Harless Tax Blog
From BloombergMarkets. Read Original Article
U.S. employers are watching the clock.
With federal rules expanding paid overtime eligibility set to take effect next month, business leaders are making moves to contain future costs, according to a New York Federal Reserve Bank survey.
The new regulation, finalized in May by the Labor Department and scheduled to come into force on Dec. 1, requires employers to pay time-and-a-half to salaried employees earning up to nearly $47,500 annually — about double the current threshold of almost $24,000 — after they work more than 40 hours per week.
In the survey, about one-in-three manufacturers and 40 percent of service firms in New York, northern New Jersey and southern Connecticut said they plan to implement one or a mix of responses: from raising salaries for some workers to above the overtime threshold, to limiting employees' hours to 40 a week, or adjusting their headcount, mostly through job reductions. Other actions they're considering include converting some workers from salaried to hourly status, according to the New York Fed survey.
The change has met resistance from businesses and Republicans, the party of President-elect Donald Trump, who on the campaign trail gave conflicting views on his employment policies, saying at different times the minimum wage should be abolished, frozen or raised. Republican governors control all but one of the 21 states that have sued Democrat Barack Obama's administration to block the regulation, saying it could lead to layoffs.
A report from the nonpartisan Congressional Budget Office released Monday found that canceling the scheduled changes before implementation — however unlikely it seems — would reduce payroll costs by $40 million in December and by $470 million in 2017. Employees' earnings would also fall, but real family income would increase by raising firms' profits and making consumer goods and services less expensive as a result, it found.
Some 3.9 million additional workers would gain overtime protection under the new rule, the CBO said.
From Accounting Today Website. Read Original Article
The Internal Revenue Service is giving victims of Hurricane Matthew in North Carolina extra time to file their tax returns and make tax payments.
North Carolina victims of the hurricane that left a path of destruction and flooding this past weekend will get until March 15, 2017, to file certain individual and business tax returns and make certain tax payments, with similar relief expected soon for Hurricane Matthew victims in other states, the Internal Revenue Service said Friday. Besides North Carolina, the storm also did extensive damage in Florida, South Carolina, Georgia, Virginia and other states. At least 34 people have died as a result, and flooding is continuing as of Monday in parts of North Carolina
The IRS said that all workers who help with the relief activities abd who are affiliated with a recognized government or philanthropic organization will also qualify for relief.
The Federal Emergency Management Agency has declared a disaster, opening up federal assistance, and the IRS said that affected taxpayers in Beaufort, Bladen, Columbus, Cumberland, Edgecombe, Hoke, Lenoir, Nash, Pitt and Robeson counties will receive this and other special tax relief. Locations in other states are expected to be added in coming days, based on damage assessments by FEMA.
The tax relief postpones various tax filing and payment deadlines starting Oct. 4, 2016. As a result, the affected individuals and businesses will have until March 15, 2017, to file tax returns and pay any taxes that were originally due during this period. That includes the January 17 deadline for making quarterly estimated tax payments. For individual tax filers, it also includes 2015 income tax returns that received a tax-filing extension until Oct. 17, 2016. The IRS pointed out, that, that because tax payments related to these 2015 returns were originally due on April 18, 2016, those are not eligible for this relief.
Several business tax deadlines are also impacted, including the October 31 and January 31 deadlines for quarterly payroll and excise tax returns. It also includes the special March 1 deadline that applies to farmers and fishermen who choose to forgo making quarterly estimated tax payments.
In addition, the IRS said it is waiving late-deposit penalties for federal payroll and excise tax deposits that are normally due on or after October 4 and before October 19 if the deposits are made by October 19, 2016. For more details, check the disaster relief page on IRS.gov.
The IRS noted that it automatically provides filing and penalty relief to any taxpayer whose IRS address of record is located within a disaster area, so taxpayers don’t need to contact the IRS to get the relief. However, if an affected taxpayer receives a late filing or late payment penalty notice from the IRS that has an original or extended filing, payment or deposit due date falling within the postponement period, the taxpayer should call the number on the notice to have the tax penalty abated.
The IRS said it will also work with any taxpayer who lives outside the disaster area but whose records necessary to meet a deadline occurring during the postponement period are located in the affected area. Taxpayers who qualify for relief but live outside the disaster area should call the IRS at (866) 562-5227.
From Accounting Today Website. Read Original Article
Almost half of accountants think that control of the Senate matters more to the profession than who wins the presidential race, according to a new Accounting Today survey.
The survey asked 328 accountants and CPAs from across the country this week which outcome matters more to the accounting profession, and 48 percent of respondents said that Senate races were more important. Only a third (32 percent) thought the struggle for the presidency was most important. (Approximately 20 percent didn’t know or didn’t have an opinion.)
They had strong opinions about who they would prefer to see control the Senate, with 49 percent calling Republican control of the chamber better for the accounting profession, and only 25 percent siding with the Democrats.
They were more evenly divided as to which presidential candidate would be best for the accounting profession: 38 percent said Donald Trump and 31 percent said Hillary Clinton.
Overall, the profession was only somewhat worked up about the presidential election: 37 percent of respondents think it will have a significant or major impact on the profession, 32 percent think it will have a middling impact on the profession, and 18 percent think it will have a mild or no impact at all. (Another 13 percent didn’t know or had no opinion.)
From Fidelity Investments Website. Read Original Article
In the midst of your summer fun, taking time for a midyear tax checkup could yield rewards long after your vacation photos are buried deep in your Facebook feed.
Personal and financial events, such as getting married, sending a child off to college, or retiring, happen throughout the year and can have a big impact on your taxes. If you wait until the end of the year or next spring to factor those changes into your tax planning, it might be too late.
“Midyear is the perfect time to make sure you’re maximizing any potential tax benefit and reducing any additional tax liability that result from changes in your life,” says Gil Charney, director of the Tax Institute at H&R Block. “Plus it doesn’t look like there are going to be a lot of changes to the tax code this year, so it’s an especially good opportunity to shift from being reactive to proactive in your tax planning.”
Here are nine questions to answer to help you to be prepared for any potential impacts on your tax return.
- Did you get a raise or are you expecting one?
The amount of tax withheld from your paycheck should increase automatically along with your higher income. But if you’re working two jobs, have significant outside income (from investments or self-employment), or you and your spouse file a joint tax return, the raise could push you into a higher tax bracket that may not be accounted for in the Form W-4 on file with your employer. Even if you aren’t getting a raise, ensuring that your withholding lines up closely with your anticipated tax liability is smart tax planning. Use the IRS Withholding Calculator, then, if necessary, tell your employer you’d like to adjust your W-4.
Another thing to consider is using some of the additional income from your raise to increase your pretax contribution to a 401(k) or similar qualified retirement plan. That way, you’re reducing your taxable income and saving more for retirement at the same time.
- Is your income approaching the net investment income tax threshold?
If you’re a relatively high earner, check to see if you’re on track to surpass the net investment income (NII) tax threshold. The NII, often called the Medicare surtax, is a 3.8% levy on the lesser of net investment income or the excess of modified adjusted gross income (MAGI) above $200,000 for individuals, $250,000 for couples filing jointly, and $125,000 for spouses filing separately. In addition, taxpayers with earned income above these thresholds will owe another 0.9% in Medicare tax on top of the normal 2.9% that’s deducted from their paycheck.
If you think you might exceed the Medicare surtax threshold for 2016, you could consider strategies to defer earned income or shift some of your income-generating investments to tax-advantaged retirement accounts. These are smart strategies for taxpayers at almost every income level, but their tax-saving impact is even greater for those subject to the Medicare surtax.
- Did you change jobs?
If you plan to open a rollover IRA with money from a former employer’s 401(k) or similar plan, or to transfer the money to a new employer’s plan, be careful how you handle the transaction. If you have the money paid directly to you, 20% will be withheld for taxes and, if you don’t deposit the money in the new plan or an IRA within 60 days, you may owe tax on the withdrawal, plus a 10% penalty if you’re under age 55.
- Do you have a newborn or a child no longer living at home?
It’s time to plan ahead for the impact of claiming one more or less dependent on your tax return.
Consider adjusting your tax withholding if you have a newborn or if you adopt a child. With all the expenses associated with having a child, you don’t want to be giving the IRS more of your paycheck than you need to.
If your child is a full-time college student, you can generally continue to claim him or her as a dependent—and take the dependent exemption ($4,050 in 2016)—until your student turns 25. If your child isn’t a full-time student, you lose the deduction in the year he or she turns 19. Midyear is a good time to review your tax withholding accordingly.
- Do you have a child starting college?
College tuition can be eye-popping, but at least you might have an opportunity for a tax break. There are several possibilities, including, if you qualify, the American Opportunity Tax Credit (AOTC). The AOTC can be worth up to $2,500 per undergraduate every year for four years. Different college-related credits and deductions have different rules, so it pays to look into which will work best for you.
Regardless of which tax break you use, here’s a critical consideration before you write that first tuition check: You can’t use the same qualified college expenses to calculate both your tax-free withdrawal from a 529 college savings plan and a federal tax break. In other words, if you pay the entire college bill with an untaxed 529 plan withdrawal, you probably won’t be eligible for a college tax credit or deduction.
- Is your marital status changing?
Whether you’re getting married or divorced, the tax consequences can be significant. In the case of a marriage, you might be able to save on taxes by filing jointly. If that’s your intention, you should reevaluate your tax withholding rate on Form W-4, as previously described.
Getting divorced, on the other hand, may increase your tax liability as a single taxpayer. Again, revisiting your Form W-4 is in order, so you don’t end up with a big tax surprise in April. Also keep in mind that alimony you pay is a deduction, while alimony you receive is treated as income.
- Are you saving as much as you can in tax-advantaged accounts?
OK, this isn’t a life-event question, but it can have a big tax impact. Contributing to a qualified retirement plan is one of the most effective ways to lower your current-year taxable income, and the sooner you bump up your contributions, the more tax savings you can accumulate. For 2016, you can contribute up to $18,000 in pretax dollars to your 401(k) or 403(b). If you’re age 50 or older, you can make a “catch-up” contribution of as much as $6,000, for a maximum total contribution of $24,000. Self-employed individuals with a simplified employee pension (SEP) plan can contribute up to 25% of their compensation, to a maximum of $53,000.
This year’s IRA contribution limits, for both traditional and Roth IRAs, are $5,500 per qualified taxpayer under age 50 and $6,500 for those age 50 and older. Traditional and Roth IRAs both have advantages, but keep in mind that only traditional IRA contributions can reduce your taxable income in the current year.
- Are your taxable investments doing well?
If you’re investments are doing well and you have realized gains, now’s the time to start thinking about strategies that might help you reduce your tax liability. Tax-loss harvesting—timing the sale of losing investments to cancel out some of the tax liability from any realized gains—can be an effective strategy. The closer you get to the end of the year, the less time you’ll have to determine which investments you might want to sell, and to research where you might reinvest the cash to keep your portfolio in balance.
- Are you getting ready to retire or reaching age 70½?
If you’re planning to retire this year, the retirement accounts you tap first and how much you withdraw can have a major impact on your taxes as well as how long your savings will last. A midyear tax checkup is a good time to start thinking about a tax-smart retirement income plan.
If you’ll be age 70½ this year, don’t forget that you may need to start taking a minimum required distribution (MRD) from your tax-deferred retirement accounts, although there are some exceptions. You generally have until April 1 of next year to take your first MRD, but, after that, the annual distribution must happen by December 31 if you want to avoid a steep penalty. So if you decide to wait to take your first MRD until next year, be aware that you’ll be paying tax on two annual distributions when you file your 2017 return.
No significant changes in your life situation or income?
Combined with a relatively quiet year for changes in the federal tax code, having an uneventful year in your personal and financial life offers a good opportunity to think more carefully about your tax planning. You might look into ways you can save more toward retirement, gift money to your children and grandchildren to remove it from your estate, or manage your charitable giving to increase its tax benefits and value to beneficiaries. A little tax planning now can save a lot of headaches in April—and maybe for years to come.
Business owners may need capital to support growth, and the money in their IRA can be tempting. Nevertheless, the pitfalls can be steep, as illustrated in a recent Tax Court case (Thiessen v. Commissioner, 146 T.C. No. 7 [3/29/16]). Here, the court ruled that because a married couple had entered into prohibited transactions with respect to their IRAs, the assets in the IRAs were deemed to have been distributed, resulting in a huge tax bill.
Describing the transaction
When James Thiessen left a long-held job after declining to relocate, he found a metal fabricating business (call it ABC Co.) for sale. Through a friend who had executed such a transaction and also from a broker, James heard about the use of IRA money to help finance the purchase.
Therefore, James and his wife, Judith, hired tax and legal advisers. Proceeding according to plan, the Thiessens created a new C corporation (call it DEF Co.); James and Judith were DEF’s officers and directors. They both also established IRA accounts. Then they rolled a total amount of more than $430,000 from their employer-sponsored retirement accounts into the IRAs.
As the next step, the Thiessens’ IRAs purchased all the shares of DEF, the new company they had created; then DEF used the money from the IRAs to buy the assets of ABC. In addition to the IRA money, DEF transferred a $200,000 promissory note to ABC’s seller in the purchase. ABC’s assets secured the note, which James and Judith personally guaranteed.
The seven-year hitch
This all happened in 2003. In 2010, the IRS asserted that the Thiessens’ guarantee of the note was a prohibited transaction, which resulted in a deemed distribution of all of the assets in their IRAs. The couple was taxed on the deemed distribution of the over $430,000 they had rolled over into the IRAs, plus a 10% early withdrawal penalty, because James and Judith were both younger than 59½. Ongoing tax deferral on the funds distributed was lost, and the Thiessens owed over $180,000 in income tax, according to the IRS. The Tax Court ruled in favor of the IRS, upholding the agency’s claim.
Usually, there’s a three-year statute of limitation on the time in which the IRS can assess extra income tax. However, there’s a six-year window for the IRS in cases where the taxpayer substantially understates income. That was the case here because the Thiessens had not included the deemed distributions from their IRAs in income on their 2003 return. The IRS’ 2010 filing came within six years of the date in 2004 when the Thiessens filed their 2003 tax return.
Debt was the downfall
The Tax Court agreed with the IRS that the Thiessen’s plan failed because they had personally guaranteed the promissory note that DEF transferred in the purchase of ABC’s assets. The Tax Court found that the Thiessens’ “guaranties of the loan were prohibited transactions and [the Thiessens’] IRAs ceased to qualify as IRAs on account of the guaranties.” As a result, all the funds in the IRAs were deemed distributed in a taxable transaction in the year the Thiessens guaranteed the promissory note.
This transaction proved to be very costly for the Thiessens. Other pitfalls can arise when IRA money is used to acquire a small business. If you desire to have your IRA own a business, our office may be able to help you put together an arrangement in keeping with the rules against prohibited transactions.
Besides financial aid, specific tax benefits can reduce the net cost of sending a child to college. Among the three major tax breaks—American Opportunity Tax Credit, Lifetime Learning Credit, tuition and fees deduction—you can claim only one on your tax return.
American Opportunity Tax Credit (AOTC)
This credit, which recently was extended through 2017, typically will be the best choice for parents of collegians. The AOTC can produce the biggest tax saving: as much as $2,500 per student per year. In addition, the AOTC has the most generous income limits.
The maximum tax credit is available with modified adjusted gross income (MAGI) up to $80,000 for single filers, partial credits with MAGI up to $90,000. For married couples filing joint tax returns, the comparable income limits are $160,000 and $180,000. Typically, MAGI for this credit is the same as your AGI, reported on the bottom of page 1 of your return.
To get the full $2,500 in tax savings, your spending must be at least $4,000 of qualified expenses for each college student. Qualified expenses include tuition and required fees but not room and board, transportation, insurance, or medical expenses. Unlike other education tax breaks, the costs of course-related books, supplies, and equipment that are not necessarily paid to the school can be qualified expenses.
You can take the AOTC for each of the first four years of a student’s higher education but not for subsequent years. Each year that you claim the AOTC, you must claim the student as a dependent on your tax return. (You also can claim the AOTC for yourself and your spouse, if the other conditions are met.)
The AOTC is also refundable: If the AOTC reduces the tax you owe to zero before the full credit is used, 40% of the remaining credit amount (up to $1,000) can be paid to you in cash.
Lifetime Learning Credit
For the Lifetime Learning Credit, the income limits are lower than for the AOTC: for single filers, the MAGI phaseout range is $55,000-$65,000; for joint filers, the range is $110,000-$130,000 of MAGI. In addition, the tax savings can’t be more than $2,000 per return, not per student. The Lifetime Learning Credit is set at 20% of the first $10,000 you spend on higher education. Otherwise, the rules for the Lifetime Learning Credit are similar to those for the AOTC.
If the AOTC is far more appealing, why use the Lifetime Learning Credit? Because the Lifetime Learning Credit might work when the rules for the AOTC can’t be met. As mentioned, the AOTC only covers a student’s first four years of higher education. Students for whom the credit is claimed must be enrolled in college at least half-time for one academic period during the tax year. The Lifetime Learning Credit, on the other hand, is available for all years of higher education as well as for courses taken to acquire or improve job skills. You can claim the Lifetime Learning Credit for an unlimited number of years, so it can be useful once you’ve claimed the AOTC for four years.
Tuition and fees deduction
A tax credit is generally better than a tax deduction, so either the AOTC or the Lifetime Learning Credit usually will save more tax than the tuition and fees deduction. You can deduct up to $4,000 of tuition and required college costs with MAGI up to $65,000 (single) or $130,000 (joint). With larger MAGI, up to $80,000 or $160,000, you can deduct up to $2,000 of those expenses. With even greater MAGI, no deduction is allowed.
Taxpayers with qualifying MAGI usually will be in the 15% or 25% federal tax bracket, so the tax savings may be modest.
Example: Ken and Kathy Long are in the 25% tax bracket. Taking a $4,000 tuition and fees deduction reduces their tax bill by $1,000: 25% times $4,000. Thus, their tax saving is less than the $2,000 possible from the Lifetime Learning Credit or the $2,500 per student from the AOTC.
If that’s the case, why would anyone choose this deduction, instead of one of the tax credits? Note that the income limits for the Lifetime Learning Credit are lower than the limits for the deduction. Thus, if the Longs can’t qualify for the AOTC (say, they’ve already used it for their child for four years) or for the Lifetime Learning Credit (their income is just over the Lifetime Learning Credit threshold), they may be able to benefit from the tuition and fees deduction.
Also, this deduction is taken as an adjustment to income, reducing your AGI. (A tax credit reduces your tax obligation, not your AGI.) A lower AGI, in turn, may offer benefits throughout your tax return. Our office can make sure you use the most effective education benefit on your tax return.
From Devenir Research.
The number of health savings accounts (HSAs) rose 22% to 16.7 million in 2015, while HSA assets reached almost $30.2 billion, a gain of 25%. Most HSA money is in low-yield savings deposits but $4.2 billion (14% of the total) is in investments, where returns might be higher. By 2018, HSA investments are projected at $9.7 billion.
The net price of higher education will depend on the amount of financial aid that’s received. The greater the financial aid, the lower the net cost of college.
In order to obtain financial aid, a key step is filling out the Free Application for Federal Student Aid (FAFSA). This is a complex form with many questions; its aim is to get a picture of a student’s family income and assets. Some of the questions request tax return information. Our office can help if you have difficulty with any FAFSA tax questions.
After filling out the FAFSA, your answers go through a formula that determines your expected family contribution (EFC). The lower your EFC, the greater the amount of financial aid a student might be awarded. This number may change every year, so if aid is requested each academic year, a FAFSA must be completed annually.
Potential financial aid awards are determined by comparing an applicant’s EFC with a given school’s listed cost.
Example 1: Carla Davis, a high school senior, fills out the FAFSA. Her EFC, based on family income and assets, is placed at $27,000 for the next academic year. Suppose Carla is accepted at a college where the published cost for the coming academic year is $44,000. Carla could be awarded as much as $17,000 in need-based aid: the $44,000 published cost minus her family’s EFC of $27,000.
Note that this process would not result in any need-based aid for Carla at a college where the published cost is $25,000. Carla and her parents would be expected to pay the full price.
New rules for the FAFSA
Starting this October, new FAFSA rules go into effect. Under the current process, including the one for the 2016-2017 academic year, the FAFSA could be submitted no earlier than January 1 of the coming school year. Thus, Ed Franklin could submit his FAFSA no earlier than January 2016 for the 2016-17 academic year.
In October 2016, Ed will be able to submit a FAFSA for 2017-18. Because of this shift in submission timing, “prior-prior year” tax return information will be required, rather than prior year numbers.
Example 2: Assume Ed submitted his FAFSA in January 2016, as early as possible. Data show that early filers tend to get more aid than latecomers. However, in January 2016, Ed’s parents had not yet prepared their 2015 (“prior year”) tax return. Therefore, the FAFSA had to be submitted with estimated information, subject to subsequent verification once the Franklins’ 2015 tax return had been filed.
If Ed wants to get an early start again, he can file his FAFSA for the 2017-18 year in October 2016. Under the new rules, Ed will use the 2015 tax return (now the “prior-prior year”) information for the 2017-18 FAFSA. He won’t have to estimate income numbers, assuming his parents’ and his own 2015 tax returns already have been filed.
Going forward, the October submission date and the prior-prior year tax returns will be used on the FAFSA. A student applying for aid in the 2021-22 academic year, for example, will use the numbers from 2019 tax returns on an October 2020 filing of that FAFSA.
As mentioned, reducing your child’s EFC may result in increased financial aid. In determining an EFC, income typically is the most important factor. (Assets count, too, but generally to a lesser extent.) Therefore, holding down income can be helpful. Under the new rules, timing strategies have been changed.
Example 3: Greg and Heidi Irwin have a daughter Jodi, age 15. The Irwins expect Jodi to go to college, starting with the 2019-2020 school year. They hope that Jodi will receive some need-based aid.
Even so, the Irwins believe they’ll have to dip into savings to pay college bills, and the money might come from selling stocks they feel have become overvalued. Selling those stocks at a gain in 2017 could increase the income they’ll report on the FAFSA, for 2019-2020, so the Irwins could decide to take gains this year. If those gains are realized in 2016, the income will never show up on the FAFSA.
On the flip side, suppose the last FAFSA filed for Jodi will cover the 2022-2023 school year. Then the last relevant tax return will be for 2020. If the Irwins plan a bump in income, perhaps from selling a vacation home at a profit or converting a traditional IRA to a Roth IRA, they might decide to wait until 2021 or later, when the income won’t affect Jodi’s financial aid.
Be aware that the new schedule poses a peril: income might decline in the interim. In example 3, Jodi Irwin files a FAFSA for the 2019-20 year, using tax return data from 2017. However, Jodi’s family might have much lower income in 2018 or 2019, perhaps because of a job loss, so the FAFSA understates her financial need. In this case, the Irwins can request a professional judgment review by a college’s admissions office, which could verify the increase in need.
Aid Without Need
- Many colleges award what’s known as merit aid: grants or scholarships not based on financial need.
- The “merit” might be academic success in high school. It also might result from accomplishments in sports, music, community service, and so on.
- Colleges may restrict merit aid to students who fill out the FAFSA. Thus, youngsters from well-to-do families might gain by filling out the form, even if need-based aid isn’t expected.
- Information sources can include the college guidance counselor at your child’s high school as well as online sites that list scholarships awarded by companies or other organizations.
- Considering the rising cost of higher education, it can be well worthwhile to encourage youngsters to participate in pre-college activities and to actively seek merit-based money.
From the CNBC.com Website. Read Original Article >
Didn't redeposit that 401(k) distribution check from your old employer into an IRA or your new boss' qualified retirement savings plan within two months' time?
That once meant you'd likely have to fork over hefty taxes and penalty fees on those hard-earned, once-tax-deferred savings but now, thanks to a new Internal Revenue Service policy, your word that it was an honest mistake will be enough for the feds to give you a break.
Under the IRS' new "self-certification" rule, announced on Thursday, eligible taxpayers who can attest to experiencing one or more of 11 "mitigating circumstances" that led to their missing the normal 60-day time limit for tax-free funds transfer can qualify for a waiver. The revenue procedure posted at the IRS.gov website includes a sample letter taxpayers "can use to notify the administrator or trustee of the retirement plan or IRA receiving the rollover that they qualify for the waiver."
The list of 11 qualifying circumstances includes misplaced, uncashed distribution checks; severe damage to a taxpayer's home; death of a family member; serious personal or family illness; incarceration; or restrictions imposed by a foreign country. The IRS will "ordinarily" honor a taxpayer's "truthful self-certification" that the circumstances indeed apply and grant the waiver, the agency said in a press release. The IRS also has the authority to grant waivers in subsequent examination to taxpayers who do not self-certify prior.
New waiver policy or no new waiver policy, the IRS still advises taxpayers arrange direct trustee-to-trustee transfers of retirement plan or IRA balances. "Doing so can avoid some of the delays and restrictions that often arise during the rollover process," according to the press release.
Financial advisor Tim Maurer, director of personal finance for Buckingham and the BAM Alliance, is of a similar mindset. "Of course, I'm glad to see that the IRS is giving a break to those who might otherwise halve their retirement savings due to the punishing taxes and penalties assessed to early 401(k) withdrawals, whether accidental or purposeful," he said. "But I'd much rather avoid subjecting myself (or my clients) to the mercy of the 'mitigating circumstances,' as defined by the IRS.
"Eliminate the worry and just get it done as soon as possible," said Maurer.
In April, the U.S. Department of Labor (DOL) made headlines with its final rule covering conflicts of interest among investment advisors. Media coverage focused on the difference between a “fiduciary” standard and a “suitability” standard. Financial advisors and investment firms have been debating this issue—often heatedly—for years, and the DOL action probably will bring about changes within the industry.
The new rules also have a message for investors, especially those who rely upon an adviser. This lesson may not be astounding but it’s worth keeping in mind: You should know what investment advice is costing and whether you’re getting your money’s worth.
Defining the terms
Investment advisors who are registered with the SEC are considered fiduciaries: They have an obligation to act in a client’s best interest. Alternatively, registered representatives associated with a securities brokerage firm are required to make investment recommendations that are suitable for a particular client, given the client’s circumstances. (Registered investment advisors are fiduciaries under the Investment Advisors Act of 1940 but not under ERISA, the federal law covering retirement plans; ERISA is the DOL’s responsibility, so that agency issued the rule on retirement advice.)
When issuing its final rule in April, the DOL came down firmly in favor of the fiduciary standard, stating that “persons who provide investment advice or recommendations for a fee or other compensation with respect to assets of a plan or IRA” will be treated “as fiduciaries in a wider array of advice relationships.”
Investors should keep in mind that the DOL rule covers retirement advice, not all investments. Therefore, this regulation applies to advisors’ recommendations for IRAs, 401(k)s, and other retirement accounts. When Wendy Jones seeks advice on how to invest in a regular (non-retirement) account, the DOL rule won’t apply, at least not directly. Advisors who adhere to a fiduciary standard for retirement advice may well follow the same approach for other client funds.
Moreover, the DOL clearly associates investors’ best interests with low costs. The DOL repeatedly has mentioned “backdoor payments” and “hidden fees” as factors that harm American workers and their families. Lowering fees would boost returns, the DOL asserts.
Some observers believe that the federal support of a fiduciary standard will result in more advisor support of passive investment strategies and less emphasis on active management. Also, sales commissions may yield ground to fee-based advisory arrangements.
Both of those assertions may come to pass, but both trends are already well under way. Passive investing generally means holding funds that track a market index, such as the S&P 500. Such funds typically have relatively low costs, as there is no need to pay for research into security selection, and relatively low tax bills, because of infrequent trading.
Index-tracking mutual funds have been popular for some time, as finding fund managers who consistently outperform the indexes has proven to be challenging. In recent years, exchange-traded funds (ETFs) have taken market share from mutual funds; most ETFs track a specific market index. Thus, many advisors and clients have been moving towards such low-cost, tax-efficient approaches.
Similarly, fee-based investment arrangements also have been on the rise. Advocates assert that paying, say, an asset management fee puts a client “on the same side of the table” as an advisor, reducing conflicts of interest. If a client’s investment assets grow through superior returns, so will the advisor’s management fee.
Given this background, what can you take away from the DOL’s proposal? First off, don’t focus solely on terminology. Whether you’re getting the “best” investment or a “suitable” investment for your needs, you will have to pay the advisor in some manner. Therefore, you should know how much you’re actually paying, so read all contracts, engagement letters, and other documents carefully to find out the true cost.
Second, realize that low costs aren’t everything. Ascertain what value you’re getting for what you pay. Is your advisor providing only investment advice? If so, what results have you received? Many financial professionals go beyond investments to insurance planning, education planning, estate planning, and other areas of wealth management. If you have such an advisor, does the total package provided to you justify the total amount of your outlays? If you are not comfortable with the answers, you may have to seek someone else to help you handle your financial matters.
- The Department of Labor’s final rule carves out educational information from the definition of retirement investment advice.
- Thus, advisors and plan sponsors can provide general financial and investment concepts on retirement saving with employment-based plans and IRAs without triggering fiduciary duties.
- For example, such education could consist of information about historic differences in rates of return among equities, bonds, or cash, based on standard market indexes.