Insights
What options do you have when you change jobs? Some people think that if they change jobs they have to take the funds out of the plan and pay heavy taxes (and in some cases, penalties) to the government. This is not your only option. In fact, that is probably your worst option.
Other options to consider when you change jobs as it pertains to your retirement funds:
Leave it in the plan of the company you left
Roll it over to your new company’s plan
Roll it over to an IRA in your name
In summary, when you get a new job, while this is an exciting time, don’t forget about your retirement funds and smart planning in that area.
Jennifer Hildebrand
Kiplinger published a great article on the steps everyone should take after the Equifax data breach. Below is a link to the article.
Retirement plan assets, whether part of an employer qualified retirement plan or an IRA, comprise one of the largest sources of wealth for many individuals. Because if may be the largest asset to be passed on to heirs upon the individual’s death, and the potential tax implications that arise when distributions are made from such accounts, it is important to review and analyze one’s beneficiary designations for these accounts to determine if they are or remain the best selection.
For married individuals in a traditional family setting, the most popular and most likely the best selection is to simply name one’s spouse as the primary beneficiary. A major benefit associated with this choice is the opportunity to defer the beginning date for the withdrawal of taxable distributions after the owner’s/participant’s death to the later of (1) the year in which the IRA owner/plan participant turns age 70 ½, and (2) the year in which the beneficiary spouse turns age 70 ½. The latter deferral date would require the surviving spouse to rollover the account balance to his or her own IRA account. In the case of an IRA, this can also be accomplished by having the surviving spouse “deem” the deceased spouse’s IRA as his or her own. It is important to remember that while naming one’s spouse as the sole primary beneficiary of retirement assets provides the most flexibility and opportunity for income tax savings, the IRA owner/participant will be giving up control of naming a secondary beneficiary of those retirement assets upon the surviving spouse’s death as well as the ability to control or limit the amount of account withdrawals that can be taken from the account over a given length of time.
In the event the owner/participant is not married, of if the owner/participant has children from another marriage, the choice of an appropriate beneficiary becomes more difficult. In those situations, overall protection of the retirement assets, including control over the amount of withdrawals will most likely take priority over potential income tax savings (or, as I like to say: “Don’t let taxes be the tail that wags the dog”). In these situations, the more appropriate primary beneficiary may be a trust. That trust if often one that is part of the owner’s/participant’s existing estate plan that is also intended to hold non-retirement assets after death.
As mentioned above, benefits of naming a trust as the beneficiary of retirement assets include:
Although designating a trust as the beneficiary of retirement assets may be motivated by non-tax reasons, it is nonetheless important to properly structure the trust arrangement to provide the most beneficial tax treatment to the ultimate trust beneficiaries. The regulations governing the timing and amount of required minimum distributions that are made to trust beneficiaries can be complicated and it is best to include specific provisions addressing the administration of retirement assets in the underlying trust agreement. For that reason, it is recommended that the owner/participant utilize the services of an estate planning attorney with specialized knowledge of these regulations to draft such documents to make sure any issues in this area are properly addressed.
The vast majority of individuals simply name a trust that is created by a separate and distinct trust agreement as the beneficiary of retirement plan assets. The use of a so-called “conduit” trust as the recipient is in most cases an effective and efficient method for handling the administration of retirement plan assets. However, in the case of an IRA, it is also possible to accomplish the same objectives by establishing the same provisions within the existing IRA document itself by establishing a trusteed IRA rather than the more common custodial IRA. Such IRAs would require the use of a bank or trust company that has the necessary ability to provide trust services to the public. Without going into details that are beyond the scope of this article, the use of a trusteed IRA can provide some additional income tax benefits that may be problematic under the more familiar “conduit” trust arrangement.
A few final caveats are worth mentioning. Distributions of retirement plan assets that are held in an employer qualified retirement plan are governed by the provisions of the employer sponsored plan that may significantly limit the ability to delay or “stretch” taxable distributions even though the tax laws permit such flexibility. This could be problematic for larger accounts that name a trust as the primary beneficiary. Although I have not seen this in practice, query whether a plan participant can name an otherwise unfunded trusteed IRA as the beneficiary of the employer qualified plan retirement assets to enable a tax-free rollover to an IRA that will permit a delayed or stretched payout of taxable distribution.
Finally, if an employer plan participant is married, he or she will be required under federal law to obtain the written consent of his or her spouse to the designation of a non-spouse primary beneficiary, including a trust for the benefit of such spouse. This consent is not required for IRA beneficiary designations under federal law. However, that requirement may vary if you are a resident of a community property state. The state of Ohio does not require such consent.
Robert W. Cabanski, J.D.
Most professional advisors are attuned to the various tax planning strategies available during their clients’ lifetime. However, some may overlook the importance of thoughtful planning and discussing such strategies with elderly clients or those nearing death. Although this may be a difficult and emotional time for the client and their family, proper planning can result in significant tax savings.
Areas that lend themselves to planning opportunities include, but are not limited to: passive activity losses; capital loss carryovers; and net operating losses. It is important to recognize if such tax attributes exist to allow for adequate time to implement strategies and take full advantage of the potential tax savings.
Suspended passive activity losses are allowed on a decedent’s final income tax return, subject to certain limitations. If any losses remain after applying these limitations, they are permanently lost as a tax deduction. However, there may be cases where the property giving rise to the loss has declined in value. In this situation, it may be beneficial to gift the property so that the higher donor basis would be assumed rather than the lower stepped-down basis in the hands of the heirs. This lower basis would result in a larger tax liability upon sale of the property.
Another type of loss to consider are capital losses. Tax law states that capital loss carryovers expire upon the death of a taxpayer and cannot be carried forward and used by the surviving spouse or on the estate income tax return. Therefore, if capital losses exist for a taxpayer approaching death, opportunities to generate capital gains should be pursued. Note that a surviving spouse can continue to generate capital gains for the remainder of the year after the taxpayer’s death to offset the decedent’s capital loss carryovers on the final joint return.
Similarly, net operating losses (NOLs) of a decedent cannot be deducted on the federal estate tax return or by the surviving spouse on future income tax returns. NOLs should be evaluated to determine if any amount can be attributed to the surviving spouse which would allow for carryforward. If not, the surviving spouse has a window of opportunity, from the date of death to the end of the tax year, to generate additional income that can be used to offset the decedent’s NOL on the final joint return. In this case, the surviving spouse should also consider delaying any tax deductions.
The above tax attributes highlight some of the areas that need to be considered as clients age and approach death. Although such discussions may be difficult, there is potential for significant tax savings to both the client and their heirs.
Connie Farell, CPA
“Sunlight is said to be the best of disinfectants”
-Louis D. Brandeis
Although Justice Brandeis wasn’t addressing investment fees, his observation is relevant to the topic.
Over the past few months I have discussed Trustee and Investment Management services with a number of families. Many of the conversations were with prospective clients who felt compelled to explore their advisor options. A common thread to these discussions is revealing; until recently forced to do so by the Department of Labor (“DOL”) “Fiduciary Rule”, many financial advisors have not clearly discussed their fees with clients. Prompted by the new rule, many fee discussions haven’t been well-received. They’ve brought to light practices which might have been “suitable”, for clients, but not necessarily “in their best interest”. Corporate trustees have worked within (and often beyond) the disclosure rules for years, but the rule now covers many advisors without prior fiduciary experience.
The DOL rule (which requires a much broader group of advisors to act as fiduciaries) faces an uncertain future. Although implementation became effective on June 9, 2017, the rule remains under review pursuant to a February memorandum from President Trump. But unless the DOL says otherwise, full compliance will be required on January 1, 2018.
Naturally risk-averse (at least in compliance-related matters), the advisor community has already adopted a new fiduciary paradigm, leading to the new client conversations around fees and services.
To be fair, advisors and clients often avoid fee discussions. Discussions about a money exchange are often awkward and stressful, so avoidance is natural.
Big picture, these discussions are bringing a greater awareness to pricing practices in financial services. The lesson is; make darn sure you know how your advisor gets paid. Be wary of ANY service provider who is hesitant in that discussion. Simple tends to be good. Hidden is almost always bad. Conflicts of interest (being wedded to a single fund family, for instance) rarely benefit the client. And for heaven’s sake, run away quickly if you hear some variation of “I have to feed my family too”, from an advisor (No kidding - I’ve heard stories of this sort).
Ask your advisor (or prospective advisor) whether they have experience acting in a fiduciary capacity, and whether they will be acting in that capacity on your behalf. If not, pay particular attention to how they are compensated.
Long story short, if your current advisor hasn’t already clearly outlined how they get paid (not to mention any potential conflicts of interest), now is a good time to ask. Bottom line; your advisor should be able to clearly articulate how you pay for their services. It is the very least you deserve, and in many cases to which you are legally entitled. The lowest cost option may not always be the best for a given client, but if an advisor isn’t able to defend the cost of a recommended strategy, you shouldn’t blindly accept it. Let the sunlight in.
Matthew M. Black, JD
Some retirement plans offer a loan feature, allowing participants to borrow from their account balances and pay the loan back via payroll deduction.
We get a lot of feedback from plan participants that “I’m paying myself back so this is a good idea” or “I don’t have any other options so I need to take this loan from my plan.” Taking a loan from your 401k may seem logical for those reasons, but there are other factors to consider.
In summary, while 401k loans may be available as an option in your plan, they are not always the best way for you to obtain the loan money you might be needing.
Jennifer Hildebrand
Photo by maxsattana/iStock / Getty Images
I recently had a question asked of me regarding investing in retirement plans versus investing in a non-retirement account. The question that is asked is whether to invest in a pretax account with higher total fees or invest in a post-tax account with much lower fees. It may seem as simple as multiplying the fee percentage against the amount invested and comparing those numbers. The answer is not necessarily that simple. There are several components to the answer:
Rationale for Employer Sponsored Retirement Plan
A retirement plan is pretax investment savings allowing for growth, harvesting of gains and redeploying funds without current tax consequences. Realized investment gains external from a retirement plan, post-tax, are taxed at a rate of 15% to 20% in the year the gains occur. Retirement plans offer the opportunity to invest on a pretax basis during higher income earnings and higher tax rate years, while ultimate withdrawals occur during the retirement years in which both income and taxes are less. Many retirement plans offer the ability to invest in mutual funds at preferred internal costs, as well as reduced or waived commissions which may not be available to the individual investor. Employer sponsored retirement plans often provide access to investment specialists who are available to assist in developing a current plan for future benefits. Making use of the tools offered by the Plan can be very beneficial. As a plan participant, either the employer or employee is paying for these benefits and it is unfortunate if these opportunities are unused.
Investment Strategy
The asset allocation is a primary consideration for the overall investments and setting goals for the future. Determining your anticipated work years, years in retirement and risk tolerance, which can and will change over time, are vital to ensuring a positive financial future. Creating an allocation that is too conservative will not allow the portfolio to grow sufficiently to meet future needs. An individual in the early years of employment may create a portfolio that will allow for a larger portion of the retirement account to be in investments with a higher, yet calculated risk. This allows for a growth rate that is anticipated to meet and hopefully exceed inflation. Discussions with investment professionals is a good way to develop a strategy that is acceptable to your risk tolerance and creates the allocation to provide a desired retirement. Individuals in later retirement years may elect to reduce the amount of equity, but not eliminate it. A diverse portfolio that is adjusted as time evolves is an effective tool. Both active and passive management should be a part of the overall strategy.
Taxes – Effect of pretax savings on wages/total income
Based on gross wages of $60,000, single taxpayer, simple tax return provides for a Federal tax savings of $2700.00. Additional savings occurs, as well in State taxation, but to a lesser degree.
Cost
The total expense related to the employer sponsored retirement plans has potentially three components of regular fees assessed the participant or employer. Those components include trustee/custodian oversight, record-keeping and internal fees of the mutual funds. Each of the investment strategies has an expense ratio associated with it. Obtaining the percentages is important to ensure accurate comparison of the routine fees. Fixed Income and Index funds generally have a lower expense ratios than actively managed equity investments. Analysis of fees should be at a comparison of like investment strategies. Total fees in the range of 1% are common, 1% is equivalent to $10.00 per every $1,000 of the account value. The investment performance in comparison to the expense ratios is another way to assist in determining effectiveness.
Employer contributions
Employers often offer incentive to save for retirement by providing a contribution to employee accounts. The contributions are usually within the .50% to 3% range, but some may offer even more. While some require employees to contribute a minimum percentage of wages, others provide the contribution without strings. The employer contribution is free money and should not be ignored.
Final words
The use of both pretax and post-tax investments is important in building a total investment picture. I believe that they both serve a purpose. I believe, based on information sited above and details related, that placing a significant amount up to the maximum in retirement ($18,000 for those under 55 and $24,000 for those 55 and over), benefits now and in the future. The cost of the investment opportunity to the tax savings should be reviewed. The tax savings is usually substantial and directly beneficial. Making sure to compare services provided by pretax and post-tax investment providers, like asset costs, tax savings and employer contributions is vital in making a decision that is right for your future. These are my thoughts and I hope that they are helpful.
Diane Ohns
Equity Update
Domestic stocks shot out of the gate in 2017, led by the S&P 500 gaining 6.1% for the quarter. This was a welcome development given that the first quarter of 2016 was one of the worst in recent history. The rally that began in November has been largely based on expectations that the current administration will be able to implement pro-growth policies such as tax reform, infrastructure spending and regulatory reform. While there have been some recent concerns about the potential timing and effectiveness of proposed legislation, the "the slump" which took place in March was relatively mild. Volatility as measured by the CBOE Index during the first quarter was the second lowest average quarter on record. Further, average daily percentage change for stocks during the first quarter was the lowest since 1965.
March 2017 marked the 8th anniversary of the current bull market, the second longest since 1928. As we look ahead, we are encouraged that U.S. business and consumer confidence surveys have been showing significant improvement. Additionally, consensus estimates are projecting 10% growth in S&P 500 earnings for 2017 while Blue Chip Economic Indicator survey respondents project 2.3% real GDP growth for 2017 (compared to the 1.6% seen in 2016). In the chart below we can see that since 1990, small business sales growth expectations have closely overlapped GDP growth.
Source: Strategas Research Partners
Internationally, we have seen an uptick in confidence and a turnaround in equity performance. Improving global economic momentum has boosted expectations for better trade prospects in the emerging markets (i.e. Brazil, Russia, India, China). Emerging market equities returned 11.4% for the quarter. In the developed markets, outside the U.S., concerns about political risks have been outweighed by encouraging economic data globally. Non-U.S. developed market equities returned 7.4% for the quarter.
Valuation-wise, international equities are much cheaper than domestic equities - a direct result of many years of underperformance. Reversion to the mean is powerful and international equity is an important diversifier within a portfolio. We remain positive on stocks (both international and domestic) amid improving fundamentals and economic momentum, especially as rising rates curb global bond returns.
Fixed Income Update
The Bloomberg - Barclays US Aggregate posted a gain of 0.82% in Q1 and the Intermediate Aggregate index gained 0.68%. Gains for the quarter came predominately from lower quality and longer maturity bonds. BBB bonds posted a gain of 1.71% vs. 0.60% for AAA bonds. The excess return of the lower grade bonds resulted from a decline in default risk from perceptions of a strengthening economy. Short bonds maturing in 1-3 years posted a 0.41% gain whereas the 10+ year maturity range posted a 1.43% gain, as the yield curve flattened somewhat.
After years of expecting rates to rise as shown in the graphic above, the Fed raised interest rates in back-to-back sessions for the first time since before the financial crisis. The delay was a result of the economic recovery being slower than expected. The uptick in the pace of rate increases is a positive, signaling continued strength in the economy. One last point from the chart, is that although there is a decrease in the rate of change expectation as compared to 2014 and 2015, we may finally be on a rate increase trajectory.
Another issue of importance is how the Fed handles its balance sheet. During and after the financial crises, the Fed not only bought significant amounts of short-term bonds, bringing short rates down, they also bought large volumes of longer treasuries and mortgage-back securities, thus reducing long rates. If maturing bonds are not replaced with new bonds, the decreasing amount of assets on the Fed's balance sheet will also tend to increase rates. This process is called runoff and could take five years or more, unless the Fed actively sells bonds before maturity. These discussions by the Fed are a sign of its view of an improved economy and should be regarded favorably.
Please contact us with any questions.
Sincerely,
Mark Evans, CFA
Renee Goubeaux
Julie Brotje Higgins, Ph.D., CFA
Richard Sasala, Ph.D., CFA
Matthew D. Sheets, MBA
Photo by Ildo Frazao/iStock / Getty Images
As an incentive to keep retirement plan assets from being siphoned off prior to an individual’s actual retirement, the federal tax code imposes an additional 10% penalty on the taxable amount of funds withdrawn from either an employer sponsored qualified retirement plan or an IRA prior to reaching age 59 ½. However, there are several exceptions to the penalty in the event there is a need or desire to access retirement funds prior to age 59 ½. Those exceptions can be found in Section 72(t) of the Internal Revenue Code. Knowledge of these rules and some careful planning may result in some significant tax savings for individuals.
At the outset it is important to note that the exceptions can differ depending upon whether the withdrawal is coming from an employer sponsored retirement plan vs. an IRA. Second, remember that the penalty is calculated on the “taxable” amount withdrawn only, so any portion of the distribution that represents non-taxable after-tax dollars is not subject to the penalty.
Notable exceptions to the penalty include:
I have encountered unfortunately several situations where better knowledge of these rules could have save an individual from some significant penalties. Examples include:
1. A 53-year old ex-spouse who withdrew her account balance representing QDRO benefits in a company retirement plan and rolled them into her own IRA before withdrawing them. (The exception didn’t apply to the IRA withdrawal but would have applied had the distribution been taken directly from the company retirement plan.)
2. A 50-year old employee takes his entire retirement plan benefit in a taxable lump sum distribution because he has an immediate need to access 50% of the funds. (The employee should have limited his withdrawal to the amount he needed and kept the balance in his employer plan or rolled the unused amount in an IRA to avoid the penalty on that amount.)
3. An employee terminates employment at age 56 and transfers his entire company retirement plan benefit to his Rollover IRA before withdrawing funds from the IRA prior to age 59 ½. (Again, the exception would have applied had the needed funds been withdrawn from the company retirement plan rather than the IRA.)
As you can see, there are nuances to each of these exceptions so the best way to avoid many of these pitfalls is to seek the counsel of a tax professional before making such withdrawals.
Bob Cabanski
