Obama Budget Changes to IRA, 401(k) and Other Retirement Rules

Financial Planning:

BY: ED SLOTT

MONDAY, AUGUST 19, 2013

When President Obama unveiled his budget for the upcoming fiscal year, which begins on Oct. 1, it represented a wish list.

English: Retirement savings for various periods with squirrel and nut analogy (Photo credit: Wikipedia)

But advisors should pay close attention to the eventual compromise because there were a number of significant proposals related to retirement savings accounts.

Here is an overview of six notable proposals and whether your clients would be winners or losers.

1. MANDATORY IRAs

Under the administration’s proposal, employers that have more than 10 workers and have been in business for at least two years would face a new requirement to set up and provide automatic enrollment in IRAs for their employees. Employees would contribute to the IRAs through payroll deductions. In addition, they would be able to elect how much of their salary they wish to contribute to their IRAs (up to the annual contribution limit), or they could elect to opt out.

In the absence of any election, 3% of an employee’s salary would be contributed to the IRA.

The argument: For nearly 15 years, Congress, the Treasury Department and the IRS have been taking steps to increase Americans’ retirement saving contributions by making it easier for employers to establish auto-enrollment in company 401(k) plans. But many small businesses choose not to adopt a retirement plan because of the costs or the burden of complying with regulations. Many small employers also do not take low-cost steps to make retirement savings easier for employees.

A Millionaire by Retirement (Photo credit: mortgagepaymentplan)

The winners: Too few Americans actively save for retirement, and even fewer save appropriate amounts. Although there is some disagreement, numerous studies have shown that automatic enrollment tends to increase participation in retirement savings. The proposal also contains a number of tax credits that small businesses could claim for helping to facilitate employees’ retirement savings.

The losers: Many small businesses say that they are already overburdened with various compliance requirements and that any new rules or regulations would be unwelcome.

2.  EMPTYING INHERITED IRAs

Most beneficiaries of IRAs and other retirement accounts would be required to empty an inherited retirement account by the end of the fifth year after the year of the original owner’s death, according to the administration proposal. (Presumably, required minimum distribution rules would apply, meaning the remaining balance would be subject to a 50% penalty -- like all other missed required minimum distributions.)

Max Baucus, U.S. Senator from Montana. (Photo credit: Wikipedia)

This proposal is a potential game changer for many clients’ estate plans. But this is not the first time the idea has been floated. In fact, since Sen. Max Baucus, a Democrat from Montana, initially introduced the idea several years ago, it has been revisted a few times.

The argument: The Green Book, released by the Treasury Department to explain the proposals in the president’s budget, says the reason for this provision is that “the Internal Revenue Code gives tax preferences for retirement savings accounts primarily to provide retirement security for individuals and their spouses. The preferences were not created with the intent of providing tax preferences to the non-spouse heirs.”

This point has been brought up a number of times when lawmakers are looking for revenue sources, which is happening again now. Some in Congress have often let it be known that IRAs were never intended to exist beyond the lifetime of the retiree who made the contributions. Instead, they argue, they were created to provide a source of retirement income, not a tax-favored inheritance to last another lifetime.

The winners: The required minimum distribution rules for non-spouse beneficiaries can be complex. Requiring non-spouse beneficiaries to withdraw inherited retirement account funds within five years would simplify the rules. The proposal exempts certain beneficiaries, including those who are disabled and minor children.

The losers: If this proposal is adopted, it would effectively end the “stretch IRA” strategy for most non-spouse beneficiaries. Beneficiaries would face more severe tax consequences upon inheriting retirement accounts, and the value of these accounts as potential estate planning vehicles would be diminished. This would also significantly reduce the value of Roth conversions as an estate planning strategy, particularly for older clients.

3. SAVINGS CAP

New contributions to tax-favored IRAs and 401(k)s would be prohibited once clients exceed an established cap, under the president’s proposal. This cap would be determined by calculating the lump-sum payment that would be required to produce a joint and 100% survivor annuity of $205,000 a year beginning when clients reach age 62. (This formula would initially set the cap at $3.4 million.)

Clients with cumulative retirement accounts in excess of this amount would be prohibited from contributing new dollars to retirement accounts on a tax-favored basis, although accounts could still grow as a result of earnings. The cap would be increased for inflation.

The argument: To increase tax revenue, the White House wants to use tax policy to encourage greater retirement savings where needed, but then phase out the benefit for the especially wealthy. “The current law limitations on retirement contributions and benefits for each plan in which a taxpayer may participate do not adequately limit the extent to which a taxpayer can accumulate amounts in a tax-favored arrangement through the use of multiple plans,” the Green Book says. “Such accumulations can be considerably in excess of amounts needed to fund reasonable levels of consumption

in retirement.”

The winners: Not many. In fact, at $3.4 million, this provision would impact only a very small percentage of retirement savers. But if interest rates increase, the cap could go much lower, since annuities paying $205,000 would cost less. This could affect many more retirees.

The losers: While $205,000 is nothing to scoff at, many clients will require substantially more annual income in retirement to maintain their desired standard of living -- especially after taxes are factored in. Such clients will need to look for alternative ways to shelter assets from taxes.

4. A 28% MAXIMUM TAX BENEFIT

Another proposed change to tax benefits: The maximum tax deduction for making contributions to defined contribution retirement plans would be limited to 28%. As a result, certain high-income taxpayers making contributions to retirement accounts would not receive a full tax deduction for amounts contributed or deferred.

The argument: According to the Green Book, “limiting the value of tax expenditures, including itemized deductions, certain exclusions in income subject to tax, and certain deductions in the computation of adjusted gross income would reduce the benefit that high-income taxpayers receive from those tax expenditures and help close the gap between the value of these tax expenditures for high-income Americans and the value for middle-class Americans.”

The winners: For the country as a whole, this provision would help raise revenue. For individual taxpayers who are not in a federal income tax bracket higher than 28%, this provision would not increase their tax liabilities.

Seal of the United States Internal Revenue Service. The design is the same as the Treasury seal with an IRS inscription. (Photo credit: Wikipedia)

The losers: High-income clients would no longer receive a full deduction for amounts contributed or deferred to a retirement account. For instance: If clients who have $500,000 of taxable income currently defer $10,000 into a 401(k), they do not pay any income tax on that $10,000. Without that tax deferral, the income would be taxed at 39.6% (currently the highest federal income tax rate). But if this proposal were to become effective, that $10,000 would effectively be taxed at 11.6% (39.6% minus 28%), since the maximum tax benefit that a client could receive would be limited to 28%. That would equate to an additional tax bill of more than $1,000.

5. SOME RMD ELIMINATION

Clients with combined savings across all retirement accounts of $75,000 or less would be exempt from required minimum distributions.

The argument: “Under current law,” the Green Book says, “millions of senior citizens with only modest tax-favored retirement benefits to fall back on during retirement also must calculate the annual amount of their minimum required distributions, even though they are highly unlikely to try to defer withdrawal and taxation of these benefits for estate planning purposes. In addition to simplifying tax compliance for these individuals, the proposal permits them greater flexibility in determining when and how rapidly to draw down their limited retirement savings.”

The winners: The proposal would decrease the compliance burden and increase simplicity for Americans with smaller retirement account balances. These individuals often have less savings on the whole and need to withdraw money from their retirement accounts anyway to meet expenses. In addition, those with low account balances often do not have access to the same level of financial expertise as those with larger account balances.

The losers: Not many. Indeed, it’s hard to find something to complain about. This provision would eliminate required minimum distributions for nearly 50% of IRA owners.

6. NON-SPOUSE ROLLOVERS

Non-spouse beneficiaries would be allowed to move inherited retirement savings from one inherited retirement account to another through a 60-day rollover period -- similar to the way they can currently move their own retirement savings.

The argument: The goal is to close the difference in treatment of spouse and non-spouse beneficiaries. According to the Green Book, “differences in rollover eligibility between surviving non-spouse beneficiaries and surviving spouse beneficiaries (and living participants) serve little purpose and generate confusion among plan and IRA administrators and beneficiaries.”

The winners: Unifying the rollover rules for retirement account owners and beneficiaries would greatly simplify this aspect of retirement accounts and reduce the number of irrevocable and costly mistakes frequently made by beneficiaries.

The losers: None. Of course, if most beneficiaries are required to empty the inherited account in five years (as required under the second proposal), this provision would be far less beneficial than it would be under current law.  FP

Ed Slott, a CPA in Rockville Centre, N.Y., is a Financial Planning contributing writer and an IRA distribution expert, professional speaker and author of many books on IRAs.

'via Blog this'

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12 worst pieces of tax advice from financial planners

LifeHealthPro:

Benjamin Franklin supposedly said, "The only things certain in life are death and taxes." Yet every year, thousands of Americans seek to prove the old sage wrong by using the most tenuous, illogical and even illegal tactics to eliminate or reduce their taxes.

Unfortunately, there are always financial advisors -- sometimes under the guise of knowledgeable accountants, lawyers, and planners -- who willingly indulge and encourage these fantasies. Read on to find out the worst of the worst.

Exaggerated deductions

Since earned income is the basis for most income tax and is documented by external W-2s and 1099s, the most common technique to reduce taxable income is increased deductions claimed by a taxpayer. Bad advice from your planner includes the following:

Tax Deduction (Photo credit: OhKyleL)

1. Claiming extra dependents ...[The] tax laws are very clear about who is a "dependent" and the criteria that must be met in order to have a legal claim for deductions. Divorced parents need to be particularly careful that they are not "doubling up" their legitimate exemption and deductions.

2. Exaggerating your deductible expenses Since the IRS audits a very small percentage of filed returns (1.02% of returns for filers making $200,000 or less), the urge to fudge the numbers can be irresistible. Claiming larger charitable deductions than you actually made, a home office that doesn't exist, and mileage or entertainment expenses as business that were actually personal are the most likely areas where fiction can affect the numbers.

If you're tempted to exaggerate, remember that all returns are electronically audited to identify unusually high deductions for certain expenses.

3. Investing in dubious or abusive "tax shelters" Legitimate shelters are designed to either transfer income from one accounting period to a later, presumably lower-taxed, period, or to convert income that would otherwise be taxed at ordinary income rates to the lower long-term capital gains rate. ...

... Simply stated, you cannot deduct amounts for which you have neither invested cash nor assumed debt for which you are personally liable.

Pseudo transfers of ownership

Some phony tax advisors specialize in fake transfers of ownership, so that income you might receive appears to be transferred to other parties who pay no taxes or taxes at a lower rate. Their advice might include any of the following tactics:

English: Map of the Cayman Islands. Information from CIA MAP, Yahoo Map, http://www.wordtravels.com/images/map/Cayman_Islands_map.jpg Can be translated through version 1 here, although text must be converted to path due to rendering problems. (Photo credit: Wikipedia)

4. Setting up secret offshore accounts ... Transferring ownership of income-earning assets to an anonymous account in the Cayman Islands, the Isle of Man, or dozens of other countries where taxes and reporting requirements are nonexistent is a scheme often promoted by unscrupulous advisors.

If you're tempted to create an offshore account, recognize that you are required by law to report any income from foreign bank accounts and file an annual form TD F 90-22.1 by June 30th each year disclosing the location and other details about any foreign financial account with an aggregate value of more than $10,000. Failure to do so can lead to criminal charges being filed against you.

5. Transferring your business to a business trust A business owner transfers his business to a trust in return for receiving shares of beneficial interests. The income of the trust (the former business) is then sent to the beneficial interest owners as deductible distributions, thereby eliminating any business or self-employment taxes that would normally be due.

Effectively, there is no meaningful change in control over the business assets, nor any business purpose other than the elimination of income taxes. The IRS is constantly on the alert for such strategies and aggressively challenges such arrangements in court if necessary.

6. Creating a family residence trust Say a homeowner transfers the title of a property to a trust at a stepped-up basis in return for trust certificates of indeterminate value. The former owner asserts that, since the value of the trust certificates cannot be determined, there is no taxable transaction. The trust claims to be in the "rental" business and rents the house back to the former owner in return for services to the trust so that no rent is actually paid. If rent is paid, the trust offsets the income by depreciation of the property and the expenses of maintenance (utilities, repairs) that would be nondeductible by the property-owning resident.

This is clearly a sham transaction that has no economic purpose other than the reduction of taxes for the homeowner. Entering into this kind of transaction may lead to severe penalties under the 2010 Revenue Reconciliation Act, with an added 40% penalty to any underpayments of tax that result.

7. Organizing a faux charitable trust Simply put, in this scenario the creator sets up a charitable trust for charitable benefit, thereby claiming any payments to the trust as charitable deductions. In reality, the charity is primarily the educational, living, recreational expenses of the creator and his family. The law is clear that supposed charitable payments are not deductible where payments are for the benefit of the creator or his or her family. The same law and penalties apply as for the Family Residence Trust.

Claims regarding the obligation to pay income tax

Over the past centuries, tax protestors have proposed a variety of theories why the requirement to pay income tax is either voluntary, inapplicable, or limited to certain specific individuals due to their status or residence. These theories have been tested in federal court and found invalid. No legitimate financial planner should make any of the following claims:

8. The filing of tax returns, the payment of federal income tax, or compliance with an IRS summons is voluntary. Based upon an incorrect interpretation of the IRS statement that "the tax system is voluntary," some misguided advisors recommend that, in lieu of filing a complete tax form, they send the following communication from the Family Guardian Fellowship publication "The Great IRS Hoax: Why We don't Owe Income Tax, version 4.53":

"... Prove to me that the Internal Revenue Code is enacted positive 'law' that applies to me ... and I will gladly pay what you say I owe... ."

Variations of this same idea would be filing a "zero tax due" return or asking the IRS to prepare a return. All of these theories are misguided and may result in civil and criminal penalties.

9. Some sources of income are not taxable. ... [Tax] protesters have argued that the exchange of "labor" for money does not produce taxable income, since the value of the labor is equal to the value of the money received ... Others argue that only foreign income is subject to tax or that payments received in Federal Reserve Notes is not valid currency and cannot be taxed.

Numerous federal court cases have determined that such arguments are "frivolous." According to IRS Revenue Ruling 2004-28, "The Service will take vigorous enforcement action against such taxpayers (attempting to use such arguments to avoid taxes) and against promoters and return preparers who assist taxpayers in taking these frivolous positions."

10. Income taxes are not constitutional. The Sixteenth Amendment to the United States Constitution provided the legal basis for the federal government to tax its citizens on their income when it became ratified in 1913. Since then, protestors have claimed that the amendment was never properly ratified by the requisite 38 states necessary to be passed.

Federal court cases have repeatedly and consistently repudiated that argument ... Protesters have made similar arguments on the basis of the Fifth Amendment (taking of property without due process of law; self-incrimination) and the Thirteenth Amendment (involuntary servitude) with [lack of] court success... .f.

11. Taxes are required only from a defined group of people. Some tax protesters have claimed that ...[only] federal employees or residents of Washington D.C., federal territories such as Guam and Puerto Rico, or federal lands such as American Indian reservations or military bases are required to pay federal income taxes, so the theory goes.

Some advisors even argue that the term "person" defined by the Internal Revenue Code doesn't apply to humans, but corporations and trusts. Most tax experts consider such arguments delusional.

12. Taxes can be reduced or eliminated on religious grounds. ... In 1982, Supreme Court case United States v. Lee 455 U.S. 252, the justices ruled, "The tax system could not function if denominations were allowed to challenge the tax system because tax payments were spent in a manner that violates their religious beliefs because the broad public interest in maintaining a sound tax system is of such a high order, religious belief in conflict with the payment of taxes affords no basis for resisting the tax."

If you disagree with the acts of the government, protest in the voting booth or peacefully in the streets.  Failing to pay your taxes is akin to an old adage: Don't cut off your nose to spite your face.

About the Author

Michael Lewis

Michael Lewis is a former corporate executive who writes about financial planning, taxes and economic policy for the online resource, Money Crashers PErsonal Finance.

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Study: Evaluating the Best Retirement Withdrawal Strategies

Financial Planning

By Elizabeth Wine
July 10, 2012




Retirement (Photo credit: 401(K) 2012)

According to a study of retirement withdrawal strategies, one of the more popular retirement drawdown methods is often the least-efficient way to go to maximize lifetime income for a retiree, while a simple rule used by the Internal Revenue Service works quite well.

The report, “Optimal Withdrawal Strategy for Retirement Income Portfolios,” conducted by Morningstar, measured five different drawdown strategies in various case studies. The real lesson from the analysis is that plans that dynamically adjust for changes in both market and longevity beat more traditional methods. It also concluded that investors should reevaluate how much to withdraw every year based on these two variables. A sophisticated simulation that takes both variables into account and is run every year is best.

Also See: VIDEO: Rethinking Retirement Withdrawal Strategies




retirement (Photo credit: 401(K) 2012)

But the recently released study found that the IRS method that takes at least one variable – longevity --  into account is a good option if an investor doesn’t have the simulation capability through an advisor or a 401(k) managed account program.

“The optimal withdrawal strategy incorporates mortality probability where the projected distribution period is updated based on the mortality experience of the retiree (or retirees) and the withdrawal percentage is determined based on maintaining constant probability of failure,” the study stated. “This approach best replicates how a financial planner would (or at least should) determine the available income from a portfolio for each year during retirement,” the report’s authors concluded. …

What’s more, after analyzing the five methods, the study found that at a couple of popular methods were in fact, poor choices for clients.

The well-known 4% rule -- in which the first year withdrawal rate is set at 4%, followed by inflation-adjusted withdrawals in subsequent years -- addresses neither market performance nor longevity. The authors call this the “Constant Dollar” approach, based on the idea that a portfolio can maintain a constant withdrawal rate or constant dollar amount either in real or nominal terms for a fixed period, such as 30 years. The authors concluded that it “is often the least efficient way to maximize lifetime income for a retiree.”

The Endowment Approach, which the report’s authors call the “constant percentage approach,” is the simplest. It withdraws the same percentage of the account balance annually.




Longevity (Photo credit: RachelmBray)

A third method, the Constant Failure Percentage, is designed to maximize withdrawals to the highest extent possible without causing the entire portfolio payment plan to fail. This is based on the idea of the probability of failure. Withdrawal amounts, which vary depending on the equity allocation of the portfolio as well as the year, are determined in order to keep that probability of failure constant through time. The problem with this strategy is that without updating, it doesn’t account for longevity well enough.




Logo of the Internal Revenue Service (Photo credit: Wikipedia)

However, a fourth strategy, the Required Minimum Distribution (RMD) method used by the IRS, does a better job of accounting for longevity. The IRS defines these distributions as generally the “minimum amounts that a retirement plan account owner must withdraw annually starting with the year that he or she reaches 70 and ½ years of age, or, if later, the year in which he or she retires.” The distribution is calculated “by dividing the prior December 31st balance of that IRA or retirement plan account by a life expectancy factor that the IRS publishes” in separate tables, the federal agency states on its website.

The final approach, the Mortality Updating Failure Percentage, combines the Constant Failure Percentage and the RMD method. In this scenario, the annual withdrawal rate is based first on the number of years remaining, then calculated based on keeping a constant probability of failure for that period. It did the best job of accounting for both market returns and longevity.

To come up with the framework for evaluating different strategies, the team headed by David Blanchett, Morningstar’s new head of retirement research, came up with a metric called the “Withdrawal Efficiency Rate” (WER), which compares the withdrawals received by a 65-year-old male and female couple by following a specific strategy to what could have been received had the retirees had “perfect information” at the start of retirement. They tested it across the five withdrawal strategies through Monte Carlo simulation analysis. #

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New proposed regulations could mean changes for employee retirement plans

Employee Benefit News:

By Sally Doubet King & Carolyn M. Trenda

April 23, 2012

Seal of the United States Department of the Treasury (Photo credit: Wikipedia)

... For several months, the Department of the Treasury, the Internal Revenue Service and the Department of Labor have been exploring ways to provide “income-stream” options for more retirement plan participants. The agencies have focused on finding a balance between lump-sum cash distributions (which provide liquidity) and lifetime-income options.

This past February, the Treasury and the IRS released two proposed regulations, and the IRS issued two revenue rulings, that provide different strategies for achieving such a balance. Here, we go over two:

Logo of the Internal Revenue Service (Photo credit: Wikipedia)

- A longevity annuity option, providing an annuity that begins at an advanced age under a defined contribution plan.

- A deferred annuity option from a defined contribution plan.

Longevity annuity option under defined contribution plan

To address the concern that retirees may outlive their savings, especially where the only retirement plan distribution received by the retiree is a lump sum from a defined contribution plan, the guidance package includes a proposed regulation that introduces a new concept, the “qualified longevity annuity contract." Such a contract would provide a stream of income commencing at an advanced age, such as 80 or 85, and would continue as long as the individual lives. ...

Under the proposed regulation, if a plan offered a QLAC, the QLAC would be disregarded in determining RMDs. Therefore, a participant would not need to commence distributions from the QLAC before the age selected under the QLAC contract.

Also under the proposed regulation, a QLAC would be an annuity contract purchased from an insurance company for a plan participant that satisfies each of the following requirements:

- Premiums for the contract satisfy a specific dollar limitation and percentage of assets limitation, i.e., the lesser of $100,000... or 25% of the account balance.

The contract provides that distributions must commence not later than a specified annuity starting date, and that annuity starting date cannot be later than the first day of the month coincident with or next following the participant’s attainment of age 85. ...

The contract does not make available any commutation benefit, cash surrender right or other similar feature.

There are no benefits provided under the contract after the death of the employee, other than a life annuity payable to a designated beneficiary.

The contract, when issued, states that it is intended to be a QLAC.

Additionally, issuers of QLACs are subject to certain reporting and disclosure requirements.

QLACs could also be provided under 403(b) plans and traditional IRAs, but not under 457(b) plans, defined benefit plans or Roth IRAs.

Note: Similar to the proposed regulation on partial annuity distributions, the new guidance on QLACs would be effective for contracts purchased after the publication date of a final regulation; in the interim, plans cannot rely on the proposed regulation.

Deferred annuities from defined contribution plans

The final piece of guidance is Revenue Ruling 2012-3. This ruling describes how the qualified joint-and-survivor annuity (QJSA) and qualified pre-retirement survivor annuity (QPSA) requirements in Code Sections 401(a)(11) and 417 apply when a deferred annuity contract is purchased under a defined contribution plan.

The ruling provides three examples that illustrate different deferred annuity design alternatives, each with different conditions: a revocable annuity, a fixed annuity and a fixed annuity with an election not to pay amounts attributable to matching contributions under the annuity contract in the event the participant dies prior to the annuity starting date. The ruling then provides an analysis of how each alternative would necessitate certain plan terms, including compliance with QJSA and QPSA notice, waiver and consent requirements.

The ruling clarifies that where the plan separately accounts for the deferred annuity contract, the remainder of the plan is not subject to the QJSA and QPSA requirements.

Future considerations

Employers may wish to provide comments to the Treasury on either or both of the proposed regulations; these comments must be provided by May 3, 2012. In addition, plan sponsors interested in the new options should evaluate how the options could be integrated into current plan design and communicated to participants.

For more information, contact Partner Sally Doubet King at            (312) 849-3684 begin_of_the_skype_highlighting            (312) 849-3684      end_of_the_skype_highlighting       or sking@mcguirewoods.com and Associate Carolyn M. Trenda at             (312) 849-8130 begin_of_the_skype_highlighting            (312) 849-8130      end_of_the_skype_highlighting       or ctrenda@mcguirewoods.com at the law offices of McGuireWoodds LLP.

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