IRAs, Roth IRAs and 401(k) Plans:IRAs, Roth IRAs and 401(k) Plans:Beginning Your Investment JourneyBeginning Your Investment Journey

October 30, 2012October 30, 2012

Valerie LeeValerie LeeMorgan Stanley Wealth ManagementMorgan Stanley Wealth Management

733 Bishop Street Suite 2800, Honolulu Hawaii 96813733 Bishop Street Suite 2800, Honolulu Hawaii 96813

tel: 808-525-6988, email: tel: 808-525-6988, email: valerie.a.lee@morganstanley.com

Morgan Stanley Smith Barney LLC. Member SIPCMorgan Stanley Smith Barney LLC. Member SIPC

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What is a Traditional IRA?What is a Traditional IRA?A retirement savings account that A retirement savings account that provides tax advantagesprovides tax advantages

Earnings grow tax-deferred until Earnings grow tax-deferred until withdrawalwithdrawal

Contributions may be tax-deductible Contributions may be tax-deductible

Can be established by an individual Can be established by an individual under age 70 ½ who has earned under age 70 ½ who has earned income or whose spouse has earned income or whose spouse has earned incomeincome

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Why invest in an IRA?Why invest in an IRA?Tax-deductible Tax-deductible contributionscontributionsTax-deferred growthTax-deferred growth

Assumptions: Assumptions: 5,000 annual IRA contribution5,000 annual IRA contribution6% annual rate of return6% annual rate of return25% ordinary income tax bracket25% ordinary income tax bracketFor illustrative purposes onlyFor illustrative purposes onlyNot representative of any specificNot representative of any specificinvestmentinvestment

IRAs

$150,000

$318,762

$351,756

$419,008

$- $50,000

$100,000

$150,000

$200,000

$250,000

$300,000

$350,000

$400,000

$450,000

TotalContribution

TaxableAccount

TraditionalIRA

Roth IRA

After 30 years

After 20 years

After 10 years

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Value of Starting EarlyValue of Starting Early

Assumptions: Assumptions: $5,000 annual IRA contribution$5,000 annual IRA contribution

6% annual rate of return6% annual rate of returnFor illustrative purposes onlyFor illustrative purposes onlyNot representative of any specificNot representative of any specific

investmentinvestment

$75,000

$756,362

$165,000

$486,389

$- $200,000 $400,000 $600,000 $800,000T

otal IR

A C

on

tribu

tion

sT

otal S

aving

s at Ag

e 65

30 Years Starting at Age 35

15 Years Starting at Age 21

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Fund Your IRA Early in the YearFund Your IRA Early in the Year

Assumptions: Assumptions:

Both contribute $5,000Both contribute $5,000annually for 30 yearsannually for 30 years6% annual rate of return6% annual rate of returnFor illustrative purposes For illustrative purposes onlyonlyNot representative of any Not representative of any specific investmentspecific investment

$433,041

$425,863

$420,000 $425,000 $430,000 $435,000

Jan

Andrew

Jan funds her IRA inJanuary of the currentyear

Andrew funds his IRAin April of the following year

Jan has a 15-monthheadstart every year

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Traditional IRATraditional IRA2013 Contribution Eligibility2013 Contribution Eligibility

Full deduction when MAGI:Full deduction when MAGI:– Single Filer: Single Filer: << $59,000 $59,000– Joint Filer: Joint Filer: << $95,000 $95,000

Partial deduction when MAGI:Partial deduction when MAGI:11

– Single Filer: > $59,000 but < Single Filer: > $59,000 but < $69,000$69,000– Joint Filer: > $95,000 but < Joint Filer: > $95,000 but < $115,000$115,00011Partial deduction only if you or your spouse Partial deduction only if you or your spouse are not covered by a workplace retirement are not covered by a workplace retirement plan; otherwise, the deduction is phased out plan; otherwise, the deduction is phased out for these income rangesfor these income ranges

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Annual Contribution LimitAnnual Contribution LimitFor 2012, you can contribute up For 2012, you can contribute up to $5,000to $5,00011 or 100% of earned or 100% of earned income, whichever is less.income, whichever is less.For 2013, you can contribute up For 2013, you can contribute up to $5,500to $5,50011 or 100% of earned or 100% of earned income, whichever is less.income, whichever is less.2012 and 2013: $1,000 catch-up 2012 and 2013: $1,000 catch-up contribution for individuals 50 contribution for individuals 50 and older.and older.

11Maximum annual contribution to either a Traditional IRA or Roth IRA, or a combination of Maximum annual contribution to either a Traditional IRA or Roth IRA, or a combination of

the twothe two

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Traditional IRATraditional IRA2012 Taxation of Withdrawals2012 Taxation of WithdrawalsBefore age 59 ½: Ordinary income tax and 10% Before age 59 ½: Ordinary income tax and 10% penalty unless certain conditions are metpenalty unless certain conditions are metPenalty free (no 10% penalty) if: Penalty free (no 10% penalty) if: – Utilizing substantially equal periodic paymentsUtilizing substantially equal periodic payments– First-time home ownership ($10,000 lifetime limit)First-time home ownership ($10,000 lifetime limit)– Qualified higher education expensesQualified higher education expenses– DisabilityDisability– Medical expenses exceeding 7.5% of MAGIMedical expenses exceeding 7.5% of MAGI– Purchase of health insurance after receiving Purchase of health insurance after receiving unemployment compensation for 12 weeks or moreunemployment compensation for 12 weeks or more

– DeathDeath

After age 59 ½: Ordinary income tax After age 59 ½: Ordinary income tax At any age beneficiaries: Ordinary income At any age beneficiaries: Ordinary income tax tax

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Traditional IRATraditional IRARequired Minimum DistributionsRequired Minimum Distributions

Begins when individual turns 70 ½Begins when individual turns 70 ½

First distribution may be First distribution may be postponed to April 1 of following postponed to April 1 of following yearyear

RMDs generally apply to RMDs generally apply to beneficiaries the year after the beneficiaries the year after the individualindividual’’s death, unless another s death, unless another option is selectedoption is selected

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Roth IRA vs. Traditional IRARoth IRA vs. Traditional IRARothRoth TraditionalTraditional Non-deductible contributionsNon-deductible contributions Tax-deferred growth Tax-deferred growth Tax-free withdrawalsTax-free withdrawals11

Deductible or non-deductible Deductible or non-deductible contributionscontributions

Tax-deferred growth Tax-deferred growth Taxable withdrawalsTaxable withdrawals

Tax-free withdrawals in Tax-free withdrawals in retirement do not raise the retirement do not raise the tax bill on Social Security tax bill on Social Security benefitsbenefits

Taxable withdrawals in Taxable withdrawals in retirement can retirement can raise the account ownerraise the account owner’’s tax s tax bill on Socialbill on Social  Security Security benefitsbenefits

No required minimum No required minimum distributionsdistributionsduring account ownerduring account owner’’s s lifetimelifetimeAbility to continue Ability to continue contributionscontributionsafter age 70½after age 70½

Must begin taking required Must begin taking required minimum distributions at age minimum distributions at age 70½70½

Cannot contribute beyond age Cannot contribute beyond age 70½70½

Assets remaining in IRA passAssets remaining in IRA passincome-tax-free to heirsincome-tax-free to heirs11

Assets left to heirs will be Assets left to heirs will be taxable as ordinary income taxable as ordinary income upon withdrawalupon withdrawal

1 Contributions can be withdrawn tax-free at any time, and earnings can be withdrawn without income tax if the account has been in effect for five years and the owner is over age 59½, has died, is disabled or is a qualified first-time home purchaser (maximum $10,000).

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Are You Eligible for a Roth IRA? Are You Eligible for a Roth IRA? 20122012

20132013

ContributionsContributionsModified Modified Adjusted Gross Adjusted Gross Income LimitsIncome Limits

For Individuals: For Individuals: <$125K<$125K

Married couples Married couples (filing jointly): (filing jointly): <$183K<$183K

For Individuals: <$127KFor Individuals: <$127K Married couples (filing Married couples (filing jointly): <$188Kjointly): <$188K

Annual Annual Contribution Contribution LimitsLimits

Individuals: $5K Individuals: $5K maximummaximum

Individuals age 50+: Individuals age 50+: $6K maximum$6K maximum

Individuals: $5K maximumIndividuals: $5K maximum Individuals age 50+: $6K Individuals age 50+: $6K maximummaximum

Converting from a Traditional IRA/ 401(k) Plan to a Converting from a Traditional IRA/ 401(k) Plan to a Roth IRARoth IRAModified Modified Adjusted Gross Adjusted Gross Income LimitsIncome Limits

NO income limits for NO income limits for anyoneanyone

Married couples filing Married couples filing separately are separately are eligible for eligible for conversionsconversions

NO income limits for NO income limits for anyoneanyone

Married couples filing Married couples filing separately are eligible separately are eligible for conversionsfor conversions

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Tax ConsiderationsTax Considerations

When you convert from a Traditional IRA or When you convert from a Traditional IRA or employer-sponsored plan to a Roth IRA, you employer-sponsored plan to a Roth IRA, you

will incur certain tax liabilitieswill incur certain tax liabilities11

These include:

Taxes on Any Pretax Contributions

Taxes on Any Earnings or Growth

1 It’s important to identify funds outside the IRA that can be put toward the taxes due on the conversion. Tapping into the IRA may offset any gains generated by the conversion – and trigger a 10% penalty if you’re under age 59½.

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Why Convert to a Roth IRA?Why Convert to a Roth IRA?A Roth IRA Provides Three Significant A Roth IRA Provides Three Significant

Benefits Over a Traditional IRA:Benefits Over a Traditional IRA:

Tax Savings Benefits

Income Planning Benefits

Wealth Planning Benefits

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Roth IRA: Tax AdvantagesRoth IRA: Tax Advantages

Contributions have tax-deferred growth potential, and withdrawals are typically tax-free if minimum holding periods and certain conditions are met1

Holding a tax-free account like a Roth IRA in addition to a taxable account (e.g., brokerage account or mutual funds) and tax-deferred account (e.g., a 401(k) or Traditional IRA) gives you the flexibility to take income from different sources to potentially keep taxes low in retirement

Tax-FreeWithdrawals

TaxDiversification

1 Contributions can be withdrawn tax-free at any time, and earnings can be withdrawn without income tax if the account has been in effect for five years and the owner is over 59½, has died, is disabled or is a qualified first-time home purchaser (maximum $10,000).

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Roth IRA: Income Planning FlexibilityRoth IRA: Income Planning Flexibility Unlike Traditional IRAs, Roth IRAs let investors make contributions after age 70½ (provided earned-income requirements are met), allowing assets the potentialto continue to grow tax-free

There are no required minimum distributions from a Roth IRA for the owner or a spouse beneficiary – i.e., no rule that you must begin tapping your account at age 70½

This enables you to:

Tailor withdrawal amounts to your actual income needs – or eliminate them altogether in any given year

Manage your taxable income in retirement

Your assets can continue to grow tax-deferred for you and your heirs

No Contributions Cutoff at Age 70½

No RMDs

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Roth IRA: Wealth Planning Roth IRA: Wealth Planning AdvantagesAdvantages

No contributions cutoff at age 70½ and no RMDs can mean your investments have the potential to continue growing tax-deferred, providing more to pass on to your heirs

Roth IRAs can be an effective wealth planning tool, since heirs can enjoy the potential for continued asset growth without paying taxes when they withdraw assets

Using the “stretch” IRA concept with a Roth IRA lets you leave a greater, tax-free financial legacy for your heirs

Tax-Deferred Growth of Assets

Tax-FreeWealth Transfer

Stretch IRA

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What Is A Traditional 401(k) Plan?What Is A Traditional 401(k) Plan?– A retirement plan set up by an employer A retirement plan set up by an employer which allows an employee to defer a part which allows an employee to defer a part of their salary on a pre-tax basisof their salary on a pre-tax basis

– Subject to FICA and FUTA taxesSubject to FICA and FUTA taxes

1 Contribution amounts are set each year by the IRS2 For those age 50 and older

2012 2013

Maximum Contribution

$17,0001 $17,5001

Maximum Catch-Up Contribution

$5,5002 $5,5002

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Benefits of 401(k)sBenefits of 401(k)sSimple, convenient and flexibleSimple, convenient and flexiblePre-tax contributions (after-tax for Pre-tax contributions (after-tax for Roth 401(k))Roth 401(k))Tax-deferred growthTax-deferred growthProfessionally managed investment Professionally managed investment optionsoptionsDiversificationDiversificationPortabilityPortabilityMatching contribution at companyMatching contribution at company’’s s discretiondiscretionConvenient payroll deductionsConvenient payroll deductions

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Employee Contribution Limit: Employee Contribution Limit: 401(k), 403(b), or 457(b) Plans401(k), 403(b), or 457(b) Plans

20122012 20132013

ContributionsContributionsAnnual Employee Annual Employee Contribution Contribution Limit Limit

$17,000 $17,000 $17,500$17,500

Annual Catchup Annual Catchup Contribution Contribution Limit (50+ Limit (50+ yrs.)yrs.)

$5,500$5,500 $5,500$5,500

Annual Limit Annual Limit for combined for combined employer-employer-employee employee contributionscontributions

$50,000 $50,000 $51,000 $51,000

2020

Pre-Tax ContributionsPre-Tax Contributions

Source: Morgan Stanley

With With Retirement Retirement Plan ($)Plan ($)

Without Without Retirement Retirement Plan ($)Plan ($)

$4,000 Mo. Pay$4,000 Mo. Pay 4,0004,000 4,0004,000

Retirement Retirement Plan Plan ContributionContribution

(100)(100) (0)(0)

Taxable PayTaxable Pay 3,9003,900 4,0004,000

Federal Income Federal Income TaxTax 975975 1,0001,000

Chart applies to participants who are allowed to contribute on their own behalf. This illustration uses a flat federal income tax withholding rate of 25%. The numbers in this illustration are hypothetical and are presented for illustrative purposes only. Actual results may vary.

Monthly Federal Tax Savings = $25

Annual Federal Tax Savings = $300

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Tax-Deferred GrowthTax-Deferred GrowthTaxable Account Tax-Deferred Account Before Taxes

The above chart assumes a participant makes $48,000 annually and contributes 8% twice a month. Also assumes a 25% tax bracket and a 7% annual rate of return. These numbers are hypothetical and are presented for illustrative purposes only. Actual results may vary.

Source: Morgan Stanley

($000's)

Tax-Deferred Account After Taxes

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What is a Roth 401(k)?What is a Roth 401(k)?

Traditional 401(k) – Withdrawals TaxedTraditional 401(k) – Withdrawals Taxed

During your working During your working years, you years, you pay no pay no Federal income tax Federal income tax on contributionson contributions

At retirement, you At retirement, you pay pay Federal income tax Federal income tax on on contributions and contributions and

earnings at earnings at distributiondistribution

Roth 401(k) – Contributions TaxedRoth 401(k) – Contributions Taxed

During your working During your working years, you years, you pay pay

Federal income tax Federal income tax on contributionson contributions

At retirement, At retirement, withdrawals are withdrawals are free free from Federal income from Federal income

taxtax111In order to withdraw funds tax free from the Roth 401(k):

The distribution must occur five taxable years after the initial contribution AND the participant must attain age 59½, die, or become disabled

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Tax Saving Benefits—Roth 401(k)Tax Saving Benefits—Roth 401(k)

If you expect to be in a higher tax bracket when you retire, you will save by paying lower income taxes now

Younger employees have a longer retirement horizon for their earnings to accumulate tax-free

Employees who aren’t eligible for a Roth IRA may pool tax-free money to draw on in retirement

Leave tax-free money to beneficiaries

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Test Your KnowledgeTest Your Knowledge

?Allows you to receive tax-free income in retirement by prepaying your taxes?

Answer: Roth IRA or Traditional IRA

Lets you make contributions after the age of 70½?

Answer: Roth IRA or Traditional IRA

Imposes requirements on how much you withdraw in retirement at age 70 1/2?

Answer: Roth IRA or Traditional IRA

Allows you to make income-tax-free transfers toyour heirs?

Answer: Roth IRA or Traditional IRA

Which one ...

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Questions?Questions?

Tax laws are complex and subject to change. Morgan Stanley Smith Barney LLC (“Morgan Stanley”, its affiliates and Morgan Stanley Financial Advisors and Private Wealth Advisors do not provide tax or legal advice and are not “fiduciaries” (under the Internal Revenue Code or otherwise) with respect to the services or activities described herein except as otherwise agreed to in writing by Morgan Stanley. This material was not intended or written to be used for the purpose of avoiding tax penalties that may be imposed on the taxpayer. Individuals are encouraged to consult their tax and legal advisors regarding any potential tax and related consequences of any investments made under such account.