Monday, January 26, 2015

IRA Transfers


Happy New Year; 2014 is a year of memories and 2015 is a year of promises. Some of those promises might not be pleasant for individuals transferring an Individual Retirement Account (IRA) unless they follow very specific rules.

The Transfer

IRAs can be transferred to a new advisor or trustee in one of two ways:

 
  1. Direct transfer- where the IRA funds move from one trustee to another trustee without the account owner ever receiving the money, and
  2. Indirect transfer- where the account owner receives funds from the IRA in the form of a check made payable to the account owner. The account owner can then deposit the IRA check into another IRA within 60 days and have no tax obligation for the “rollover.”  This 60 day withdrawal has also been used by some IRA owners to temporarily access IRA funds for short term purposes. An account owner has been allowed to access each IRA account he/she owned once in a 12 month period with no tax consequences as long as the 60 day rule was met. This once per year rule was allowed for each IRA account an individual had.

 
The Change

There has been a major change in these IRA rollover rules beginning January 12, 2015. Now, only one IRA (defined as traditional IRAs, Roth IRAs, SEP IRAs, and Simple IRAs) can be transferred or accessed in the preceding twelve months regardless of the number of IRAs the individual has. A tax court case in early 2014 changed the interpretation of once per year per account to once per year per individual.

The Consequences

The result of this change is that any subsequent transfer or access to another IRA within the same 12 month period will be considered a taxable distribution—subject to income tax and 10% pre-mature distribution tax if applicable (i.e. the individual is under age 59 ½). There are no provisions for remediation of an erroneous second transfer in the same 12 months—the second transfer is taxable.

Consider the following example. An account owner accesses his/her account for a small distribution in March. In January of the following year, the account owner decides to transfer the same (or a different) IRA to another trustee. If the account owner receives the funds for the transfer, the second distribution is a taxable distribution. A significant tax burden may be incurred inadvertently.

Clarifications

Given the complexities involved, some clarifications are warranted. This rule does not apply to rollovers from an employer sponsored plan (401(k), 403(b), etc.) into a self-directed IRA. Rollovers from an IRA back into an employer plan are also exempt. Roth conversions (rolling funds from a traditional IRA to a Roth IRA) are excluded from the rule.

In Summary

In summary, individuals transferring IRA accounts to another trustee should always use a direct transfer (where funds are transferred directly from the old trustee to the new trustee or the check is made payable to the new trustee if it comes to the IRA owner). Short term, 60 day access to IRA funds should be done with great care—only once in any 12 month (not calendar year) period regardless of the number of IRA accounts owned.

We at Paragon Financial Advisors will assist our clients as they prepare for accessing their IRA accounts. Which accounts should be accessed first and asset allocation within accounts for investment purposes can have significant long term implications on your retirement planning. Consult your tax professional if you are contemplating indirectly transferring your IRA in this new year of “promise.”  Paragon Financial Advisors is a fee-only registered investment advisory company located in College Station, Texas. We offer financial planning and investment management.



Thursday, January 15, 2015

Retirement Plans


Corporate retirement plans have been, historically, either defined benefit (DB) or defined contribution (DC) plans. With a DB plan, the employer is “guaranteeing” a life-long retirement benefit to the employee at the time of retirement. That benefit is usually a function of the years worked at the company and the salary earned over a previous time period. Annual contributions are made into the DB by the employer to ensure that the plan will be able to pay benefits over the retiree’s life expectancy.
 
With a DC plan, the employer is guaranteeing only a certain “contribution” amount for the employee’s retirement. The actual benefit or amount received by the employee at retirement will be based on the amount to which the plan account has grown over the years until retirement. One can readily see that the shift to DCs (and it has been pronounced) from DBs places the investment burden on the employee and away from the employer. That shift in investment responsibility has been a primary driver of the elimination of DBs (pension plans) in favor of DCs (401(k), 403(b), etc.).
 
Since 401(k)s now require employee management, it behooves us to look at some of the factors affecting the final amount in the 401(k) that generates the income stream in retirement. Some of these factors include the following:
 
  1. Sign Up- Participation in the plan is usually voluntary and requires the employee to take action to participate. Most plans offer an “employer match” whereby the employer matches the employee’s contribution (i.e. the employee contributes 3% of his/her salary and the employer matches that 3% contribution). Every employee should at least contribute the maximum the employer will match; if not, the employee is leaving “money on the table.”
  2. Asset Allocation- The employee is responsible for investment selection in the 401(k) plan. How the money is invested (stocks, bonds, etc.) and in what percent is an employee choice. Again, this investment selection is critical for the long term benefit in the account.
  3. Plan Expenses- Most individuals are familiar with the preceding two items; they may not be as familiar with plan costs. Plan costs basically include the following:
    • Investment Management Expenses- These are the expenses charged by the individual mutual fund managers for investments in mutual funds allowed as investment options in the plan. It is the fund’s “expense ratio” and the pro-rated amount is deducted daily from the fund.
    • Administration Fees- These fees cover the costs associated with operating the plan: accounting, legal, record keeping, trustee services, etc.
    • Individual Fees- These fees cover charges associated with account owner actions (such as taking a loan against the 401(k)).
Who pays the fees associated with a 401(k)? It depends. The employer may pay a portion or all of the fees; however, the employer may shift some of the costs to the employee. For example: A common share class of mutual fund offered in retirement plans is the “R” class. However, that R share comes in several “flavors:” R1, R2, R3, etc. One popular mutual found in many 401(k)s—a four star, gold Morningstar rating—has seven separate share classes for the same fund. The difference in the R class is the expense ratio charged. Of the seven different classes, the highest expense ratio is 1.55%; the lowest expense ratio is 0.05%. The higher the expense ratio in the plan’s R class, the greater the proportion of plan expense shifted from the plan sponsor (the company) to the employee. Plan expenses are a significant concern. There is now a lawsuit working its way through the legal system to the Supreme Court; it was filed by an employee against his employer for excessive 401(k) fees (Glenn Tibble v. Edison International). There may be significant changes in plan expense structure as a result.

There are multiple items to consider toward maximizing your retirement plan results. Investments in retirement plans should be integrated with investments held outside retirement plans; this integration provides for a more diversified total portfolio.  

We at Paragon Financial Advisors are happy to help our clients evaluate their company retirement plan options and their potential consequences.  Please call us anytime to see if our services are a good fit with your needs.  Paragon Financial Advisors is a fee-only registered investment advisory company located in College Station, Texas. We offer financial planning and investment management.

Monday, December 29, 2014

Paragon Perspectives


This quarter's edition of Paragon Perspectives discusses mistakes to avoid in your Individual Retirement Account and some simple steps for late contributions.
Individual Retirement accounts (IRAs) have been great savings devices for many individuals.  Contributions have been limited to several thousands of dollars per year; however, rollovers of corporate retirement plans into self-directed IRAs have resulted in significant dollar values in many IRAs.  Because many individuals have significant amounts in IRAs, we discuss some of the planning issues involved with IRAs in this quarter’s issue of the Paragon Perspectives Newsletter.
Please contact us if you have questions about your IRA or company retirement plan, the asset allocation therein, and required minimum distribution.

Sincerely,
Wm. Jene Tebeaux CFP® CFA® CAIA®


If you did not receive a copy of this quarter's newsletter please email
info@paragon-adv.com to request a copy. 

Monday, December 15, 2014

Spending (Time) in Retirement


The December 1, 2014 Wall Street Journal (Encore Section, pg R3) had an interesting article about how people spend time in retirement. The implication was that time spent in retirement was different than time spent when working. That time utilization difference in retirement is intuitively obvious. What is not so obvious, however, is the financial impact of the time difference.
When we do a retirement plan, we assume that the individual/family spending needs will increase on an inflation adjusted basis until the end of the projection period. We do that knowing that, at some point, spending will start to decrease (barring catastrophic medical needs) as people age. The ability or desire to engage in expensive activities tends to decrease. Projections in such a plan are basically over estimating expenses and trying to match income to those expenses. This conservative planning is trying to ensure running out of “time” before running out of “money.”
The Journal article (from the Bureau of Labor Statistics data “How Retirees Spend Their Time: Helping Clients Set Realistic Income Goals,” Charlene M. Kalenkoski and Eakamon Oumtrakool) showed the following data: (Note-The original data measured weekday activities in average minutes per day for full time workers vs. retirees. We have converted the differences to a percent using the full time worker number as the base; thus a “+” percent means more time spent by the retiree than the full time worker in that activity).

Full Time Worker                                                                            Retiree
Sleeping                                                                                           +13%
Television/Movies                                                                         +130%
Socializing/Communicating with others                                   +42%
Reading for Personal Interest                                                     +269%

The study also found that retirees spent increased time in activities that were not exceedingly expensive (lawn/garden care, house cleaning, eating out less and preparing more meals at home).  In essence, although time spent may change dramatically in retirement, the change may not necessarily be significantly more expensive—especially as one ages.
We, at Paragon Financial Advisors, help our clients analyze the financial impact of retirement decisions; we’ll leave the time utilization to their desires. Paragon Financial Advisors is a fee-only registered investment advisory company located in College Station, Texas. We offer financial planning and investment management.


Friday, November 7, 2014

Live Long and Prosper

On Monday, October 27, 2014, the Society of Actuaries issued new estimates of life expectancies in the U.S. A 65 year old female has a life expectancy of 88.8 years, an increase of 2.4 years from the 2000 age projection. Males age 65 have a life expectancy of 86.6 years, an increase of 2 years from the 2000 projections. The good news—we’re living longer; the bad news—we’re living longer.


This increase in life expectancy has financial planning implications. Many defined benefit pension plans are currently underfunded. The Society of Actuaries predicts that the underfunded status of these plans could increase between 4 and 8% because of the increased life span. Defined contribution plans—such as 401(k) and 403(b) plans which shift retirement benefits to the employee’s successful management of funds invested—will require a greater time period of income coverage. Such increased coverage should come from increased savings, more aggressive investment management, delayed retirement, reduced spending in retirement, or some combination of all the preceding.


Syndicated columnist Scott Burns provided additional statistics with planning implications. He quoted data from a 2012 study by the Census Bureau that showed what the average group of 65 year olds could expect by age 80:


          Thirty eight (38) percent will have passed away.


          Thirty four (34) percent will have some form of severe disability.


          Nine (9) percent will have some disability.


          Eighteen (18) percent will have no form of disability.  (There is some rounding error in totals.)


The first three categories may require special financial planning problems. Given their relative likelihood, planning now may be a prudent course of action.


We at Paragon Financial Advisors can help our clients as they plan for their “golden years.” Please call us with questions. We do not sell any products (i.e. insurance, etc.) but we will help clients analyze those options available to them.  Paragon Financial Advisors is a fee-only registered investment advisory company located in College Station, Texas. We offer financial planning and investment management.






Wednesday, October 15, 2014

Monthly Pension or Lump Sum Benefit?


More and more retiring employees are facing the question of whether to take their retirement benefits as a lump sum payment or a life-time monthly payment. The “correct” decision obviously lies with the individual’s particular circumstances (health of retiree and spouse, other financial assets, fund needs, etc.). There are compelling reasons for both scenarios in today’s interest rate environment. Monthly pensions usually come from employer sponsored defined benefit plans. Such pensions are “guaranteed” by the employer as long as the employee (and/or possibly another beneficiary) is alive. Following death, all benefits cease. The lump sum option represents a current payment of all future retirement benefits offered by the employer; the employer’s obligation ceases with the lump sum payment.

Monthly pension amounts are usually based on formulas established by the benefit plan. Common conditions include length of employee service with the company and the highest annual earnings of the employee for a specified number of years. This type of plan is just what the name implies: a defined benefit. The employer is guaranteeing the retiree an income for the rest of the retiree’s life. Therefore, the employer is responsible for providing contributions into the retirement plan that will sustain anticipated benefits for all employees and retirees of the company over their lifetimes. The employer also bears the investment risk for plan assets. If the plan assists earn more than projected, less money can be contributed to the plan. If the plan assets earn less than projected, the employer must increase contributions to the plan.

Each choice offers advantages and disadvantages which we will discuss below.

Monthly Pension

When a retiree elects the monthly pension option, there are several payment offerings available. The amounts differ depending on the actuarial assumptions involved. The retiring employee may select a single life payment (for the life time of the retiree only), a joint and survivor payment (where monthly payments continue as long as the retiree or a designated beneficiary is alive), or an option for payment over a certain time period (which guarantees payment for life time but also for a minimum specified period). The obvious benefit is a steady source of monthly income. However, inflation may erode the value of monthly payments depending on the cost of living adjustments (if any) to the monthly benefit. In addition, the retiree is depending on the strength of the plan to maintain payments over a retirement lifetime.

Lump Sum Payment

With a lump sum payment, all retiree benefits are given to the retiring employee at retirement. The retiree is now responsible for investing the benefit payment in such a way that the monthly income checks are duplicated. The length of time such payments continue is purely dependent on how successfully the investments perform. The investment risk has been shifted from the employer pension plan to the retiree. In exchange for that risk, the retiree gains a significant opportunity. While payments stop at death for monthly pensions, retirees with a lump sum option may have assets remaining which they can pass to heirs of their choice.

Lump sum payments are based on an assumed earning rate over the retiree’s lifetime. The higher the assumed earning rate, the lower the amount that needs to be distributed as a lump sum payment. Conversely, the lower the assumed earning rate, the greater the amount that needs to be distributed as a lump sum. Today’s low interest rates favor larger lump sum payments.

Why are employers offering the lump sum option?

The primary reason for a lump sum option is the shifting of responsibility for future benefits from the employer to the retiree. Many retirement plans today are underfunded; i.e. the plan does not have enough assets to meet the expected liabilities of current and future retirees. The lump sum payment removes any further obligation from the employer.

Employers also pay an annual premium to the Pension Benefit Guaranty Corporation for each employee covered by the plan. This premium is made to guarantee that the retiree will receive some (not necessarily all) retirement benefits if the employer’s plan fails. The current premium (for 2014) is $49 per employee; it is rising to $64 per employee in 2016. That increase will likely continue as the premium payments are tied to inflation in the future. Reducing the employees covered by a plan also helps reduce overall plan expenses.

What to Do?

As mentioned earlier, this retirement election is critical to a successful retirement. We at Paragon Financial Advisors will assist in analyzing the benefits available under retirement plan options to ensure that the choice matches the best interest of the retiree. Paragon Financial Advisors is a fee-only registered investment advisory company located in College Station, Texas. We offer financial planning and investment management.


Tuesday, October 7, 2014

IRA Changes

Individual Retirement Accounts (IRAs) have been a popular savings vehicle for a long time (since 1974). They became more popular with the Economic Recovery Tax Act of 1981. Contributions made into an IRA were usually tax deductible (depending on your income level) and grew tax deferred until money was taken from the IRA. There were contribution limits (the smaller of 15% of taxable income or $1500 in 1974 and $5500 today for those under age 50). There are also penalties if the money was withdrawn before age 59 ½. No taxes were due on the earnings until payments were taken from the IRA; that payment was then taxed as ordinary income. There was also a “required minimum distribution” (RMD) at age 70 ½. Failure to withdraw your RMD was subject to a 50% penalty plus ordinary income tax on the amount that should have been withdrawn.


Since contributions were limited, one would think that IRA accounts have modest account values. However, rollovers from corporate benefit plans have been allowed. Such rollovers did not result in a taxable distribution from the benefit plan to the employee, and the rolled amounts could continue to grow tax deferred. The net result is that significant amounts (trillions) of dollars are now contained in IRAs. There have been some recent changes in IRA laws which warrant planning consideration. We discuss some of those below.


Asset Protection

In many states, IRAs were protected assets; i.e. they were not subject to attachment by creditors as long as the IRA was established under the Employee Retirement Income Security Act (ERISA). Such plans had an anti-alienation provision which prevents an employer or plan administrator from releasing benefits to a creditor. In July, 2014, the Supreme Court of the United States ruled that “inherited” IRAs were not protected from creditors. An IRA passed to a non-spousal heir was not protected because the non-spousal owner: 1) could not add to the account, 2)had immediate access to the entire account without penalty, and 3) was required to take annual distributions from the IRA regardless of age. There are still state considerations which may come into play, but the case does show that IRA creditor protection is worthy of planning.

Exemption from Required Minimum Distributions

As previously mentioned, IRAs are subject to a required minimum distribution at age 70 ½. However, there is an exception to that rule. An exemption is given to funds put into a deferred annuity. The IRA owner can purchase an annuity and defer the start of benefit payout until age 80. The purchase amount is limited to the smaller of 25% of the IRA or $125,000. That annuity is excluded in the calculation of the annual RMD amount. The basic intent was to allow the individual to provide guaranteed income protection later in life from the IRA holdings. While such a plan provides protection from minimum distribution requirements, the economic advisability warrants another complete analysis.

Temporary Withdrawals

Currently an IRA owner is allowed to withdraw from an IRA with no tax implications if the total amount withdrawn is replaced into the IRA within 60 days. Such a withdrawal is allowed once every 12 months and can be done from each IRA account. For example, an individual with two IRA accounts could do two such withdrawals and replacements every 12 months with no income tax consequences. That rule will change beginning in January, 2015. After that date, an IRA owner can make only one temporary withdrawal within 12 months from IRA accounts—regardless the number of accounts.

We, at Paragon Financial Advisors, assist our clients in management of their IRAs. If you have questions or concerns about your particular situation, please call us.  Paragon Financial Advisors is a fee-only registered investment advisory company located in College Station, Texas. We offer financial planning and investment management.


Share It