All Nerd's Eye View Articles On Retirement Planning

The New Pooled Employer 401(k) Plan And The Hazards Of Advisor-Led PEPs

December 30, 2020 07:05 am 4 Comments CATEGORY: Retirement Planning

Recognizing that retirement saving is an important goal for many individuals, and an employee benefit that many job-seekers commonly screen for as they consider new employment opportunities, business owners commonly offer employer-sponsored retirement plans, such as 401(k) plans, to attract (and keep) their employees. For small business owners, though, the hassle and expense of setting up and running such plans can be a serious hurdle to offer competitive benefits for employees, and often are the reason that some small business owners have no retirement plan benefits in place to begin with! In an attempt to help small business owners offer employer-sponsored retirement plans to their employees, Congress has passed various pieces of legislation, one of the most recent being the December 2019 SECURE Act, which for the first time created a new “Pooled Employer Plan” (PEP) intended to make it easier for small business owners to establish and administer a 401(k) plan.

Notably, Multiple Employer Plans (MEPs) to facilitate employer-sponsored retirement plans for small business owners by allowing multiple employers to pool together and create one single plan for all of their respective employees have existed for many decades. But they have failed to rise in popularity, mainly because of limitations established by the IRS and Department of Labor (DOL) over the years, including the IRS’ “one bad apple” rule that can disqualify an entire MEP if one single participating employer fails to follow the plan’s requirements, and the DOL’s “nexus” rule that required an MEP’s participating employers to be in the same general line of business. The SECURE Act’s recently introduced Pooled Employer Plan (PEP) version, however, eliminated these limitations, clearing the way for multiple employer 401(k) plans without being in the same line of business, and with a pathway to remove an employer that fails to comply with the plan’s rules (without disqualifying the rest).

In order to create and offer a PEP, the plan provider must become a designated “Pooled Plan Provider” (PPP), registered with the Department of Labor, and serving in a fiduciary capacity as the plan administrator and performing all of the plan’s 3(16) fiduciary administrative duties.

Notably, RIAs (and broker-dealers) will be allowed to serve as PPPs, creating the potential that advisory firms could establish their own ‘private PEP’ for their small business owner clients (and gaining the efficiencies as the plan provider). However, there are several issues that advisory firms should understand before deciding to commit to a role as a PEP’s Pooled Plan Provider. Most significant is the fact that by providing investment services to the plan (and managing assets for an AUM fee) while serving as the PPP, there is potential for creating a Prohibited Transaction, as the Internal Revenue Code Section 4975(c)(1) disallows a plan fiduciary from dealing with the income or assets of a plan for their own interest, or from receiving compensation from the plan in connection with transactions involving the income or assets of the plan… with penalties for such Prohibited Transactions starting at 15% of the amount involved and, if not rectified in a timely manner, can be as high as 100% of the amount involved! Whether or not the DOL releases legislation that will provide for a Prohibited Transaction Exemption addressing the challenge created by IRC Section 4975(c)(1) is yet to be seen.

Ultimately, while the PEP may become a valuable tool for small business owners to be able to offer employees competitive retirement plan options, RIAs will need to carefully consider whether to choose to take on the role of a PPP for their small business clients plans and the associated ramifications if they do choose to do so… including asking the question of whether branching out into plan administration would actually result in more business anyway, or if it will be better to find a third-party administrator (TPA) to partner with instead?

Coordinating Social Security Benefits For Those Who Lived Or Retire Abroad

December 16, 2020 07:03 am 4 Comments CATEGORY: Retirement Planning

For many Americans, Social Security income plays an integral role in retirement planning, and while retirement planning is generally straightforward for Americans with income solely from US employment that pays into Social Security, the situation becomes more complex when income from multiple countries is involved. As working in a foreign country may not count towards US Social Security benefits, either reducing benefits or even rendering the worker with insufficient quarters of coverage to be eligible for Social Security benefits at all. In addition, receiving non-US pension or foreign Social Security benefits can impact US benefits, and there is the potential for double-taxation of benefits when more than one country seeks to tax the same individual (the foreign country because the US citizen lives there, and the US because it taxes all citizens on all of their income worldwide!).

In this guest post, Jonathan Lachowitz – Founder of White Lighthouse Investment Management, which specializes in cross-border retirement planning – explores some of the cross-border planning issues that financial advisors and their clients face in the context of Social Security when there is residency or past work experience outside of the United States. For these clients, the main factors that will affect their Social Security benefit are how long they contribute to the US Social Security system, whether they are entitled to a foreign Social Security pension, and the presence of a tax treaty and/or a Totalization Agreement with the country in which the overseas work has been (or is being) done.

Totalization Agreements are currently in place with 30 countries and serve not only to eliminate double taxation (i.e., taxes paid by employers and employees in both the US and the foreign country) of the same income being taxed for Social Security programs by more than one country but also to coordinate the accrual of worker’s benefits when they have been employed in multiple countries. These agreements also typically include a “detached worker” provision that exempts an employee from their local (temporarily-foreign-country) Social Security taxes for up to five years while continuing to pay into their own national Social Security program.

The Windfall Elimination Provision (WEP) is another consideration to take into account when planning for an individual’s Social Security benefit when they have years of service abroad. As while the WEP was initially established to more fairly adjust Social Security benefits for workers who earned income eligible for Social Security benefits alongside other income from US state and local government jobs that were not covered by Social Security, it also applies to individuals who receive both US Social Security benefits and a foreign pension benefit that does not pay into the US Social Security system. The WEP prevents workers who receive benefits from a non-covered plan (that did not pay into Social Security, and thus would not be factored into the employee’s income history used to calculate their US Social Security benefit) from receiving more US Social Security benefits as though they were long-time lower-wage earners.

Fortunately, Congress has provided for a Foreign Tax Credit, which prevents a US taxpayer from having to pay tax on eligible foreign income taxed by both the foreign country and the US, and the Foreign Earned Income Exclusion, which allows a US taxpayer who meets either a bona fide residence test or a physical presence test to exclude up to $107,6000 in foreign income from US income taxation. However, only the Foreign Tax Credit or the Foreign Earned Income Exclusion – not both – can be used by an eligible worker. And in practice, the FEIE generally will not apply to Social Security and other retirement benefits, as it’s not considered earned income at the point of receiving payments or taking retirement account withdrawals.

Ultimately, cross-border retirement planning can be a complex yet rewarding area that financial advisors can address with clients who have earned income from more than one country. By understanding the role of international tax treaties, Totalization Agreements, and the social security benefit systems offered by other countries, financial advisors can help their cross-border clients optimize their retirement income and Social Security benefits.

Coordinating Social Security Couples’ Benefits For The Self-Employed: The False Promise Of Salary-Splitting

October 7, 2020 07:05 am 7 Comments CATEGORY: Retirement Planning

For many financial advisors, Social Security retirement benefits are often an integral part of their clients’ retirement strategies to provide income. However, married couples not only have their own retirement benefits that are calculated based on each person’s individual’s work history (assuming they have the requisite 40 quarter-credits of earnings) available to them, but can also take advantage of spousal benefits when an individual’s spouse has a work history that leads to a benefit greater than their own retirement benefit. While the spousal benefit is often advantageous to the extent that the work history of an individual’s spouse leads to a greater benefit than the individual’s own retirement benefit, it does lend to potential strategies for married couples to maximize total Social Security benefits that are not available to single individuals.

The amount of an individual’s Social Security retirement benefit that would be received at Full Retirement Age (FRA; 66 for individuals born in 1954 and thus reaching that age in 2020) is the Primary Insurance Amount (PIA) and is calculated based on a formula that takes a certain percentage of the wage-inflation-adjusted average of the worker’s highest 35 years of FICA- or SECA-taxed earnings (i.e., the Average Indexed Monthly Earnings, or AIME). While the retirement benefit is equal to the PIA when a worker claims their benefit at FRA, benefits are reduced if they begin prior to the worker reaching FRA and increased if taken later (up to age 70). By contrast, an individual’s spousal benefit is equal to 50% of their spouse’s PIA. The spousal benefit is not adjusted if the working spouse claims the benefit early (e.g., if the working spouse begins taking retirement benefits before reaching FRA), but the spousal benefit is adjusted lower if the non-/lower-earning spouse claiming the benefit does so before their own FRA.

A business owner who is married may have the flexibility to hire their spouse and 'transfer' a portion of their salary between themselves and their spouses (assuming that the spouse actually provides services to the company to earn a salary in the first place). While this can serve to increase the couple’s combined retirement benefits, it often results in lower combined overall Social Security benefits for the couple! Notably, without shifting any salary, the non-/lower-earning spouse is already entitled to a spousal benefit. Accordingly, shifting salary away from the higher-earning spouse will often reduce their PIA right away (unless they already have 35 years of higher wage-inflation-adjusted earnings or, after the split, they continue to have earnings in excess of the maximum amount subject to FICA taxes for the year), while the benefit that the non-/lower-earning spouse would be entitled to won’t increase until their own retirement benefits exceed the spousal benefit that they would have received absent any changes.

In situations where a married worker receives compensation higher than the maximum amount subject to FICA taxes, cumulative Social Security benefits to the couple can potentially be increased by splitting the business owner’s salary between spouses. The caveat, though, is that by shifting the higher-than-FICA-maximum compensation to a lower-earning spouse, there can be a significant increase in annual FICA tax liability. In many – and perhaps, most – cases, the downside of the increase in FICA taxes will more than offset any cumulative increase in potential Social Security benefits. Thus, such an approach typically does not benefit a couple.

There are, however, situations where splitting the business owner spouse’s salary can make sense. One such situation is when a worker’s annual compensation will not be included in one of their top-35 years in calculating their Social Security AIME. If such is the case, and the worker’s compensation to be split is below the maximum amount subject to FICA, it may be possible to increase the spouse’s retirement benefit such that it exceeds their spousal benefit, thus netting a higher overall Social Security benefit for the couple (and without impacting the total FICA tax due)! Additionally, shifting compensation from a higher-earning spouse to their lower-earning partner will result in increasing the lower earner’s PIA. And with a higher PIA, calculated from the AIME based on the lower earner's own work history, the individual’s retirement benefit will be commensurately higher, with the flexibility to claim those benefits as retirement benefits whenever they desire (versus being required to wait until the higher-earning spouse decides to claim their own benefit, which would only then allow them to claim their spousal benefit). And while the net retirement benefit amount may not be higher, it may be the couple’s particular situation where flexibility to claim the benefits is more important.

Another situation where salary splitting may make sense for a married couple is if one spouse earns less than the other, but their own retirement benefit is already close to, equal to, or greater than their spousal benefit. In such circumstances, less (or potentially none) of the additional compensation received by the spouse will be ‘wasted’ by only increasing their own retirement benefit to equal their already-existing spousal benefit. Thus, salary shifting in this instance would potentially result in increasing the lower-earning spouse’s own retirement benefit such that the couple’s net Social Security benefits would be greater.

Ultimately, the key point is that to the extent a spouse can be legitimately hired for providing services to a working spouse's company, salary-splitting strategies can be considered (or avoided) as a way to help the couple optimize their Social Security benefits, and offer some timing flexibility for spouses who may feel constrained by the rules of claiming spousal benefits. However, financial advisors should be aware of the potential limitations that these strategies have, especially because of the role that spousal benefits play in a couple’s total Social Security benefit.

Complications To Undoing Unwanted 2020 RMDs From The “Same-Property Rule” And Other Factors

August 20, 2020 07:12 am 5 Comments CATEGORY: Retirement Planning

As an initial response to the economic devastation created by the COVID-19 pandemic, Congress passed the Coronavirus Aid, Relief, and Economic Security (CARES) Act back in March, a $2+ trillion emergency fiscal stimulus package. In addition to several notable provisions, such as direct government payments to taxpayers and the elimination of the 10% early withdrawal penalty on distributions from retirement accounts, the CARES Act also suspended required minimum distributions (RMDs) for 2020 for IRAs, 401(ks), and other defined contribution retirement plans.

Unfortunately, the CARES Act didn’t address those who had already taken their RMD(s) – or at least what they thought were RMDs at the time – earlier in the year, but in April 2020, the IRS issued Notice 2020-23, which started to address this issue. More specifically, the Notice extended the rollover window deadline for distributions taken on or after February 1, 2020 to the later of July 15, 2020, or (the regular) 60 days after the distribution was received.

On June 23rd, 2020, the IRS further expanded its relief for early-year would-have-been-RMDs, when it issued Notice 2020-51. Notice 2020-51 provided unprecedented relief for many taxpayers, by not only (further) extending the rollover window for distributions that would have been 2020 RMDs (but for the CARES Act) to the later of August 31, 2020, or (the regular) 60 days after the distribution was received, but also by allowing taxpayers to ignore the prohibitions on completing multiple IRA rollovers in a 365-day period (the once-per-year rollover rule) or a rollover of a distribution from an inherited retirement account, that normally apply. The cutoff date for this unprecedented relief, however, is rapidly approaching, advisors have been fielding a flurry of questions from clients regarding the rollback guidance.

As a starting point, many clients are wondering if they have any options available if they miss the deadline. Unfortunately, distributions received more than 60 days ago, or for which a rollover would violate the one-per-year rollover rule, or that were made from an inherited IRA (401(k), or other defined contribution plan) generally won’t be able to be rolled back after the August 31, 2020 deadline. The sole exception to the hard deadline of August 31,2020 is for IRA, 401(k), and other defined contribution retirement plan owners (not beneficiaries) who can treat an early 2020 distribution as a Coronavirus-Related Distribution. More specifically, such distributions, as defined by Section 2202 CARES Act, can be returned up to three years after the date of distribution.

Meanwhile, some clients have asked what their options are if they took more than the required minimum distribution and would now like to roll those back. Unfortunately, unless such individuals are still within the 60-day window, or they can treat their distribution as a Coronavirus-Related Distribution, the portion of their distribution in excess of what would have been their 2020 RMD will not be eligible for return.

Another very common question has been around what happens when a client took an in-kind distribution earlier this year to satisfy their required minimum distribution. In many instances, the value of the distributed asset may have appreciated substantially since they were distributed. If the distribution was made from an IRA, retirees must return the same property that was taken out (as if the distribution was never made in the first place), regardless of how much the value of the property increased (or decreased) in the past few months. For those who may have already (incorrectly) returned cash to try and complete a rollover of the in-kind distribution, two steps are required to ‘fix’ the ‘problem’ without any penalties. First, the same property must be rolled back by the August 31, 2020 deadline. Second, the cash, along with any gain/loss attributable must be distributed as an excess contribution, by October 15, 2021.

Ultimately, the key point is that time is running short to return unwanted RMDs from retirement account, and while it’s possible for a limited number of retirees to classify prior distributions as Coronavirus-related distributions, the majority of individuals must take action by August 31, 2020 if they are to rollover an early year distribution that would have been an RMD, if not for the CARES Act. And while it’s possible that further relief for such amounts may be included in future stimulus bills by Congress, retirement accounts have already been specifically addressed with historic guidance, making it less likely that we’ll see future RMD relief from either Congress or the IRS.

Successor Beneficiary RMD Rules After The Death Of The Original Inherited Retirement Account’s Primary Beneficiary

July 29, 2020 07:33 am 8 Comments CATEGORY: Retirement Planning

In December of 2019, Congress passed the Setting Every Community Up For Retirement Enhancement (SECURE) Act, introducing substantial updates to the laws governing retirement accounts. Changes to post-death distribution rules resulted in the death of the ‘stretch’ provision for certain (most) non-spouse Designated Beneficiaries of inherited retirement accounts and introduced a new “10-Year Rule” for account distributions, which have important implications, not just for the Designated Beneficiaries of those retirement accounts, but also for their Successor Beneficiaries as well.

Prior to the passage of the SECURE Act, Designated Beneficiaries of retirement accounts were allowed to ‘stretch’ Required Minimum Distributions (RMDs) from the account over their own life expectancies. However, the SECURE Act eliminated the stretch option for most non-spouse Designated Beneficiaries, and instead, requires the account to be emptied by the end of the 10^th year following the year of the original owner’s death. The SECURE Act, however, also created a new category of beneficiaries – Eligible Designated Beneficiaries – that is still permitted to use the ‘stretch’ provision.

Any of these beneficiaries, of course, could, themselves, die prior to emptying their inherited retirement accounts, leaving the balance to a Successor Beneficiary. Accordingly, there are now three potential scenarios for Successor Beneficiaries of inherited retirement accounts: 1) Successor Beneficiaries of post-SECURE-Act-Eligible Designated Beneficiaries, 2) Successor Beneficiaries of pre-SECURE Act Designated Beneficiaries, and 3) Successor Beneficiaries of post-SECURE Act Non-Eligible Designated Beneficiaries.

In scenarios 1) and 2), Successor Beneficiaries will generally be subject to the full 10-Year Rule. One exception to this is if the post-SECURE Act Eligible Designated Beneficiary (or pre-SECURE Act Designated Beneficiary) is the surviving spouse of the original account owner and dies before the decedent would have been required to begin taking RMDs. In such cases, upon death, they are no longer be considered a “Designated Beneficiary” of the account, but instead, are treated as if they had been the original account owner. Thus, the Successor Beneficiary wouldn’t be treated as a Successor Beneficiary and would not be automatically subject to the 10-Year Rule (i.e., if they were able to qualify as an Eligible Designated Beneficiary, they could qualify to take advantage of the ‘stretch’ provision).

For scenario 3, Successor Beneficiaries who inherit from post-SECURE Act Non-Eligible Designated Beneficiaries are, like other Successor Beneficiaries, subject to the 10-Year Rule; however, unlike other Success Beneficiaries, they will not have their ‘own’ 10-Year timeframe. Instead, their distribution period is a continuation of the 10-Year period that started when the Successor Beneficiary inherited the account.

Although the SECURE Act may negatively impact some Successor Beneficiaries by limiting the time they are allowed to prolong their Required Minimum Distributions, some Successor Beneficiaries may actually be able to benefit from the Act’s changes. In some instances, the number of years a Successor Beneficiary may have to empty their inherited retirement account may be extended, while in other instances, they may simply have a similar amount of time, but more flexibility than was previously allowed prior to the passage of the SECURE Act.

For example, for a Designated Beneficiary who ‘stretched’ RMDs and lives for a long time yet still dies with a substantial account balance, their Successor Beneficiary may have been left with only a few short years to distribute the remaining assets had it been under pre-SECURE Act rules (as they would have been required to use the original beneficiary’s remaining Single Life Expectancy). However, the 10-Year Rule of the SECURE Act now allows these Successor Beneficiaries up to 10 full years to distribute their accounts.

Ultimately, the key point is that while most of the attention on the SECURE Act’s impact on retirement account rules has focused on Primary Beneficiaries, the reality is that Successor Beneficiaries are impacted by the SECURE Act changes as well. While Successor Beneficiaries who inherit accounts from beneficiaries taking RMDs using the ‘stretch’ provision will get the 10-Year Rule (from scratch), some Successor Beneficiaries (i.e., post-SECURE Act beneficiaries of Non-Eligible Designated Beneficiaries) will ‘only’ be able to step into the initial beneficiary’s shoes, and will have to empty the balance of the IRA by the end of the 10-year period established by the original 10-year rule (i.e., the Non-Eligible Designated Beneficiary’s 10-year window). For both the original account beneficiary and their own named Successor Beneficiaries, the SECURE Act has created changes and potential opportunities that impact them both.

Navigating Income Harvesting Strategies: Harvesting (0%) Capital Gains Vs Partial Roth Conversions

July 22, 2020 07:01 am 17 Comments CATEGORY: Retirement Planning

For many high-income clients, financial advisors recommend deferring income as a strategy to mitigate taxes, especially when the client is in a high tax bracket and expects to be in a lower tax bracket in the future as income levels decline (e.g., after retirement). However, in the opposite circumstance, when current taxable income is lower than anticipated future income (e.g., because the client is building substantial wealth), it can be beneficial instead to harvest income instead, take advantage of the taxpayer’s lower tax bracket, and limit the amount of income deferred into the future which would presumably be taxed at a higher rate anyway (as the more income that is deferred to the future, the greater the risk of bumping up the taxpayer into an even higher tax bracket as a result!). But how does the financial advisor choose the best strategy when it comes to avoiding too much tax deferral and harvesting income instead, especially when there are opportunities to harvest both ordinary income (e.g., Roth conversions) and also capital gains (at their own preferential rates and tax bracket thresholds)?

Advisors choosing between these methods – and whether to harvest ordinary or capital gains income – should consider the tax rate brackets associated with each income type to assess how to most effectively minimize overall tax liability (both now and in the future), as well as the “Capital Gains Bump Zone” – where the marginal tax rate on ordinary income can be driven substantially higher by indirectly driving capital gains (along with income generated from qualified dividends) into higher capital gains brackets as well. Because capital gains may be harvested at 0% for those in the bottom two tax brackets… but only if other ordinary income doesn’t ‘crowd out’ those lower tax brackets first!

Accordingly, financial advisors can design optimal income harvesting strategies for their clients by considering when it’s better to harvest ordinary income at its brackets, versus capital gains at those brackets, depending on the relative outlook for each in the future. For instance, those in the 0% ordinary income tax bracket can benefit more from harvesting additional ordinary income (versus capital gains) at 0%, as the jump to the next ordinary income tax bracket (once income turns from negative to positive) is significant. However, for clients in the 10% or 12% ordinary tax bracket (but still in the 0% capital gains tax bracket), it’s often better to harvest capital gains income (versus ordinary income) to reduce the impact of future capital gains income taxed at the 15% capital gains rate (and thus minimizing a 15% increase in capital gain taxation from 0%, compared to a 10% increase, from 12% to 22%, in ordinary income tax). In other words, the choice to harvest either ordinary or capital gains income will largely depend on how that additional harvested income will impact future income tax rates (for that particular type of income, given that individual’s own income growth trajectory).

However, the changes in ordinary and capital gains tax brackets as income itself rises (if only through the impact of deferring that income in the first place) are not the only factors to consider when deciding whether to harvest income, though, as there are other mitigating factors that will impact a taxpayer’s overall tax liability. These include the taxation of Social Security benefits, which phases in as income levels rise (such that harvesting income can actually trigger taxation of these benefits); Medicare Part B and Part D Premium Surcharges, which increase with higher income levels; and the Net Investment Income Tax (NIIT), which increases part of the 15% and the entire 20% capital gains tax brackets by 3.8% and applies not just to capital gains income but also to interest and dividend income as well (except for IRA withdrawals, including those carried out for Roth conversions, which are not subject to NIIT). Financial advisors should also consider the impact of state income taxes (especially if the client is planning to relocate to a different state in the future), and charitable contributions, as well as the step-up in basis of inherited assets received by beneficiaries, and even the beneficiaries’ own tax rates.

Ultimately, the key point is that financial advisors whose clients have lower tax rates today should be wary about deferring income at those low rates – often causing higher rates in the future – and instead can soften the impact of higher future tax rates by strategically harvesting ordinary and/or capital gain income today (with their separate tax bracket structures). However, there are several mitigating factors (such as Social Security, Medicare premiums, and the Net Investment Income Tax) that need to be considered when designing a suitable strategy for the client, and because of the unique tax rates (and bracket structures, and strategies) of ordinary income versus capital gains, it’s often necessary to navigate from year to year which is actually the ‘optimal’ strategy to pursue!

New Rollover Rules For Unwanted 2020 RMDs Under IRS Notice 2020-51… Welcome Relief And A Troubling Precedent

June 25, 2020 07:08 am 28 Comments CATEGORY: Retirement Planning

In response to the coronavirus global pandemic, Congress passed the Coronavirus Aid, Relief, and Economic Security (CARES) Act in March 2020. A more-than-$2-trillion-emergency fiscal stimulus package, the CARES Act was enacted to ease the effects of the economic damage caused by the COVID-19 pandemic by providing a wide range of relief efforts to help individuals, businesses, healthcare entities, and state and local governments meet short-term cashflow demands. Among the many provisions provided by the CARES Act was the suspension of Required Minimum Distributions (RMDs) during 2020. But since the CARES Act wasn’t passed until March 27, 2020, many individuals had already taken what they thought, at the time, were their 2020 RMDs!

Not surprisingly, many of those retirement account owners and beneficiaries wanted to ‘undo’ those distributions that were no longer RMDs and put them back into a retirement account. For some retirement account owners, that was possible by making a 60-day rollover. But for retirement account owners whose 60-day rollover window had already closed (including the extended window for distributions made on or after February 1, 2020 by IRS Notice 2020-23), or where such rollovers would have been a violation of the once-per-year rollover rule, or where distributions were made to non-spouse beneficiaries, there appeared to be no way to ‘unring’ the RMD ‘bell’.

Cue IRS Notice 2020-51…

On June 23^rd, the IRS released “Guidance on Waiver of 2020 Required Minimum Distributions” (Notice 2020-51), which ultimately solved all the problems noted above, allowing anyone who took a distribution (that, but for the CARES Act, would have been a RMD) to rollover that amount until August 31, 2020 .

While the IRS released Notice 2020-23 in April 2020, which extended the 6o-day rollover rule for distributions taken on or after February 1, 2020 to the later of 60 days after receipt of the distribution or July 15, 2020, individuals who took distributions prior to February 1 were excluded from the opportunity and were still unable to rollover their unwanted distributions. Notice 2020-51 provides even further 60-day rollover relief, by extending the 60-day-rollover window for all unwanted 2020 RMD distributions to the later August 31, 2020 date or 60 days after receipt of the distribution).

Notice 2020-51 provides further relief by excluding rollovers of amounts, that if not for the CARES Act would have been 2020 RMDs, from being counted as a rollover for purposes of the once-per-year rollover rule. Finally, while beneficiaries are explicitly prohibited from completing 60-day rollovers under the law, Notice 2020-51 essentially allows beneficiaries to temporarily ignore this portion of the Internal Revenue Code and rollover their 2020 inherited ‘RMDs’ until as late as 8/31/2020.

Ultimately, the new guidance just released by the IRS provides a fair and favorable outcome for people who took their RMDs earlier this year, as those individuals should not be penalized for being proactive and complying with the RMD rules early during the year. However, this is an unprecedented and potentially troubling move by the IRS, given that they do not actually have the legal authority to make this change (it is technically the job of Congress to create and amend laws). The IRS’s action can arguably be interpreted as circumventing well-defined statutes prescribed by the Tax Code, Tax Court decisions, and its own long-standing guidance via Private Letter Rulings (PLRs). While it’s unlikely that anyone will take issue with the IRS’ attempt to be fair and equitable, there’s little question that they seriously stretched their legal authority when issuing this Notice, which may set a troubling precedent moving forward.

Why Discretionary See-Through Trusts May Require Reform After The SECURE Act’s 10-Year Rule

May 27, 2020 07:06 am 2 Comments CATEGORY: Retirement Planning

The passage of the SECURE Act in December of 2019 introduced several notable changes to the rules governing retirement accounts. One of the most significant was the elimination of the ‘stretch’ provision applicable to most non-spouse Designated Beneficiaries of inherited retirement accounts. Instead of allowing such beneficiaries to continue ‘stretching’ their distributions over the span of their own lifetimes, the SECURE Act now requires that certain beneficiaries deplete their inherited retirement accounts by the end of the 10th year after the year of the account owner’s death. And while that poses challenges when planning for individuals who are retirement account beneficiaries… the planning challenges increase exponentially for “See-Through” Trusts, which can also be designated retirement account beneficiaries.

See-Through Trusts are treated as a Designated Beneficiary (by “seeing through” to the underlying beneficiaries) of an inherited retirement account and come in two basic forms – a “Conduit Trust” and a “Discretionary Trust”. Whereas conduit trusts require all distributions from an inherited retirement account received by the trust to be passed out (i.e., “conduited”) to the trust beneficiaries each year, discretionary trusts allow for the build-up of distributed dollars within the trust. Under certain circumstances, each type of trust can still take advantage of the stretch provision if the underlying beneficiaries can be considered Eligible Designated Beneficiaries, but See-Through Trusts will generally be subject to the 10-Year Rule if the underlying beneficiaries are Non-Eligible Designated Beneficiaries.

Applicable Multi-Beneficiary Trusts, meanwhile, can be used for trusts that have multiple beneficiaries (all of whom are people), when one or more of the beneficiaries is a disabled or chronically ill person. These trusts were established by the SECURE Act to help beneficiaries maintain their eligibility in certain means-tested programs such as Supplemental Security Income and Medicare. If Non-Eligible Designated Beneficiaries are named as beneficiaries to an Applicable Multi-Beneficiary Trust, the stretch provision can still apply to the disabled/chronically ill beneficiary (and would be based on the oldest beneficiary if all are disabled/chronically ill), provided the trust splits into a separate sub-trust for the disabled/chronically ill person immediately upon the account owner’s death.

The primary challenge that the SECURE Act imposes on discretionary trusts stems from the high trust tax rate – the income threshold for the maximum trust tax rate (37%) is only $12,950, versus the income threshold of $622,050 for the 37% personal income tax bracket for joint filers! And because any funds distributed from a retirement account to the trust will be taxed at the trust’s income tax rate if they are not subsequently distributed to the trust beneficiary in the same tax year, the tax liability that can result from distributions left in the trust can be substantial.

Some strategies that financial advisors can use to help clients maximize the post-tax value of inherited retirement account funds left to a Discretionary Trust include immediate Roth conversions of any distributions from the inherited retirement account, which especially makes sense when the account owner is in a lower tax bracket. If Roth conversions are not possible (e.g., if income is too high to permit them), using distributions to fund a life insurance policy can be a potential alternative strategy, but only if there is relative certainty that the funds won’t be needed during the account owner’s lifetime. Other strategies that permit distributions to be taxed at potentially lower individual income tax rates instead of the higher trust rates include providing the trustee with the freedom to time inherited retirement account distributions and creating a Discretionary Trust that allows a beneficiary to exercise a power of withdrawal over annual distributions made from the IRA to the trust.

Ultimately, the key point is that Discretionary Trusts, like Conduit Trusts, have been significantly impacted under the SECURE Act. Accordingly, it is crucial for advisors to know which clients have named a discretionary trust as part of their planning, and for those clients with special needs trusts, to ensure that they conform to applicable MBT guidelines. The low-income threshold for the highest trust tax rate bracket is a particular challenge for trust distributions and can be avoided by using Roth conversions immediately after distributions are made to the trust; timing distributions between inherited retirement accounts, the trust, and the beneficiaries; and providing the beneficiary with the power of withdrawal over annual distributions (when it makes sense to do so).

Fixing Unwanted RMDs Taken Before The CARES Act Waiver Of 2020 RMDs

April 22, 2020 10:05 am 11 Comments CATEGORY: Retirement Planning

With the passage of the Coronavirus Aid, Relief, and Economic Security (CARES) Act by Congress last month, Americans were provided with a more-than-$2 trillion emergency fiscal relief package that included benefits for many individuals, small business owners, healthcare providers, and government entities. For financial advisors with clients who have retirement accounts or who are beneficiaries of retirement accounts, one particular provision of interest established by Section 2203 of the CARES Act is the suspension of Required Minimum Distributions (RMDs) during 2020.

The suspension of RMDs applies to all IRA accounts (including SEP and SIMPLE IRAs) and defined contribution plan accounts, such as those under 403(a), 403(b), 401(a), and 401(k) plans, as well as the Federal Thrift Savings Plan (TSP). RMDs from 457(b) plans are also suspended, but only from plans offered by government employers.

In fact, not only can individuals who have RMDs for 2020 suspend their distributions, but individuals who either turned 70 ½ in 2019 or who were older but had retired in 2019 (taking advantage of the provision offered by IRC Section 401(a)(9)(C)(i)(II), the “Still-Working Exception”) can avoid any 2019 RMDs that were delayed to 2020.

Beneficiaries of retirement accounts are also eligible to suspend their 2020 RMDs. Specifically, these include individuals who are Designated Beneficiaries that can ‘stretch’ their RMDs with the life expectancy method and Non-Designated Beneficiaries (e.g., charities, estates, and certain non-See-Through trusts) who inherited the account from a decedent who died on or after their RBD.

On the other hand, accounts that are not eligible for suspended RMDs include defined benefit plans, non-governmental 457(b) plans, annuitized annuities held in an otherwise eligible plan, and 72(t) Distributions. Qualified Charitable Distributions (QCDs) are also not impacted by the CARES Act’s suspension of RMDs (and can still be made normally in 2020 for those who were otherwise QCD eligible).

For financial advisors with clients who have already taken RMDs for 2020 from their retirement accounts (or who have postponed RMDs for 2019 in 2020, as noted above) but who could have benefitted from suspending the distributions, there are a few ways to address the unwanted now-no-longer-necessary RMDs. Individuals can return the funds to the original account or rollover the funds to another retirement account (either through the 60-day-rollover window, or the extended rollover deadline offered through IRS Notice 2020-23), or for individuals directly affected by the COVID-19 virus (e.g., they or their family member has been diagnosed with the illness or has been experiencing financial hardship caused by the pandemic) by using the Coronavirus-Related Distribution Provision outlined in Section 2202(a) of the CARES Act.

However, in the case of IRA owners, it’s important to be mindful of the once-per-year IRA-rollover rule. Effectively, the rule prevents an unwanted RMD (or any other IRA distribution) from being rolled back into another IRA via a 60-day rollover (or using the relief provided by Notice 2020-23) if another IRA-to-IRA or Roth IRA-to-Roth IRA 60-day rollover has been completed during the past 365 days. Though IRA owners ‘stuck’ with multiple distributions may be able to fix them while steering clear of the once-per-year rollover rule by rolling the second, third, fourth, etc. distributions to a non-IRA-based employer-sponsored retirement plan that accepts roll-ins. If no such plan account is available, they may, at least, be able to salvage some tax benefits by timely completing a Roth conversion (which is also not subject to the once-per-year rollover rule).

For non-spouse beneficiaries of inherited retirement accounts, there is, unfortunately, no option to fix an unwanted RMD, as they are not permitted to do rollovers in any case. Spousal beneficiaries, on the other hand, do at least have the option to make spousal rollovers to move distributions to their own retirement accounts (but such rollovers are subject to the once-per-year rollover rule).

Ultimately, the key point is that financial advisors whose clients are retirement account owners can use relief offered through the CARES Act by suspending 2020 RMDs that aren’t immediately needed. For retirees who may already have taken their RMDs for 2020 (or for certain individuals who took 2019 RMDs timely in 2020), there are strategies for them to return these unwanted distributions using the 60-day-rollover rule, the relief provided by IRS Notice 2020-23 (which pushes back the deadline to rollover distributions taken on or after February 1, 2020, to July 15, 2020), or a Coronavirus-Related Distribution (for individuals directly affected by the COVID-19 virus).

Accommodate Real World Dynamic Retirement Goals By Projecting Retirement Dates Instead Of Retirement Wealth

March 11, 2020 07:04 am 3 Comments CATEGORY: Retirement Planning

In 2014, Robert Merton lamented in “The Crisis in Retirement Planning” that “investment value and asset volatility are simply the wrong measures if your goal is to obtain a particular future income”. Which is an important concept to emphasize, as many basic financial planning strategies focus only on solving for an asset-based goal to be achieved at a specific point in time (e.g., needing to have $X by the time I retire at age Y), and at best project a range of wealth outcomes around that target at the intended future date.

In this Guest Post, Charles Fox, a financial advisor with Integrity Wealth Partners (an RIA in Walnut Creek, CA) shares how a more robust analysis that accounts for real world outcomes and the potential for retirement delay (or retiring early) can be a powerful tool to really help clients plan for their goals. In other words, the variability of time (and not just the variability of wealth) is a key variable to include in a retirement planning analysis, and when used together with retirement cashflow and desired asset-based goals, financial advisors can help clients better understand how to connect their actual saving and spending behaviors with the trade-offs illustrated in their financial plan.

However, even with plans that incorporate time-based factors to examine asset-based goals, if the plan is limited by a deterministic analysis (i.e., one that does not consider the impact of random events on the results), the client may not have a realistic perspective of the potential impact that market risk and volatility will have on their plan. Which means that Monte Carlo simulations can still be a valuable tool to help clients put these factors into perspective, but by demonstrating not only how asset-based goals would change in dollar amounts but also over time, when affected by the impact of a wide range of potential market conditions.

Accordingly, by using dynamic retirement dates and asset goals that make sense for the client, and by adjusting the simulation parameters to factor in variable times actually spent in retirement (i.e., dependent on the actual retirement date), advisors can present simulation-based results in terms that are relevant and relatable to the client (e.g., not just answering the question “how much do I need to save to retire” but answering the more direct question, “When might I be able to retire?”), while accounting for potential market risk and volatility. In other words, advisors can illustrate how target goal thresholds (e.g., the amount needed to retire at a certain point in time) can change over time as the required assets to meet that goal change as well. Additionally, Monte Carlo-based simulations can be used to effectively illustrate how changing the cost of a goal can affect the timeframe required to achieve that goal, as well as showing the impact of changing small habits over long periods of time (not just in terms of wealth accumulation, but in the speed of reaching a retirement goal in the first place).

Ultimately, the key point is that dynamic time-oriented reporting (as contrasted with traditional deterministic wealth-oriented reporting), when coordinated with flexible retirement goals, can help clients understand not just the timeframe required to complete a goal, but also how different factors (e.g., a delay – or acceleration – in retirement date, the costs associated with reaching the goal, market variability, etc.) play into and trade off with each other in reaching their goal. And using simulation-based analyses provides even more texture than can be communicated in a single probability of success. Perhaps most importantly, time-oriented reporting can help facilitate conversations with the client about how the variables considered in a multifactorial, simulation-based analyses affect their financial plan – in a manner that the client can understand and use!