Retirement accounts at ‘serious risk’ as COVID-19 spurs bankruptcies

The coronavirus pandemic has disrupted many things around the world, let it be the workplace, schools, everyday life habits, and it has even disrupted retirement accounts. In the nine months of COVID-19 hitting businesses, bankruptcies and lawsuits have risen and caused many questions. Read this blog post to learn more.

If there’s one thing clients have always relied on in troubled times, it’s that last bastion of savings, the retirement account — whether it be a 401(k) or an IRA.

But we’re now into the ninth month since COVID-19 hit our shores and nothing can be taken for granted. Business closures, bankruptcies and lawsuits from creditors have soared, calling into question even that formerly unassailable bulwark. That’s why it’s crucial that advisors know which accounts can be protected in bankruptcy and in non-bankruptcy lawsuits — and which cannot.

Make no mistake: Not all possess the same safeguards. Retirement accounts carry a number of different protections. These layers of defense shield IRA owners and company plan participants from bankruptcy and general (non-bankruptcy) creditors. In addition, levels of protection vary widely from state to state. In the current environment with so many small businesses on the brink of closing and struggling employees in limbo, increased bankruptcy filings are placing retirement savings at serious risk, especially when these might be the only funds available for a personal bailout.

That’s why it is imperative to understand which accounts hold what protections, and how retirement assets are shielded from those anxious to get a piece of their nest egg.

ERISA plans: The gold standard
Most employer-sponsored retirement plans, such as 401(k)s, fall under the Employee Retirement Income Security Act of 1974 guidelines and receive creditor protection at the federal level. ERISA offers the gold standard of protection up to an unlimited amount against both bankruptcy and non-bankruptcy general creditor claims.

To illustrate, let’s take the hypothetical example of “Mark,” a successful contractor who flips houses. He has a 401(k) plan set up for himself and the employees of his sole proprietorship. Mark’s current plan balance is $1,500,000.

Recently, however, there was an accident at one of his construction sites, and Mark is being sued personally. Even if Mark loses the lawsuit, the assets in his 401(k) remain protected by ERISA up to an unlimited amount. Additionally, if Mark were to declare bankruptcy, his 401(k) would be off limits to bankruptcy creditors.

Going solo = greater exposure
The same protections do not, however, hold for solo 401(k) plans.

Often, business owners worried about potential lawsuits keep their retirement funds in their so-called solo-K because they believe it to be fully creditor proof, as opposed to an IRA.

Butsolo 401(k) plans are not covered by ERISAand have no creditor (non-bankruptcy) protection under that law. Plan balances will only receive non-bankruptcy creditor protection available under applicable state law.

These plans do, however, receive full bankruptcy protection under the bankruptcy code. This is also the case with other non-ERISA company plans such as SEP and SIMPLE IRAs, non-ERISA 403(b) plans and 457(b) governmental plans.

Bankruptcy and IRAs
Traditional and Roth IRA contributions and earnings are protected from bankruptcy under federal law up to an inflation-adjusted cap — currently $1,362,800.

Is this a sufficient limit?

If the maximum amount was contributed to an IRA each year from 1975 to 2020, there would be $141,500 in contributions — $158,500 if the IRA owner qualified for age 50 catch-up contributions available beginning in 2002. It is unlikely that the earnings, even for those who contributed the maximum each year, would push an IRA balance over $1,362,800.

But what about rollovers from plans to IRAs? Do these dollars count against the $1,362,800 cap?

They do not. Former company plan assets (previously protected by ERISA while in the plan) rolled to an IRA will obtain unlimited bankruptcy protection under the bankruptcy code. As an added bonus, rollovers from SEP and SIMPLE plans also do not count against the $1,362,800 cap.

As an example, let’s conjure up “Sheila,” an attorney with a $2,000,000 balance in her company’s ERISA 401(k) plan and a $700,000 balance in her IRA, which is composed entirely of contributions and earnings.

In April, Sheila retired from her law firm and in May rolled her 401(k) into her IRA. Sheila’s IRA is completely shielded from bankruptcy. The bankruptcy code protects her $2 million 401(k) rollover up to an unlimited amount, and the $1,362,800 cap is enough to cover her original IRA balance.

Note that in this example, Sheila did not need to keep her 401(k) and IRA dollars separate to retain the maximum bankruptcy protections. However, from an administrative standpoint, it could make sense for some individuals to keep rollover assets separate via a conduit IRA to avoid confusion.

Lawsuits and IRAs (non-bankruptcy)
General creditor protection (e.g., when a person wins a judgment in court against the account owner) for IRAs, Roth IRAs and IRA-based company plans like SEPs and SIMPLEs is based on individual state law — and these state-level, non-bankruptcy protections vary widely.

As such, it is important to understand your client’s state coverage, especially before advising the client to roll over ERISA plan dollars into an IRA.

As mentioned, ERISA-covered plans enjoy full bankruptcy and general creditor protection. While all former plan dollars remain protected in bankruptcy by the bankruptcy code after a rollover to an IRA, these same dollars do not retain unlimited general creditor (non-bankruptcy) protection. Assets rolled from an ERISA plan to an IRA will now fall under the applicable state-level protections. These state safeguards may be comparable to ERISA levels, or they may be significantly less so.

For instance, the hypothetical“Dr. Kapp” changed employers and is deciding what to do with his $400,000 401(k) plan. His profession exposes him to malpractice lawsuits. If Dr. Kapp rolls the assets from his work plan to an IRA, the $400,000 will be fully protected in bankruptcy. However, he will be limited to the general creditor (non-bankruptcy) protections offered under state law.

Instead, Dr. Kapp elects to roll his former plan assets into the 401(k) plan offered by his new employer. That way, he ensures the $400,000 will retain 100% ERISA protection from both bankruptcy claims and any malpractice judgments against him.

Inherited IRAs and bankruptcy
In a landmark decision released in 2014,Clark v. Rameker, the U.S. Supreme Courtruled unanimously that inherited IRAs are not protected in bankruptcy under federal law.

Since only "retirement funds" are protected under the bankruptcy code, the primary issue before the court was whether an inherited IRA is, in fact, a retirement account. The Supreme Court decided that inherited IRAs do not contain “retirement funds” because:

1. Beneficiaries cannot add money to inherited IRAs;

2. Beneficiaries of inherited IRAs must generally begin to take RMDs, regardless of how far away they are from retirement; and

3. Beneficiaries can take total distributions of their inherited accounts at any time and use the funds for any purpose without a 10% early distribution penalty.

As a result, the favorable bankruptcy protection afforded to such funds under the bankruptcy code does not extend to inherited RIAs.

Bankruptcy timing and rollovers in transit
IRAs and retirement accounts protected under the bankruptcy law are generally shielded only as long as the funds remain qualified. Creditors will sit patiently until retirement dollars are withdrawn to snatch them as unprotected assets.

However, these funds remain safeguardedas long as they are qualified dollars. If funds are withdrawn, the law protects these dollars while they are out of the IRA in transit to the new IRA or retirement account. This protection applies to 60-day rollovers as well as trustee-to-trustee transfers. An individual only receives this protection if bankruptcy paperwork was officially filed while the funds were still in the retirement account. Timing is key in such cases. Funds already out on rollover when bankruptcy is declared lose all protection.

IRAs and the LLC shield
IRAs enjoy specific levels of protection against “outside” claims, i.e., claims brought personally against the IRA owner.

But what happens when a claim is brought against an investment within the IRA? The answer is that such “inside” claims may not only devastate the IRA but could also put an IRA owner’s personal non-qualified assets at risk. Inside claims can be mitigated with the use of a limited liability company (LLC).

The imaginary “Blake” owns a self-directed IRA worth $500,000 that invests entirely in a local Jet Ski rental and watersports company. He did not use an LLC within the IRA to acquire the rental business. Blake has other personal assets worth $1.5 million.

Last summer, a Jet Ski renter had an accident and suffered a catastrophic injury. After almost a year of litigation, the renter won a $2 million judgment against the IRA.

All of Blake’s IRA assets could be reached because the claim arose from activities of the IRA investment. His personal assets could also be at risk. But if Blake’s IRA had been invested in an LLC that subsequently purchased the water sports company within the IRA, the LLC structure would have protected both the IRA assets and Blake’s personal assets against the $2 million judgment.

Be keenly aware of outside vs. inside claims and how to mitigate certain risks with an LLC.

Clear and present danger
Add the ongoing COVID-19 outbreak to our litigious society with the increasingly looming possibility of bankruptcies, all under the watchful eye of SEC Reg BI, and educating clients on available safeguards becomes increasingly vital.

That education holds even more true for financial advisors in whom clients have placed their trust and financial futures. Understanding the levels of bankruptcy and non-bankruptcy protections afforded to both workplace retirement plans and IRAs is now a must to safeguard the dreams of post-work life clients have worked so hard to achieve.

SOURCE: Slott, E. (10 September 2020) "Retirement accounts at ‘serious risk’ as COVID-19 spurs bankruptcies" (Web Blog Post). Retrieved from https://www.financial-planning.com/news/retirement-accounts-at-risk-as-coronavirus-spurs-bankruptcies

by 6dhannah

The little-discussed downsides of retirement

As the discussions of retirement are inevitable, there are questions that do not always get addressed. Continue reading this blog post to learn more about questions regarding retirement that are not always talked about.

The downsides of retirement that nobody talks about

Clients should identify the possible downsides in retirement and plan on how to avoid them, according to this article in Yahoo Finance. One of these snags is taxation on their retirement income, which can hurt their cash flow. To minimize income taxes in retirement, clients should consider creating sources of tax-free income, such as Roth 401(k), Roth IRA and permanent life insurance coverage.

Can clients have a 401(k) and an IRA?

Employees who are contributing to 401(k) plans can also save in traditional IRAs, but their IRA contributions will not be tax deductible if their income exceeds a certain threshold, according to this article in NerdWallet. Participants in 401(k)s can also contribute to Roth IRAs if they earn below the income limits set for Roth accounts. To make the most of these savings vehicles, clients should make enough 401(k) contributions to qualify for their employer's full match and save the rest of their retirement money in traditional IRAs to reduce their taxable income. Those in a lower tax bracket may opt to direct the funds to Roth IRAs to boost their after-tax income in retirement.

A big question in retirement planning: How long will I live?

Although people cannot predict their own lifespan retirement, there are online tools and services that clients can use to have a good estimate of their longevity and plan for retirement, according to this article in The Wall Street Journal. “No one can predict definitively how long someone is going to live,” says an expert. “But we can say, ‘For someone your age and gender, with your level of income and education, your body-mass index and sleep and exercise patterns, this is what science tells us you are likely to experience.’”

Retiring this year? Here's what clients need to do first

There are a few things seniors should do before they retire later this year, according to this article in Forbes. Pre-retirees should maximize their contributions to 401(k)s and other tax-favored retirement accounts, review Social Security numbers and Medicare changes and create estate plans. They should consider converting some of their traditional assets into Roths to boost their after-tax income in retirement.

SOURCE: Schiavo, A. (28 February 2020) "The little-discussed downsides of retirement" (Web Blog Post). Retrieved from https://www.employeebenefitadviser.com/news/the-little-discussed-downsides-of-retirement

by 6dhannah

Older workers are staying in the job market. Here’s why

According to the Bureau of Labor Statistics, the amount of employees over the age of 65 has risen by 697,000. With over two million jobs being created over the past 12 months with the help of the economy, the older generations are still wanting to be employed. Read this blog post to learn more as to why.

Older workers are sticking around the job market. This is why
The number of workers aged 65 and above increased by 697,000 as the economy created more than 2 million new jobs over the past 12 months, according to data from the Bureau of Labor Statistics in this CNBC article. The spike in the number of older workers represents about 36% of the overall increase, reflecting a trend over the past 10 years. “The norms about working at older ages have changed quite a bit, and I think in a way that really is to the advantage of older workers who want to keep working,” says an expert.

What ‘Rothifying’ 401(k)s would mean for retirees
Clients will not benefit from a switch to a retirement system where contributions would be made on an after-tax basis even if it could result in bigger tax revenue in the near term, experts write in The Wall Street Journal. "Over their lifetimes, workers would accumulate one-third less in their 401(k)s under a Roth system. This is because, with no tax advantage from contributing to a 401(k), workers would save less and those lower contributions would earn less over the years," they write. Moreover, "lifetime tax revenue generated by the average worker under a Roth regime would fall 6% to 10%, compared with the current regime."

Stop 'dollar-cost ravaging' your clients’ portfolio in retirement
Retirees who stick to a 4% withdrawal rule during a market downturn are putting their financial security at risk, as their portfolio would not recover even if the market eventually improves, writes an expert in Kiplinger. Instead, seniors should focus on how much income they can generate from their portfolio, he writes. "[I]t means choosing investments — high dividend-paying stocks, fixed income instruments, annuities, etc. — that will produce the dollar amount you need ($2,000, $3,000, $5,000 or more) month after month and year after year."

Will clients owe state taxes on their Social Security?
Retirees may face federal taxation on a portion of their Social Security benefits — but they could avoid the tax bite at the state level, as 37 states impose no taxes on them, writes a Forbes contributor. "While probably not a big enough issue to warrant moving in retirement, it is something to consider when choosing where you want to spend your retirement," writes the expert. "At the very least, you need to know about Social Security taxation when figuring out how much additional income you will need to have in order to maintain your standard of living during retirement."

8 ways clients can start saving for college now
There are a few savings vehicles that clients can use to prepare for college expenses, but they need to consider the pros and cons, according to this article in Bankrate. For example, clients who save in a 529 savings plan can get tax benefits — such as tax deferral on investment gains and tax-free withdrawal for qualified expenses — but will face penalties for unqualified withdrawals aside from taxes. Parents may also use a Roth IRA to save for their child's college expenses, but these accounts are subject to contribution limits and future distributions will be treated as an income, which can reduce their child's eligibility for scholarships or assistance.

SOURCE: Peralta, P. (18 February 2020) "Older workers are staying in the job market. Here’s why" (Web Blog Post). Retrieved from https://www.employeebenefitadviser.com/news/why-older-workers-are-staying-in-the-job-market

by 6dhannah

Saver's Credit Can Spur Retirement Plan Contributions

Many employees are not aware of employer-sponsored retirement accounts, or individual retirement accounts (IRA), which could be costing those more money. Tax season is the best time for employers to educate their employees on how they can earn extra tax credits through their 401(k) plans. Read this blog post to learn more about how to educate employees on what retirement account opportunities that are available to them.

Many workers don't know that they're eligible for a tax credit by saving in an employer-sponsored retirement plan or individual retirement account (IRA)—and that could be costing them money. Tax time, however, is prime time for employers to inform eligible workers about the saver's credit.

The Retirement Savings Contributions Credit, or saver's credit, is available to low- and moderate-income workers who are putting money aside for retirement. But only 29 percent of workers with annual household income below $50,000 know about the saver's credit, according to the nonprofit Transamerica Center for Retirement Studies in Los Angeles, which surveyed nearly 6,000 employees last fall.

"Tax season is an ideal time to tell eligible workers how they can earn extra tax credits by saving through their employer's 401(k) or a similar retirement plan," said Catherine Collinson, president of the Transamerica Center. "The saver's credit might just be the motivator for those not yet saving for retirement to get started."

Scott Spann, a senior financial planner with Financial Finesse, a provider of workplace financial wellness programs in Charleston, S.C., said, "Saving for retirement is a challenge for many households in America. Special tax incentives help make the process of saving easier."

What Is the Saver's Credit?

Like other tax credits, the saver's credit can increase a taxpayer's refund or reduce the tax owed. Here's how it works:

The amount of the credit is a maximum of 50 percent of an employee's retirement plan contributions up to $2,000 (or $4,000 for married couples filing jointly), depending on the filer's adjusted gross income as reported on Form 1040. Consequently, the maximum saver's credit is $1,000 (or $2,000 for married couples filing jointly).

The saver's credit "is different than a tax deduction due to the fact that a tax credit is a dollar-for-dollar reduction of your gross tax liability, which is the total amount of taxes you're responsible for paying before any credits are applied," Spann explained.

The saver's credit also differs from the separate tax benefit of contributing pretax dollars to a qualified retirement plan, such as an employer-sponsored 401(k) or an IRA. "Many eligible retirement savers may be confusing these two incentives because the notion of a double tax benefit"—pretax contributions and an additional tax credit—"seems too good to be true," Collinson said.

Who Can Claim the Saver's Credit?

The credit is available to workers age 18 or older who have contributed to a company-sponsored retirement plan or an IRA in the past year and meet the income requirements shown in the table below. The filer cannot be a full-time student nor claimed as a dependent on another person's tax return.

Income Caps for Tax Years 2019 and 2020

For eligible workers, the amount of the available tax credit diminishes as adjusted gross income (AGI) rises. To help preserve the credit's value, income thresholds are adjusted annually to keep pace with inflation. Below are the AGI caps for tax year 2019 (for tax returns filed this year) and 2020 (for returns filed next year).

2019 Saver's Credit
Tax Credit Rate Single Filers and Married, Filing Separately* Married, Filing Jointly Heads of Household
50% of contribution AGI not more than - $19,250 AGI not more than $38,500 AGI not more than $28,875
20% of contribution AGI of $19,251 - $20,750 AGI of $38,501 - $41,500 AGI of $28,876 - $31,125
10% of contribution AGI of $20,751- $32,000 AGI of $41,501 - $64,000 AGI of $31,126 - $48,000
No credit AGI more than $32,000 AGI more than $64,000 AGI more than $48,000

 

2020 Saver's Credit
Tax Credit Rate Single Filers and Married, Filing Separately* Married, Filing Jointly Heads of Household
50% of contribution AGI not more than $19,500 AGI not more than $39,000 AGI not more than $29,250
20% of contribution AGI of $19,501 - $21,250 AGI of $39,001 - $42,500 AGI of $29,251 - $31,875
10% of contribution AGI of $21,251 - $32,500 AGI of $42,501 - $65,000 AGI of $31,876 - $48,750
No credit AGI more than $32,500 AGI more than $65,000 AGI more than $48,750

Deadlines for Retirement Contributions

"You must make eligible contributions to your employer-sponsored retirement plan or IRA for the tax year for which you are claiming the income tax credit," Spann said.

While 401(k) contributions for a tax year can be made only up to Dec. 31, those who are eligible but did not save last year can still make a tax year 2019 IRA contribution until April 15, 2020.

Filing for the Saver's Credit

Employers can advise eligible workers to take the following steps to claim the saver's credit, according to the Transamerica Center:

  • If using tax-preparation software, including those programs offered through the IRS Free File program, use Form 1040 or Form 1040NR for nonresident aliens. Answer questions about the saver's credit, which may be referred to as the Retirement Savings Contributions Credit or the Credit for Qualified Retirement Savings Contributions.
  • If preparing tax returns manually, complete Form 8880, Credit for Qualified Retirement Savings Contributions, to determine your exact credit rate and amount. Then transfer the amount to the designated line on Form 1040 (Schedule 3) or Form 1040NR.
  • If using a professional tax preparer, ask about the saver's credit.

Financial planners advise having tax refunds directly deposited into an IRA to further boost your retirement savings.

The Transamerica Center has additional information, in English and Spanish, on its Saver's Credit webpage, along with a downloadable fact sheet.

IRS Free File Program Is Available

Another potentially overlooked opportunity for workers is the IRS Free File program, which offers federal income tax preparation software at no charge to tax filers with an AGI of $69,000 or less.

Free File opened on Jan. 10, 2020, for the preparation of 2019 tax returns. Eligible taxpayers can do their taxes now, and the Free File provider will submit the return once the IRS officially opens the tax filing season on Jan. 27.

For 2020, the Free File partners are: 1040Now, Inc., ezTaxReturn.com (English and Spanish), FileYourTaxes.com, Free tax Returns.com, H&R Block, Intuit, On-Line Taxes, Inc., Tax ACT, TaxHawk, Inc. and TaxSlayer (English and Spanish).

Here's how Free File works:

  1. Taxpayers go to IRS.gov/FreeFile to see all Free File options.
  2. They browse each of the offers or use a "look up" tool to help find the right product. Each Free File partner sets its own eligibility standards generally based on income, age and state residency. But if the taxpayer's adjusted gross income was $69,000 or less, they will find at least one free product to use.
  3. They select a provider and follow the links to their web page to begin a tax return.
  4. They complete and e-File a tax return if they have all the income and deduction records they need. The fastest way to get a refund is by filing electronically and selecting direct deposit. For taxes owed, they can use direct pay or electronic options.

Many Free File online products also offer free state tax preparation, although some charge a state fee. Taxpayers should read each provider's information carefully.

"The IRS has worked to improve the program for this year, and we encourage taxpayers to visit IRS.gov, and consider using the Free File option to get a head start on tax season," said IRS Commissioner Chuck Rettig.

Nearly 57 million returns have been filed through the Free File program since it began in 2003, and 70 percent of U.S. taxpayers (about 100 million people) are eligible for Free File, according to the IRS.

SOURCE: Miller, S. (10 January 2020) "Saver's Credit Can Spur Retirement Plan Contributions" (Web Blog Post). Retrieved from https://www.shrm.org/resourcesandtools/hr-topics/benefits/pages/remind-low-wage-earners-about-savers-credit.aspx

by 6dhannah

The Mega Backdoor Roth IRA and Other Ways to Maximize a 401(k)

Did you know: Numerous 401(k) retirement plans allow after-tax contributions. This creates financial planning opportunities that are frequently overlooked. Read this blog post for more information on maximizing your 401(k) plan.

The most popular workplace-sponsored retirement plan is far and away the 401(k) — a plan that can be both simple and complex at the same time. For some of your clients, it functions as a tax-deductible way to save for retirement. Others might see its intricacies as a way to maximize lifetime wealth, boost investments and minimize taxes. One such niche area of 401(k) planning is after-tax contributions, an often misunderstood and underutilized area of planning.

Before we jump into after-tax contributions, we need to cover the limits and the multiple ways your clients can invest money into 401(k) plans.

Employee Salary Deferrals and Roth

The most traditional way you can contribute money to a 401(k) is by tax-deductible salary deferrals. In 2019, employees can defer up to $19,000 a year. If they’re age 50 or older, they can contribute an additional $6,000 into the plan. In 2020, these numbers for “catch-up contributions” rise to $19,500 and $6,500 respectively.

Someone age 50 or over can put up to $25,000 into a 401(k) in 2019 and $26,000 in 2020 through tax-deductible salary deferrals. Additionally, the salary deferral limits could instead be used as a Roth contribution, but with the same limits. The biggest difference is that Roth contributions are after-tax. And as long as certain requirements are met, the distributions, including investment gains, come out income tax-free, whereas tax-deferred money is taxable upon distribution.

Employer Contributions

Employers often make contributions to a 401(k), with many matching contributions. For instance, if an employee contributes 6% of their salary (up to an annual indexed limit on salary of $280,000 in 2019 and $285,000 in 2020), the company might match 50%, 75%, or 100% of the amount. For example, if an employee earns $100,000 a year and puts in $6,000 and their employer matches 100%, they will also put in $6,000, and the employee will end up with $12,000 in their 401(k). Employers can also make non-elective and profit-sharing contributions.

Annual 401(k) Contribution Cap

Regardless of how money goes into the plan, any individual account has an annual cap that includes combined employee and employer contributions. For 2019, this limit is $56,000 (or $62,000 if the $6,000 catch-up contribution is used for those age 50 and over). For 2020, this limit rises to $57,000 ($63,500 if the $6,500 catch-up contribution is used for those age 50 and over).

Inability to Max Out Accounts

If you look at the limits and how people can contribute, you might quickly realize how hard it is to max out a 401(k). If a client takes the maximum salary deferral of $19,000 and an employer matches 100% (which is rare), your client would only contribute $38,000 into the 401(k) out of the maximum of $56,000. Their employer would need to contribute more money in order to max out.

Where After-Tax Contributions Fit In

Not all plans allow employees to make after-tax contributions. If the 401(k) did allow this type of contribution, someone could add more money to the plan in the previous example that otherwise maxed out at $38,000.

After-tax contributions don’t count against the salary deferral limit of $19,000, but they do count toward the annual cap of $56,000. After-tax contributions are what they sound like — it’s money that’s included into the taxable income after taxes are paid, so the money receives all the other benefits of the 401(k) like tax-deferred investment gains and creditor protections.

With after-tax contributions, clients can put their $19,000 salary deferral into the 401(k), get the $19,000 employer match, and then fill in the $18,000 gap to max out the account at $56,000.

Mega-Roth Opportunity

If the plan allows for in-service distributions of after-tax contributions and tracks after-tax contributions and investment gains in separate accounts from salary deferral and Roth money, there’s an opportunity to do annual planning for Roth IRAs.

Clients can convert after-tax contributions from a 401(k) plan into a Roth IRA, without having to pay additional taxes. If a plan allows in-service distributions of after-tax contributions, the money can be rolled over to a Roth IRA each year. However, it’s important to note that any investment gains on the after-tax amount would still be distributed pro rata and considered taxable. Earnings on after-tax money only receive tax-deferred treatment in a 401(k); they aren’t tax free.

Clients can roll over tens of thousands of dollars a year from a 401(k) to a Roth IRA if the plan is properly set up. They can even set up a plan in such a way so the entire $56,000 limit is after-tax money that’s distributed to a Roth IRA each year with minimal tax implications. This strategy is referred to as the Mega Backdoor Roth strategy.

Complexities Upon Distribution of After-Tax Contributions

What happens to after-tax contributions in a 401(k) upon distribution? This is a complex area where you can help clients understand the role of two factors:

  1. After-tax contributions are distributed pro-rata (proportional) between tax-deferred gain and the after-tax amounts.
  2. Pre-tax money is usually considered for rollover into a new 401(k) or IRA first, leaving the after-tax attributed second. The IRS provided guidance on allocation of after-tax amounts to rollovers in Notice 2014-54.

Best Practices for Rollovers

Help your clients navigate the world of rollovers with after-tax contributions by following best practices. If a client does a full distribution from a 401(k) at retirement or separation of service, they can roll the entire pre-tax amount to a new 401(k) or IRA and separate out the after-tax contributions to roll over into a Roth IRA. The IRS Notice 2014-54 previously mentioned also provides guidance for this scenario.

You can help your clients understand after-tax contributions by envisioning after-tax money in a 401(k) as the best of three worlds. These contributions enter after taxes and give your client tax-deferred money on investment growth, allow them to save more money in their 401(k) while also giving them the opportunity to roll it over into a Roth IRA at a later date.

After-tax contributions build numerous planning options and tax diversification into retirement plans. Before your clients allocate money toward after-tax contributions, it’s important they understand what their plan allows and how it fits into their overall retirement and financial planning picture.

SOURCE: Hopkins, J. (17 December 2019) "The Mega Backdoor Roth IRA and Other Ways to Maximize a 401(k)" (Web Blog Post). Retrieved from https://www.thinkadvisor.com/2019/12/17/the-mega-backdoor-roth-ira-and-other-ways-to-maximize-a-401k/

by 6dhannah

IRA spousal contributions can mitigate the high cost of women’s work breaks in retirement plans

According to a November 2018 study, women who took a year off from work in a 15-year period had 39 percent lower average annual earnings than women who worked continuously through that time. Read this blog post for more on how spousal contributions can mitigate the high cost of work breaks in retirement plans.

Women employees face special retirement savings challenges compared with their male counterparts. On average, they earn less and log fewer years of earned income compared to men. That’s because, in part, because women take multiple breaks from work, turn down work or decline promotions because of family care obligations.

The cost of a career break can be high. A November 2018 study by the Washington-based Institute for Women’s Policy Research found that women who took just one year off from work in a 15-year period had 39% lower average annual earnings than women who worked continuously through that time. The study also showed that the number of women taking at least one year off of work during a 15-year period was nearly twice the rate of men — 43% of women compared to 23% of men.

As a result, women are less likely to set aside money in a savings arrangement or to contribute to an employer-sponsored retirement plan.

Spousal advantage

Married women (and men) who take work breaks may stay on track with their retirement savings goals by making IRA (traditional or Roth) contributions based on their working spouse’s income — if they meet these requirements.

  • The couple must file a joint federal income tax return
  • The working spouse must have enough earned income to make any IRA contributions on behalf of the nonworking spouse, or, if both spouses are contributing, enough income to support both spouses’ contributions
  • Assuming enough earned income, each spouse can contribute up to $6,000 (plus $1,000 if turning age 50) for 2019. This limit applies to traditional and Roth IRA contributions combined
  • The spouse receiving a traditional IRA contribution must be under age 70 ½ for the entire year
  • To be eligible for Roth IRA contributions, the couple must also satisfy income requirements.

Roth IRA income restrictions

The amount that an individual is eligible to contribute to a Roth IRA depends on the amount of the couple’s modified adjusted gross income (MAGI). If the couple’s joint MAGI for a tax year is less than the IRS phase-out range, each spouse can make the maximum Roth IRA contribution allowed for that tax year (assuming enough MAGI to support both spouse’s contributions). If it’s above the phase-out range, neither spouse is eligible to contribute to a Roth IRA. Keep in mind that they could still contribute to a traditional IRA, if under age 70 ½. If the couple’s joint MAGI falls within the phase-out range, their maximum contribution amount is reduced. The MAGI phase-out range is subject to cost-of-living adjustments each year.

Traditional IRA income tax deductions

Note that separate MAGI phase-out ranges apply to traditional IRA contribution deductions — another way for non-working married individuals to potentially benefit when saving for retirement with an IRA. The ability to take a federal income tax deduction for a traditional IRA contribution — if eligible — appeals to many savers. But deduction eligibility depends on whether either spouse is an “active participant” in an employer-sponsored retirement plan. An active participant is generally making or receiving contributions to her retirement plan accounts for the applicable year. Because active participants have access to a workplace retirement plan, the IRS uses its MAGI to determine whether each spouse can take a full deduction, a partial deduction or no deduction at all.

No minimum required

Regardless of which IRA a couple chooses to, the main thing is to contribute — even if it’s a small amount. There is no minimum amount that must be contributed to either type of IRA. Couples can contribute whatever they’re comfortable with, up to the previously described limit. For those concerned about not having enough to set aside in an IRA during a career break, contributing even just $500 or $1,000 for the year will still make a difference.

It certainly beats not saving at all.

SOURCE: Van Zomeren, B. (9 December 2019) "IRA spousal contributions can mitigate the high cost of women’s work breaks in retirement plans" (Web Blog Post). Retrieved from https://www.benefitnews.com/opinion/ira-spousal-contributions-can-mitigate-cost-of-womens-work-breaks-in-retirement

by 6drachael

CenterStage: Traditional IRA, Roth IRA, 401(k), 403(b): What’s the Difference?

In this month’s CenterStage article, we are going to take a look at the difference between traditional IRA, Roth IRA, 401(k), 403(b), curtesy of Kevin Hagerty, a Financial Advisor at Saxon.

The earlier you begin planning for retirement, the better off you will be. However, the problem is that most people don’t know how to get started or which product is the best vehicle to get you there.

A good retirement plan usually involves more than one type of savings account for your retirement funds. This may include both an IRA and a 401(k) allowing you to maximize your planning efforts.

If you haven’t begun saving for retirement yet, don’t be discouraged. Whether you begin through an employer sponsored plan like a 401(k) or 403(b) or you begin a Traditional or Roth IRA that will allow you to grow earnings from investments through tax deferral, it is never too late or too early to begin planning.

This article discusses the four main retirement savings accounts, the differences between them and how Saxon can help you grow your nest egg.

“A major trend we see is that if people don’t have an advisor to meet with, they tend to invest too conservatively because they are afraid of making a mistake,” said Kevin. “Then the problem is that they don’t revisit it and if you’re not taking on enough risk you’re not giving yourself enough opportunity for growth. Then you run the risk that your nest egg might not grow to what it should be.”

“Saxon is here to help people make the best decision on how to invest based upon their risk tolerance. We have questionnaires to determine an individual’s risk factors, whether it be conservative, moderate or aggressive and we make sure to revisit these things on an ongoing basis.”

Traditional IRA vs. Roth IRA

Who offers the plans?

Both Traditional and Roth IRAs are offered through credit unions, banks, brokerage and mutual fund companies. These plans offer endless options to invest, including individual stocks, mutual funds, etc.

 

Eligibility

Anyone with earned, W-2 income from an employer can contribute to Traditional or Roth IRAs as long as you do not exceed the maximum contribution limits.

With Traditional and Roth IRAs, you can contribute while you have earned, W-2 income from an employer. However, any retirement or pension income doesn’t count.

Tax Treatment

With a Traditional IRA, typically contributions are fully tax-deductible and grow tax deferred so when you take the money out at retirement it is taxable. With a Roth IRA, the money is not tax deductible but grows tax deferred so when the money is taken out at retirement it will be tax free.

“The trouble is that nobody knows where tax brackets are going to be down the road in retirement. Nobody can predict with any kind of certainty because they change,” explained Kevin. “That’s why I’m a big fan of a Roth.”

“A Roth IRA can be a win-win situation from a tax standpoint. Whether the tax brackets are high or low when you retire, who cares? Because your money is going to be tax free when you withdraw it. Another advantage is that at 70 ½ you are not required to start taking money out. So, we’ve seen Roth IRA’s used as an estate planning tool, as you can pass it down to your children as a part of your estate plan and they’ll be able to take that money out tax free. It’s an immense gift,” Kevin finished.

Maximum Contribution Limits

Contribution limits between the Traditional and Roth IRAs are the same; the maximum contribution is $5,500, or $6,500 for participants 50 and older.

However, if your earned income is less than $5,500 in a year, say $4,000, that is all you would be eligible to contribute.

“People always tell me ‘Wow, $5,500, I wish I could do that. I can only do $2,000.’ Great, do $2,000,” explained Kevin. “I always tell people to do what they can and then keep revisiting it and contributing more when you can. If you increase a little each year, you will be contributing $5,500 eventually and not even notice.”

Withdrawal Rules

With a Traditional IRA, withdrawals can begin at age 59 ½ without a 10% early withdrawal penalty but still with Federal and State taxes. The Federal and State government will mandate that you begin withdrawing at age 70 ½.

Even though most withdrawals are scheduled for after the age of 59 ½, a Roth IRA has no required minimum distribution age and will allow you to withdraw contributions at any time. So, if you have contributed $15,000 to a Roth IRA but the actual value of it is $20,000 due to interest growth, then the contributed $15,000 could be withdrawn with no penalty.

 

 

Employer Related Plans – 401(k) & 403(b)

A 401(k) and a 403(b) are theoretically the same thing; they share a lot of similar characteristics with a Traditional IRA as well.

Typically, with these plans, employers match employee contributions .50 on the dollar up to 6%. The key to this is to make sure you are contributing anything you can to receive a full employer match.

Who offers the plans?

The key difference with these two plans lies in if the employer is a for-profit or non-profit entity. These plans will have set options of where to invest, often a collection of investment options selected by the employer.

Eligibility

401(k)’s and 403(b)’s are open to all employees of the company for as long as they are employed there. If an employee leaves the company they are no longer eligible for these plans since 401(k) or 403(b) contributions can only be made through pay roll deductions. However, you can roll it over into an IRA and then continue to contribute on your own.

Only if you take possession of these funds would you pay taxes on them. If you have a check sent to you and deposit it into your checking account – you don’t want to do that. Then they take out federal and state taxes and tack on a 10% early withdrawal penalty if you are not age 59 ½. It may be beneficial to roll a 401(k) or 403(b) left behind at a previous employer over to an IRA so it is in your control.

Tax Treatment

Similar to a Traditional IRA, contributions are made into your account on a pretax basis through payroll deduction.

Maximum Contribution Limits

The maximum contribution is $18,000, or $24,000 for participants 50 and older.

Depending on the employer, some 401(k) and 403(b) plans provide loan privileges, providing the employee the ability to borrow money from the employer without being penalized.

Withdrawal Rules

In most instances, comparable to a Traditional IRA, withdrawals can begin at age 59 ½ without a 10% early withdrawal penalty. Federal and State government will mandate that you begin withdrawing at age 70 ½. Contributions and earnings from these accounts will be taxable as ordinary income. There are certain circumstances when one can have penalty free withdrawals at age 55, check with your financial or tax advisor.

In Conclusion…

“It is important to make sure you are contributing to any employer sponsored plan available to you so that you are receiving the full employer match. If you have extra money in your budget and are looking to save additional money towards retirement, that’s where I would look at beginning a Roth IRA. Then you can say that you are deriving the benefits of both plans – contributing some money on a pretax basis, lowering federal and state taxes right now, getting the full employer contribution match and then saving some money additionally in a Roth that can provide tax free funds/distributions down the road,” finished Kevin.

 

Editor’s Note: This article was originally published in June 2017 and was updated in January 2018 for accuracy.

by 6djina