with market volatility comes opportunity. Strategic investors know that history tells us stocks are likely to recover, and making smart moves now —

like converting a traditional ira to a Roth ira — can bring significant tax benefits. With market values depressed and federal tax rates at a historical low (at least for now), Roth conversions appear to be a wise tax planning strategy. Still, there are factors to consider when determining whether a Roth conversion is right for you.

The differences between traditional and Roth iras

The main differences are:

Contributions: Those made to traditional iras may be tax deductible, while contributions to Roth iras are made on an after-tax basis. Both are subject to limitations. Contributions may be made to both types of iras at any age, provided an investor has earned income. Distributions: Investors must take required minimum distributions (rmds) from their traditional iras no later than April 1, following the year they turn 72. Those distributions are taxable. There are no rmds for Roth iras, and qualified withdrawals are tax-free.

What is a Roth conversion?

A Roth conversion is when an investor transfers (or converts) money from a traditional ira to a Roth ira. A conversion is considered a distribution, and thus the amount converted is taxed at the investor’s ordinary income tax rate in the year of conversion. The 10% penalty will not be assessed if the investor is under age 59 1/2 as long as the taxes owed on the converted amount are paid with non-ira assets.

Example: A 40-year-old investor has pre-tax funds of $100,000 in a traditional ira and is in the 24% tax bracket. The investor decides to convert the entire amount to a Roth ira and pays $24,000 in federal income taxes with funds in a taxable account. Twenty years later, when the account is worth $300,000, if the investor withdraws all of it, no tax will be due since this is a qualified distribution.

On the other hand, if any part of the ira contains nondeductible contributions, only a portion of the converted amount will be taxable.

Example: The same situation as above, except $60,000 of the $100,000 consists of nondeductible (after-tax) contributions. In this case, the investor will pay $9,600 in federal income taxes. The $60,000 is considered basis and isn’t taxable when it’s converted to a Roth ira.

In addition, an investor can choose to convert smaller amounts over several years and stay within their current tax bracket while reducing the size of their traditional ira. By converting smaller amounts, the investor is making smaller tax payments over time rather than making a substantial one-time tax payment.

Considerations for a backdoor Roth conversion

If the investor already has an ira with pre-tax dollars, that ira will be aggregated together with any new nondeductible contributions when the conversion occurs. An investor cannot convert just the nondeductible contributions, regardless of whether the contributions were made to the existing ira or a new account. Instead, the conversion is subject to the ira aggregation rule, and the tax consequences are determined on a pro rata basis across all the accounts. Due to the ira aggregation rule, having an ira

2 summer 2020 3determining if roth conversion is right for you

(including sep- and simple iras) with pre-tax funds has effectively eliminated the investor’s ability to engage in a tax-free backdoor Roth conversion.

Example: The investor has $100,000 of pre-tax dollars in a traditional ira and is in the 24% tax bracket. The investor’s income exceeds the threshold to establish a Roth ira, and therefore the investor decides to make a $6,000 nondeductible contribution to a new traditional ira, then convert it to a Roth ira. The conversion of the new ira will be treated as $340 of after-tax funds and $5,660 of pre-tax funds that are taxable as a result of the conversion.

An important exception to the aggregation rule is that it doesn’t apply to qualified retirement plans, such as 401(k) plans. It’s possible to move only pre-tax funds from an ira to a 401(k), leaving only after-tax funds in the ira and thus reducing or eliminating the tax on a Roth conversion. Such a transfer is only possible if the plan allows it. Review the plan document or check with the plan administrator before acting.

Roth conversion considerations

Deciding whether to convert a traditional ira to a Roth ira requires careful consideration of several factors. Investors should talk with their tax advisors to evaluate their own financial circumstances.

· Future asset appreciation: If an ira is depressed in value relative to its future appreciation potential, converting earlier in the year may make sense.

· Current and future taxable income or tax rates: If an investor expects their taxable income or tax rates to decrease in the future, converting a traditional ira to a Roth ira may not make sense, as the investor would pay income tax on the converted amount at a higher rate.

· Taxes due on conversion: If the ira to be converted has substantial nondeductible contributions, there may be minimal tax due on the conversion.

· Taxable funds to pay the taxes on the conversion: Using funds from a converted ira to pay taxes means there will be less money in the Roth ira to grow tax-free. When possible, taxes should be paid with funds from a taxable account.

· Losses or deductions could offset income from the conversion: Making a charitable contribution or having a charitable contribution carryover (or other deduction) may offset all or some of the income recognized on the conversion.

· Reduced income in the year of conversion could make taxes more palatable: The cares Act waived rmds from retirement accounts in 2020. Converting an amount equal to the rmd will place an investor in a similar tax situation, as though the rmd hadn’t been waived. Likewise, deferring income to a later year and converting an amount equal to the income deferred will place an investor in a comparable tax situation.

· Disqualification for various tax benefits: The income from a full conversion could push an investor into a higher tax bracket, phase out deductions or credits, or disqualify the investor for other means-tested benefits.

· Time left until retirement: An investor who is close to retirement has less time to make up for what was lost to taxes on the conversion.

When done thoughtfully, a Roth conversion can be a powerful tax planning tool that can provide tax-free income to a family for years to come. In the current moment, with lower account values and historically low tax rates, this could be an ideal time to convert a traditional ira to a Roth ira. However, investors should fully review the tax consequences and other considerations to help determine whether a conversion is suitable.

First Republic can work with you and your tax professionals to help you weigh all options and help guide you through the decision-making process. ■

1 States have different laws regarding which income is taxable and nontaxable. Given the myriad rules, this article doesn’t account for state income taxes.

2 For example, a married couple filing a joint return may not contribute to a Roth ira if their modified adjusted gross income is equal to or greater than $206,000.

3 The secure Act changed the age requirement of rmds from 70 1/2 to 72.4 The calculation is ($100,000 – $60,000) x 24%.5 The calculation is Total Nondeductible Contributions Converted x (Total Nondeductible Contributions Converted / Total of All iras),

or $6,000 x ($6,000 / $106,000).

First Republic Private Wealth Management encompasses First Republic Investment Management, Inc., an sec-registered Investment Advisor, First Republic Securities Company, llc, Member finra/sipc, First Republic Trust Company, First Republic Trust Company of Delaware llc and First Republic Trust Company of Wyoming llc.

The strategies mentioned in this document will often have tax and legal consequences; therefore, it is important to bear in mind that First Republic does not provide tax or legal advice. This information is provided to you “as is,” does not constitute legal advice and is governed by our Terms and Conditions of Use, and we are not acting as your attorney. We make no claims, promises or guarantees about the accuracy, completeness or adequacy of the information contained here. Client’s tax and legal affairs are their own responsibility. Clients should consult their own attorneys or other tax advisors in order to understand the tax and legal consequences of any strategies mentioned in this document.

4 summer 2020 5determining if roth conversion is right for you

Prepare for the Unexpected —Reviewing Your

Buy/Sell Agreement

Will Hendricks Estate & Business Planning Specialist, First Republic PrivateWealth Management

Jay HalversonEstate & Business Planning Specialist, First Republic PrivateWealth Management

Hundreds of new businesses are formed each day in the United States. Founding partners come together with an idea, map out a plan, take all the right steps to set up the corporate structure, create formation

documents and get their businesses off the ground. They put their heads down working on their business, and the years fly by. The company grows, and life — both personal and professional — becomes more complicated.

Suddenly, an unexpected trigger event requires that a founding partner’s controlling interest in the company be transferred. The need may be the result of premature death, career-ending illness, a complicated divorce or merely a decision to retire early. Whatever the cause, we find most often that when this happens, those long-forgotten formation documents are pulled out of a filing cabinet, dusted off and read — only to discover that the terms are going to cause more harm than good. What now?

Not having a clear, written plan can put an entire business at risk. Departing partners and surviving family members could potentially be forced to walk away with far less than what they should have received. Conversely, a poorly written or nonexistent buy/sell agreement could leave the remaining partners with a potentially crippling buyout liability and put the business at risk.

Having buy/sell provisions in place from the beginning, and regularly updating them, is a crucial step that entrepreneurs often overlook when they start. Investing time early on to have these sometimes difficult conversations ensures that all stakeholders are on the same page, and can help mitigate the emotional and financial burden of an unforeseen or contentious transition in the future. Not only will business owners build a stronger foundation for their company, but addressing these loose ends can increase the value of the organization over the long run.

6 summer 2020

Every business needs a contingency plan — in writing

A client once confessed to us that they give better advice to their in-laws about what to do with their kids over a long weekend than what to do with their company if they didn’t make it through the door the next day. From a business continuity standpoint, the riskiest plan is the one that exists in an owner’s head and not on paper. Now more than ever, updating or creating a written contingency plan and letting family members, employees, clients and lenders know that it exists can be the difference between weathering the storm and being forced to shut down.

Business valuation — make sure it works for everyone

One of the biggest sticking points of any agreement is determining how the business will be valued when a transfer of ownership needs to occur. Many business owners, and the advisors who draft these agreements, believe the best way to establish a value is by appraisal. Not only can an appraisal be time-consuming, but it can also create unnecessary expenses when cash flow might be an issue.

We often see up to three appraisals required if there is any disagreement between the parties. While formal business valuations are often necessary when selling to an outside buyer, there can be a simpler way to value the business. Many business owners use the “Agreed Value” method as an alternative approach. Simply put, Agreed Value means that the owners meet at least annually and decide, among themselves, the value of their business.

Owners should also have a backup methodology for valuation in the event they skip the annual meeting. The most common method is formula-based, a multiple of revenues, earnings or whatever makes sense for the business — as long as the formula is accepted and agreed upon by all.

Think through payment terms

In our work with clients, we focus on playing out the real-life consequences of a particular event occurring, modeling the terms as they exist in their existing agreement, and asking: “Would you or your family be happy with the outcome?” Often the answer is “no.”

Buyout payment terms should be structured in a way that provides the business with flexibility and time. We often see the initial down payment percentage being unrealistically high, or the duration of the note payment being too short. We often hear the question: “Where am I going to get the cash for a 40% down payment within 30 days?”

In most situations, insurance is an inexpensive tool that can be used to provide tax-free liquidity in the event of a death or career-ending illness. Still, other triggers such as bankruptcy or divorce cannot be insured. Most owners are also surprised to learn that note payments are non-deductible. By establishing clear, realistic buyout terms from the outset, and leaving room to make adjustments over time, business owners can lay the foundation for a successful transition.

Other considerations

There are several other components of the agreement that should be considered depending on the industry. Are the partners involved in real estate development on the hook for construction guarantees of a particular project, or would they be in technical default of a loan if a partner passes away? Does a potential buyer of a dentist practice need to satisfy certain medical requirements to be a permitted purchaser? Is your long-time partner comfortable being in business with your spouse or adult children when you are no longer around?

Call to action

Don’t let an out of date agreement define your legacy. Now more than ever, we urge our clients and fellow business owners to come up for air and invest well-spent time working on their business. Dust off the agreement that you probably haven’t looked at in years, review the provisions and make sure you and your partners can live with the terms. Task your advisors to take the project off your punch list and complete the necessary changes. It doesn’t always need to be an expensive or time-consuming effort. Unfortunately, many of the stories we hear about nonexistent agreements or out of date terms — and the ensuing drama — could have been avoided with a little emphasis on staying current. We take pride that our business clients sleep a bit better at night, knowing that their planning loose ends have been addressed. ■

8 summer 2020 9prepare for the unexpected — reviewing your buy/sell agreement

Closing the Gender Gap on Money Matters

Miranda HolmesAdvanced Planner

Dagny MaidmanWealth Manager

Women now control more than half of u.s. personal wealth and their share of the wallet is growing. Women are staying single for longer, taking on bigger roles in the workplace and on average

outliving men. While women own a growing share of wealth, many neglect to truly take control

of it. Numerous studies suggest that women often aren’t as proactive about managing their money as they could be. Single women are more likely than the general population to say that a lack of financial literacy hinders their ability to invest, and fewer than half say they’re confident about making the right financial decisions for their portfolios. Among married women globally, more than half defer to their spouses when it comes to long-term financial decisions. This is true even among younger segments, with 61% of millennial women saying their spouses handle investment decisions.

In our own work in financial planning and investment management, we’ve observed that women are often reluctant to ask questions or share their concerns for fear they’ll sound uninformed or slow down the process. Here’s the thing: Real financial planning is all about this very process. It’s too personal and too important for women to not have a voice. Here’s how to find yours.

Know where you are — and where you want to go

When you strip away the jargon and often overly complex concepts, financial planning is not unlike planning for any other goal. It begins with understanding where you are, what you hope to achieve and how you’re going to get there.

Before thinking about developing new savings habits or getting into the weeds on investment decisions, a key first step is taking stock of your current picture. That means

doing a detailed assessment of all of your assets and debt. It also means factoring in all of your sources of income and getting a clear view of your expenses. No matter what your situation is, knowing where your money goes is a foundation of good financial planning.

Once you have a clear view of those components, you can start to think about what you want to accomplish, both in the short and longer term.

Map a plan — stay the course

One of the most difficult aspects of financial planning is prioritizing multiple goals, which can include everything from building emergency funds and paying off debt to investing for retirement, buying a home and helping fund your child’s college education.

You can begin to bring these priorities into focus by listing, quantifying and plotting them over an appropriate timeline. This process alone can make the task seem less daunting, and with a clear vision, it’s possible to tackle multiple goals at once.

For example, if you have an employer-sponsored retirement plan, one of your top priorities should be to save enough to get the benefit of any employer 401(k) match. As your salary increases, you can gradually bump up your contributions.

Meanwhile, you also want to make sure you have savings outside of retirement to cover emergencies or a sudden loss of income — aim for three to six months’ worth, or even up to one year’s worth, of living expenses. An adequate safety net helps ensure that you don’t need to raid your retirement or take on debt. And if you do have debt? Make room in your budget to chip away at it, prioritizing payments toward the highest-interest debt first.

10 summer 2020 closing the gender gap on money matters 11

When it’s time to invest, start simple

When it comes to investing, start with the basics. The most important thing to know is that time, diversification and low costs will ultimately mean more than picking the next hot stock.

Not sure where to start? Most retirement plans offer target-date funds, which are diversified portfolios based on when you expect to retire. Start there, and as you get more confident, you can explore other strategies.

In fact, research has shown that women may actually be better long-term investors, namely because they trade less and don’t assume that they can beat the market. In our own work, female clients are often less emotional than their male counterparts during times of market volatility.

Of course, most people, regardless of gender, can benefit from working with professionals who can help them map out a financial plan and create an investment strategy that makes sense — and navigate the detours and roadblocks they may encounter.

If you opt to work with a financial advisor, you’ll not only want to make sure that person has the experience and resources to get you where you need to go. You’ll also want to make sure he or she is the person you want to bring with you. If you find you’re not comfortable asking questions or voicing your concerns and aspirations, keep looking until you find the right person. ■

Values: Shaping Your Legacy With Intention

Although many families find conversations about money uncomfortable, the reality is that money and values are closely intertwined. A lifetime of experiences and traditions thoughtfully shared and brought to life

through family discussion is an ideal vehicle for communicating values across generations and building a foundation for financial decisions.

At the same time, experts say that 90% of intergenerational wealth transfers fail by the third generation. This failure is due to a lack of communicating values and preparing heirs. Without a framework for making financial decisions, the next generation is left on a path without a road map.

While most families feel they know their own value system, following an intentional process of reflection to help identify your family values and effectively communicate them to your loved ones is a valuable step.

Exploring your history

The process of exploring family stories and experiences can illuminate your family’s unspoken values and their sources. Questions to consider include:

· What is the story around your wealth? What struggles did you and your family encounter along the way?

· Did you receive support — either monetary or moral — from your family?

· How did your parents communicate about and deal with money?

Take the example of a client who grew up observing their parents’ frugal habits. As a result, the client developed an implicit value of frugality, despite being quite wealthy. The fear of scarcity had been amplified and carried forward for generations without the

Kelly ArrillagaSenior Trust & Fiduciary Advisor, First Republic Trust Company

Anna HowardFamily Wealth Resources Leader

12 summer 2020 13

family stopping to reflect upon where that value came from and whether it should be carried forward.

Defining your family values

As you think about your children and future heirs, what kind of people do you want them to be? What do you want your family to represent? We encourage our clients to engage the entire family in the conversation by asking:

· How would you define your family’s wealth beyond the financial component?

· What are your favorite family traditions and why?

· How do you define success?

Each person has their own story, and family members will have different perspectives. However, the goal with this step is to actively practice sharing, listening and understanding across generations. By encouraging the participation of the family as a whole, each individual can feel empowered to contribute toward a shared lasting vision.

Formalize your family values

Once your family has defined their history and values, you can consider how to craft a family mission statement together. By focusing on three to five key values, you can more consistently incorporate those values into your family’s communication and decision-making process. We often hear about themes of independence, work ethic, self-confidence, kindness and enjoying life, but there’s no right answer. Your values are unique to your family.

Share your family valuesCommunication is key

The most powerful way to communicate your family’s values to your loved ones and trusted advisors is through storytelling. Rather than simply making a list, telling stories brings these beliefs to life. The listener can engage with the narrative, visualize themselves in your place and empathize with your emotions at the time. Scientists have found that when we listen to a story, parts of our brain are activated as if we were experiencing the event ourselves. First Republic can support you in actively sharing your values and providing guidance on best practices based on your family structure.

Practice makes perfect

Family values aren’t a one-time discussion. Making a habit of using your family values as a guide for financial decisions ensures consistency and accountability. The discipline around referencing your values and stories when making decisions will set the course for ensuring alignment with and sustainability of your family’s vision.

15values: shaping your legacy with intention

Collaboration with trusted advisors

While it’s important to share your values with your family, incorporating those values into your estate plan is equally important. There are a number of ways you can accomplish this, and First Republic can help you successfully navigate the process.

At First Republic, it’s our privilege to support you in exploring your values and stories. Whether you’re establishing values for the first time or needing a refresh, we can help you successfully navigate these conversations around your legacy. ■

We hope you enjoyed this issue.If you have questions or comments related to the topics in this edition, please contact your relationship manager.

This information is governed by our Terms and Conditions of Use.

First Republic Private Wealth Management includes First Republic Trust Company; First Republic Trust Company of Delaware llc; First Republic Investment Management, Inc., an SEC-Registered Investment Advisor; and First Republic Securities Company, llc, Member finra/sipc. Insurance Services provided through First Republic Securities Company, dba Grand Eagle Insurance Services, llc, ca Insurance License # 0I13184, and First Republic Investment Management, dba Eagle Private Insurance Services, ca Insurance License # 0K93728. This document is for information purposes only and is not intended as an offer or solicitation, or as the basis for any contract to purchase or sell any security or other instrument, or to enter into any type of transaction as a consequence of any information contained herein. Although information in this document has been obtained from sources believed to be reliable, we do not guarantee its accuracy, completeness or fairness, and it should not be relied upon as such. The document may not be reproduced or circulated without our written authority. Strategies mentioned in this article will often have tax and legal consequences. First Republic Bank and its affiliates do not provide tax or legal advice. This information is provided to you as is, does not constitute legal advice, is governed by our Terms and Conditions of Use, and we are not acting as your attorney. Clients’ tax and legal affairs are their own responsibility. Clients should consult their own attorneys or other tax advisors in order to understand the tax and legal consequences of any strategies mentioned in this document.

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