8 Wealth Issues: Retirement Planning

Two 2014 court decisions you need to know about

In this installment of our 8 Wealth Issues blog, I thought it important to focus on two recent court decisions that clients need to understand as they will effect your retirement nest egg. These include a ruling on the tax treatment of rollovers & the asset protection of inherited IRAs.

One Indirect IRA Rollover per Year
What was once allowed is now prohibited. In 2008, an affluent New York City couple made a series of withdrawals and transfers among contributory IRAs, rollover IRAs and non-IRA investment accounts, all with the long-established 60-day deadline for tax-free IRA rollovers in mind. As esteemed tax attorney Alvan Bobrow and his wife withdrew and rolled over a series of five-figure sums within a six-month period, they assumed their actions were permissible under the Internal Revenue Code. In January 2014, a U.S. Tax Court judge ruled otherwise.1

Starting in 2015, you are allowed one IRA-to-IRA rollover per 365 days - period. A subtle but important change has been made. Publication 590 has long stated that a taxpayer can generally only make one tax-free rollover of any part of a distribution from a single IRA to another IRA during a 12-month period. That didn’t preclude a taxpayer from making multiple IRA-to-IRA rollovers using multiple IRAs during such a timeframe.1,4 So beginning next year, you can only make a tax-free IRA-to-IRA rollover if you haven’t made one within the past 365 days.3

Don’t grumble just yet. If you want to move money between IRAs more than once next year, there is still a way you can do it. The new IRS rule change doesn’t apply to every type of IRA “rollover.” Here’s the good news. IRS Announcement 2014-15 states: “These actions by the IRS will not affect the ability of an IRA owner to transfer funds from one IRA trustee directly to another, because such a transfer is not a rollover and, therefore, is not subject to the one-rollover-per-year limitation of § 408(d)(3)(B).”3

In other words ... the new restriction does not apply to trustee-to-trustee transfers.

Inherited IRAs are not protected from bankruptcy
The other court case that was recently decided involved inherited retirement assets. In the case of Clark v. Rameker, the Supreme Court decided unanimously on June 12 against Heidi Heffron-Clark and her husband Brandon C. Clark, finding that an IRA Ms. Clark inherited directly from her deceased mother in 2000 isn't eligible for protection from creditors. The couple had filed for Chapter 7 bankruptcy back in 2010, and at that time identified the inherited IRA — then valued at $300,000 — as exempt from the bankruptcy estate.

The court's decision was unanimous, and held that Inherited IRAs differ from traditional IRAs in 3 ways:

1. Holders of inherited IRAs cannot invest additional money into the account, whereas those with traditional and Roth IRAs can do so.

2. The tax code requires inherited IRA holders to withdraw the money from the account, either taking all of the money in the IRA within five years after the death of the owner or taking minimum annual distributions each year.

3. Inherited IRA holders may also take all of the money out at any time and for any purpose without penalty. Roth and traditional IRA holders, meanwhile, are subject to a 10% penalty for withdrawals before age 59.5.

Those three characteristics led the court “to conclude that funds held in such accounts are not objectively set aside for the purpose of retirement,”5

Conclusions

In light of these two court decisions, people should be reminded of two things. Planning needs constant review in light of decisions in Washington that affect the assumptions we make in financial plans. Reviewing the uses & purposes of different accounts and their application to your financial life is vitally important. The other consideration people should make is in regard to making IRA rollover and transfer decisions. Be sure you understand the tax ramifications as you make these requests and work with a professional who can ensure that your deferred savings stays deferred.

This information has been derived from sources believed to be accurate This article is for informational purposes only. It is intended to be accurate and authoritative in regard to the subject matter covered. It is presented with the understanding that we are not engaged in rendering legal or tax advice through this article. If assistance is needed, the reader is advised to engage the services of a competent professional. This information should not be construed as investment, tax or legal advice and may not be relied on for the purpose of avoiding any Federal tax penalty. This is neither a solicitation nor recommendation to purchase or sell any investment or insurance product or service, and should not be relied upon as such. IRS Circular 230 Disclosure: Any discussion pertaining to taxes in this communication (including attachments) is not intended or written to be used, and cannot be used, for the purpose of avoiding penalties under the Internal Revenue Code. Individuals should seek advice based on their own particular circumstances from an independent tax advisor.

Citations.
1 - wealthmanagement.com/retirement-planning/seeing-double [2/4/14]
2 - marketwatch.com/story/new-ira-rollover-rule-coming-in-2015-2014-04-04 [4/4/14]
3 - irs.gov/pub/irs-drop/a-14-15.pdf [4/16/14]
4 - tinyurl.com/lnd86vs [4/24/14] 5 – investmentnews.com/article/20140623/FREE/140629977# [6/23/14]

Re-Visioning Retirement Planning?

President Obama has recently provided us with a peek into his vision for retirement savings he hopes to embed in the tax code. This, of course, can be found in the White House’s preliminary budget proposal, which will be volleyed about the halls of Washington over the coming months in an effort to compromise. I think it’s important to take a look at some of the proposals because of policy vision it provides, and how that vision could affect current financial plans in the future.

Here are 3 proposals within the budget and the likely effects on your financial plan:

SAVINGS CAP 

A per person savings cap would be established, which 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. Confused yet? The initial formula would set the current cap at $3.4 million. This means that additional contributions to tax-favored retirement savings plans like IRAs & 401ks would not be allowed once this cap is hit.

If people determine that their annual retirement expense needs will exceed what the annual withdrawal from the capped account will be, then they will need to find different ways to save for retirement outside of deferred and tax-preferenced accounts.

EMPTYING INHERITED IRAs 

Right now, due to “stretch” IRA provisions, inherited IRAs (non-spouse) can be managed, withdrawn, and taxed over the life of the inheritor—basically allowing an inheritied retirement savings to retain its tax preferenced status over the life of the inheritor. This proposal would require to withdraw the savings in an inherited IRA by the end of the 5th tax year after the year of the original owner’s death.

This could be a big development as most people’s estate plan has considered the stretch IRA feature for their beneficiaries. This could mean that 20% of the account would need to be withdrawn per year as soon as the inheritor establishes the inherited IRA. If that person is in the height of their earning years, this withdrawal could be taxed at a very high tax bracket.

MANDATORY IRAs 

This proposal is aimed at closing the retirement savings gap that we are facing in the US. It requires employers with a certain number of employees to provide automatic enrollment in IRAs. If the employee does not make an election to contribute to the account, an automatic 3% of salary would be deferred (unless an employee explicitly opts out).

 Ultimately this is a good thing, as it should encourage more consistent savings into retirement accounts. It could prove more onerous for business owners, as they would be required to set up a plan.

A Few 2013 Social Security Changes

As an important piece of the puzzle for structuring retirement income, the Social Security system can be daunting for the average American to understand & access. 2013 sees a few adjustments the administration and impact of Social Security Funds. The first important change to look at is always the annual cost of living adjustment. Social Security has deemed a 1.7% annual cost of living increase for 2013, which began this January. The average monthly Social Security benefit in January increased from $1,240 to $1,261.

Let’s take a brief look at a few of the other items worth noting:

Higher Payroll Tax Threshold
With the return of the normal payroll tax (which goes toward funding SS & Medicare benefits, Americans will also see an increase in the cap on earnings that are exposed to payroll taxes. Starting this year the cap increased from $110,100 in 2012 to $113,700. People whose earnings exceed this threshold do not pay SS taxes on earnings above the limit.

Higher Earnings Allowed for “Working” Retiree
Many early retirees go back to work part-time or via consulting. If you are claiming Social Security and are between the ages of 62 and 66, this can result in a temporary penalty of $1 for every $2 earned above a certain threshold. The 2013 threshold is $15,120. Those who turn 66 this year will have $1 of benefits for every $3 earned above a $40,080 limit. However, once you turn age 66, the earnings limit no longer applies. Benefits may be recalculated at age 66 to reflect the withheld benefits and continued earnings—that is why this is termed a temporary penalty; one that is “paid back” to the pensioner at full retirement age.

Shift Toward Online Services
More an administrative and cost-saving move, you are now encouraged to start your payments through online request. 2012 online services allowed Americans to access statements online that reflected their full earning history. This is coupled with reduced office hours at your local Social Security office.

As these advising resources change, it is incumbent upon people to get educated on their benefits and how those benefits fit in to their overall retirement income plan. Be sure to join us in the coming months for our Social Security and Medicare Workshop to get some more clarity on this issue.

The 3 "Other" Risks to Retirement Income Success

Clients that work with our planning team to navigate through their transition to retirement are fully aware of what we call the 3 Largest Risks—namely Longevity, Behavioral, & Timing Risk (for a detailed entry, you can read another of my blogs HERE).  However, as we begin to roll through 2013, we can also identify 3 other risks that are worth noting, due to the confluence of current economic forces.

Inflation Perils

As the Fed continues to pump $40 billion-a-month in bond purchases, there is a risk that U.S. currency will ultimately devalue, leading to higher inflation rates. This can result insufficient retirement balances to achieve an individual’s goals because of faulty assumptions within a financial plan.

The figures look worse if you actually look under the hood of the factors which calculate Consumer Price Index (The indicator economists use to measure inflation).  CPI is calculated with a principle known as substitution.  Substitution simply states that when the cost of fresh vegetables creeps too high, the government calculation assumes you buy canned veggies—and thus any additional inflation on vegetables is avoided.  This can make inflation seem more bearable than reality of the situation.

Potential Rising Taxes

Even after the recent tax law changes, I believe there is the likely possibility of an increase in income tax over the long term as government will need more revenue to pay for social programs and national debt.  With the debate over the debt ceiling set as the next big Washington grudge match later in the quarter, it’s a question as to whether potential tax increases are completely off the table. 

While healthcare is typically cited as the greatest retirement expense, increasing federal, state, & local sales tax could start to eat into your retirement wallet.  Required minimum distributions at age 70 can also force to pay tax on withdrawal (taxed as income whether you need it or not).  To help plan for this impact we work with clients on weighing the pros and cons of pre-RMDs or partial Roth conversions.  Ultimately, if not managed properly, taxes may reduce spendable cash and cash saved for retirement.

Weakened Day-to-Day Budget Management

There was a decline in personal saving rates among employees in the first half of 2012 compared to the same period in 2011. This can partially be attributed to more employees requesting retirement plan loans and hardship withdrawals.  While there is no doubting that the last recession and protracted unemployment has been a weight on some people’s ability to save, it is time for revisit the idea of a budget and get back to the basics of cash-flow management.  If you do not know what you are spending and where you are spending it on a monthly basis, there are a number of tools out there to help you sort this out.  Our clients have access to a spending tool through our financial planning portal. 

Not only is budgeting helpful to give your current savings a boost, but it can also provide a clearer picture of your expense needs now and during your projected retirement.


With so many risks that seem out of control, working with a guide through retirement transition is a great idea.  Independent perspective rooted in financial planning is the best place to start.