Must-Know Changes for Your Estate Plan After the SECURE Act

Must-Know Changes for Your Estate Plan After the SECURE Act

 

The Setting Every Community Up for Retirement Enhancement (SECURE) Act passed in late 2019, creating significant retirement and tax reforms with the goal of making retirement savings accessible to more Americans. We wrote a blog article detailing the major changes from this piece of legislation.

We’re going to dive deeper into some of the questions we’ve been receiving from our clients to shed more light on topics raised by the new legislation. We have divided these questions into six major themes; charitable giving, estate planning, Roth conversions, taxes, stretching IRA distributions, and trusts as beneficiaries.  Here is our third of six installments on the SECURE Act and how it could impact you.

 

Given the new rules for inherited IRAs, who should be considering changes to their estate plan?

IRA owners will need to evaluate how changes in the SECURE Act impact estate planning and beneficiaries. If you have a small Traditional IRA and plan to leave your assets to several beneficiaries, the accelerated income your beneficiaries will receive from distributing their share of your IRA within 10 years of your passing may not significantly affect their taxes. However, if you have a very large IRA balance or plan to leave your assets to only one or two people, distributions could push your beneficiaries into higher tax brackets. It will be important to evaluate your tax situation and potential taxes to your heirs to determine if it makes sense to accelerate IRA distributions or conversions during your lifetime.

 

Here are some strategies you might consider:

Leave IRAs to multiple beneficiaries: Here, each person receives income from a smaller portion of the account, which reduces the likelihood of pushing them into a higher tax bracket.

Make Roth conversions: IRA owners can evaluate their personal tax situation compared to their beneficiaries. For example, if large inherited IRA distributions would likely push beneficiaries into higher tax brackets like the 32% marginal rate, an account owner might have an opportunity to convert some assets to a Roth IRA now at a lower rate. Current owners may be able to convert at a lower tax rate if they have a more favorable tax situation (e.g. earning less ordinary income) or can spread out conversions. Planning Roth conversions throughout retirement at lower rates can reduce the taxable portion of future inherited IRAs.

Evaluate Trust structures: Many people name a trust as the beneficiary of their IRA, and they need to evaluate their trust structure following the implementation of the SECURE Act to make sure the trust is properly drafted to account for new provisions in the law. Commonly used trust structures like conduit and accumulation trusts, or those with “see-through” provisions, are affected by changes in the new law. Existing conduit trusts could face issues with how RMDs are distributed to beneficiaries, and accumulation trusts may need to include flexibility for discretionary distributions to allow tax-efficient planning. We can help facilitate a review with your estate attorney or recommend one of our trusted professionals to evaluate your plan.

As with all new legislation, we will continue to track the changes as they unfold and notify you of any pertinent developments that may affect your financial plan. If you have further questions, please reach out to us.

 

First Installment: I’m Planning to Leave Assets to Charity – How Does the SECURE Act Change That?

Second Installment: How to Optimize Your Accounts After the SECURE Act

Fourth Installment: How to Circumvent the Demise of the Stretch: Strategies to Provide for Beneficiaries Beyond the 10-year Rule

Fifth Installment:

Sixth Installment:

 

 

Disclosure: The material provided is current as of the date presented, and is for informational purposes only, and does not intend to address the financial objectives, situation, or specific needs of any individual investor. Any information is for illustrative purposes only, and is not intended to serve as personalized tax and/or investment advice since the availability and effectiveness of any strategy is dependent upon your individual facts and circumstances.  Investors should consult with a financial professional to discuss the appropriateness of the strategies discussed.

 

Employee Spotlight | Jeff Barnett

Employee Spotlight | Jeff Barnett

 

 

Danielle: How did you come to Merriman?

Jeff: I went to school at Ohio State. After graduating, I stayed in Columbus and got a job at Ohio State in health care research. As a new employee, I had to figure out my benefit and retirement plan options, which I knew nothing about. I asked a friend about my benefits and he suggested I read A Random Walk Down Wallstreet, which first sparked my interest in personal finance. I then read a lot of books about saving and investing, including Paul Merriman’s books.

After moving to Seattle for a research job at Swedish in 2017, I saw Merriman was hiring and applied for the position. When I was thinking about changing careers, it was either Merriman or staying the course in research. I didn’t want to jump ship for some entry level sales role at a big bank, but I knew Merriman would be a great fit because I really identified with the philosophy and perspective Paul presented in his books. So far, I think I made the right choice.

 

Danielle: What do you do at Merriman and what do you love about working here?

Jeff: I’m an associate advisor, supporting both advisors and clients. I’m here to answer questions, expedite the process, and make sure nothing slips through the cracks. I love the collaborative experience of working with advisors and our client service team to help clients, and I love teaching clients about the technical side of investing.

It’s great to see how energized the long-time advisors are even though they’ve been doing this for a while. The relationships I’ve built with team members have also been really rewarding. I want to come to work every day, and really enjoy being here.

 

Danielle: Tell me about your family.

Jeff: My wife, Brooke, is currently working and living in Berlin. We’ve done long-distance before, but it’s still challenging being continents apart. I look forward to visiting Germany, and we are excited to use our apartment there as a home base for touring around Europe.

My parents live down in Florida now, my sister is still in Ohio, and my brother is in a residency program in New York. My whole family is from the east coast, so I’m used to being the farthest west. Seattle is just a little farther than Ohio!

 

Danielle: What are your hobbies?

Jeff: I have a close group of friends from college, guys I lived with in the dorms freshman and sophomore year, then on the same block off campus. Now that I have moved to Seattle, we all play videogames together online to stay connected. I’m sure my neighbors must hate listening to us shouting over voice chat!

I also try to enjoy what the Pacific Northwest has to offer. I’m usually city-bound, living in South Lake Union, but I try to get out of town with friends sometimes. I’ve started rock climbing with the encouragement of the Merriman team – especially Chris Waclawik and Paresh Kamdar. We have taken a trip out to the “Exits” and hit some of the rock gyms in Seattle. I also play pool locally with Phuc Dang, and he even convinced me to join his team for a session last year. We’d go play a few times a week—it was a lot of fun, and I had the chance to meet some new people.

 

 

Think Twice Before Moving Into Your Rental To Avoid Taxes

Think Twice Before Moving Into Your Rental To Avoid Taxes

Updated 10/07/2019 by Geoff Curran, Jeff Barnett, & Scott Christensen

National real estate prices have been on the rise since 2014, and many investors who jumped into the rental industry since the Great Recession have substantial gains in property values (S&P Dow Jones Indices, 2019). You might be considering selling your rental to lock in profits and enjoy the fruits of your well-timed investment, but realizing those gains could come at a cost. You could owe capital gains tax in addition to potential depreciation recapture on the profits from your rental sale.

One strategy for paying less tax is to move back into your rental and use the property as a primary residence before selling. Living in your rental full-time for at least two years prior to selling can help you take advantage of the gain exclusion of $500,000 ($250,000 if single), which can wipe out all or most of your gain on the property. Sounds easy, right?

Let’s take a look at some of the moving pieces for determining the taxes when you sell your rental. Factors like depreciation recapture, qualified vs. non-qualified use and adjusted cost basis could make you think twice before moving back into your rental to avoid taxes.

Depreciation Recapture

One of the benefits of having a rental is the ability to claim depreciation on the property, which allows you to offset rental income that would otherwise be taxed as ordinary income. The depreciation you take reduces your basis in the property, potentially resulting in more capital gains when you ultimately sell. If you sell the property for a gain, the amount up to the depreciation you took is taxed at the maximum recapture rate of 25%. Any remaining gains are taxed at the lower long-term capital gains rate. Moving back into your rental to claim the primary residence gain exclusion does not allow you to exclude your depreciation recapture, so you might still owe a hefty tax bill after moving back, depending on how much depreciation was deducted. (IRS, 2019).

When the Property Sells for a Loss

Keep in mind that if you sell your home for a loss, whether it’s currently a rental or is now your primary residence, you aren’t subject to depreciation recapture or other gains taxes. However, due to depreciation decreasing your cost basis in the property each year until it reaches zero, it’s more common that sales of former rental homes result in gains. (more…)

The Ins and Outs of Deferred Compensation Plans

The Ins and Outs of Deferred Compensation Plans

Executives and other highly compensated employees might notice a different option in their benefits plan, beyond the usual 401(k). Some employers also offer Section 409A nonqualified deferred compensation plans to high earners, which have their own mix of rules, regulations and potential drawbacks to navigate. However, when you’re earning income in the hundreds of thousands, it’s important to consider every option for saving on taxes and setting aside a larger nest egg for retirement. Contributing to the usual bevy of IRAs and 401(k) might not be enough to see you through your golden years, and tools like deferred compensation plans could also help you bridge the gap of early retirement.

Deferred compensation plans look a bit different than the 401(k) you already know. Like a 401(k), you can defer compensation into the plan and defer taxes on any earnings until you make withdrawals in the future. You can also establish beneficiaries for your deferred compensation. However, unlike 401(k) plans, the IRS doesn’t limit how much income you can defer each year, so you’ll have to check if your employer limits contributions to start building your deferred compensation strategy. Elections to defer compensation into your nonqualified plan are irrevocable until you update your choices the following year, and you have to make your deferral election before you earn the income. If you’re in the top tax bracket (37.0% in 2019), this can allow you to defer income now and receive it at a later date (such as when you retire) in a lump sum or a series of payments, when you expect to be in a lower tax bracket.

Unlimited contribution amounts and optional payout structures may sound too good to be true, but nonqualified deferred compensation plans also have significant caveats to consider. The big risk is that unlike 401(k), 403(b) and 457(b) accounts where your plan’s assets are qualified, segregated from company assets and all employee contributions are 100% yours—a Section 409A deferred compensation plan lacks those protections. 409A deferred compensation plans are nonqualified, and your assets are tied to the company’s general assets. If the company fails, your assets could be subject to forfeiture since other creditors may have priority. The IRS permits unlimited contributions to the plan in exchange for this risk, and the potential loss of deferred compensation can motivate company officers to maintain the health of the company.

Let’s review potential distribution options from nonqualified deferred compensation plans. A Section 409A deferred compensation plan can provide payment no earlier than the following events:

  • A fixed date or schedule specified by the company’s plan or the employee’s irrevocable election (usually 5 to 10 years later, or in retirement)
  • A change of company control, such as a buyout or merger
  • An unforeseen emergency, such as severe financial hardship or illness
  • Disability
  • Death

Once your income is deferred, your employer can either invest the funds or keep track of the compensation in a bookkeeping account. Investment options often include securities, insurance arrangements or annuities, so it’s important to evaluate the potential returns and tax benefits of your deferred compensation plan versus other savings options. Plan funds can also be set aside in a Rabbi Trust; however, those funds still remain part of the employer’s general assets.

Nonqualified deferred compensation plans have a variety of structures, rules and withdrawal options depending on how your employer builds the plan. Consider the following pros and cons of deferred compensation plans when reviewing your employer’s options.

Pros

  • You can defer a significant amount of income to better help you replace your income in retirement. The IRS does not limit contributions.
  • You have the ability to postpone income in years when you’re in high tax brackets until later when you expect to be in a lower tax bracket.
  • If your employer offers investment options, you may be able to invest the money for greater earnings.
  • There are no nondiscrimination rules for participants, so the plan can benefit owners, executives and highly compensated employees specifically. Other retirement plans may limit contributions or participation due to discrimination rules.

Cons

  • Your deferred compensation plus any investment earnings are subject to forfeiture based upon the general financial health of the company.
  • The election to defer compensation and how/when it will be paid out is irrevocable and must be made prior to the year compensation is earned.
  • Depending on the terms of your plan, you may end up forfeiting all or part of your deferred compensation if you leave the company early. That’s why these plans are also used as “golden handcuffs” to keep important employees at the company.
  • The plan may or may not have investment options available. If investment options are available, they may not be very good (limited options and/or high expenses).
  • If you leave your company or retire early, funds in a Section 409A deferred compensation plan aren’t portable. They can’t be transferred or rolled over into an IRA or new employer plan.
  • Unlike many other employer retirement plans, you can’t take a loan against a Section 409A deferred compensation plan.

The questions below are helpful for assessing whether a deferred compensation plan makes sense for you.

  • Is your company financially secure? Will it remain financially secure?
  • Will your tax rate be lower in the future when this deferred compensation is paid?
  • Can you afford to defer the income this year?
  • Does the plan have investment options? Are the fees and selection of funds reasonable?
  • Does the plan allow a flexible distribution schedule?

Section 409A deferred compensation plans have inherent drawbacks and prominent risks, but they could help you save toward your retirement planning goals. We recommend working with a Merriman advisor to review your specific plan terms and financial situation when preparing for the future. We can help you decide whether a nonqualified deferred compensation plan makes sense for your situation, weigh issues like future taxes and create a long-term plan. We want you to feel ready for everything life has to offer.

 

Mega Backdoor Roth Explained!

Mega Backdoor Roth Explained!

By: Geoff Curran & Jeff Barnett

Everyone thinks about saving for retirement, and not many people want to work forever. However, have you thought about the best way to save for the future? If you are setting aside the yearly max in your 401(k) and channeling extra savings to your brokerage, you might be missing out on powerful tax-advantaged saving opportunities. In this article, we will show you how we help clients maximize savings, minimize taxes and secure their future using the Mega Backdoor Roth IRA.

 

Most people know they can contribute to their employer’s retirement plan from their paychecks through pre-tax and Roth contributions up to $19,000 a year ($25,000 if age 50 or older; IRS, 2018). What people miss is whether their retirement plan allows for additional after-tax contributions beyond this limit. Enter the supercharged savings!

It turns out that some company plans permit you to contribute up to the IRS maximum for total contributions to a retirement plan, which is $56,000 in 2019 ($62,000 with catch-up contributions; IRS, 2018). The IRS maximum counts contributions from all sources, including pre-tax employee deferrals, employer matching contributions, and even after-tax contributions for the Mega Backdoor Roth. That means you might be able to contribute an additional $20,000 or more after-tax each year after maxing your elective deferral and receiving your match. You can then convert the extra after-tax savings to Roth dollars tax-free. This more than doubles what most individuals can contribute to their retirement plan, and you won’t have to pay taxes on your Roth account distributions in retirement. This benefit is even greater when both spouses have this option available through their employers, so be sure to check both plans.

Retirement plans like those at Boeing, Facebook, and Microsoft permit easy conversions of after-tax to Roth dollars within the retirement plan. Other companies offer a variation where you can make in-service distributions and move after-tax dollars into a Roth IRA. Make sure to check with your benefits team to find out if your company’s retirement plan supports after-tax contributions and Roth conversions, the steps involved and the maximum amount you can contribute to the after-tax portion of your retirement plan. It’s important not to run afoul of plan rules or IRS requirements, so also be sure to consult experts like your accountant or financial advisor if you have any questions.  

Why contribute extra after-tax?
Now that we have covered the high-level view, let’s hammer down the why. The benefit of contributing to your employer’s after-tax retirement plan is that those contributions can subsequently be converted to Roth tax-free. This is sometimes called a ‘Mega Backdoor Roth,’ whereby you can contribute and convert thousands of dollars per year depending on your retirement plan. Once converted, these Roth assets can grow tax-free and be distributed in retirement tax-free. After several years of Mega Backdoor Roth contributions, you can amass a meaningful amount of wealth in a tax-free retirement account

How do I contribute?
1. Log in to your employer’s retirement plan through their provider website, such as Fidelity.

2. Find the area where you change your paycheck and bonus contributions (i.e., deferrals).

3. Find “after-tax” on the list showing how much you elected to contribute pre-tax, Roth, or after-tax to your 401(k).

4. Enter a percentage to have withheld after-tax from your upcoming paychecks and bonuses that works for your budget.

5. Select an automated conversion schedule, such as quarterly (Microsoft’s retirement plan even offers daily conversions!). If your plan doesn’t offer automated periodic conversions, contact your retirement plan provider regularly throughout the year to convert the assets.

6. Remember to select an appropriate investment allocation for your retirement account that aligns with your overall investment plan.

Is any part of the conversion taxed?
For retirement plans that don’t convert after-tax contributions to Roth daily, there may be growth in the account prior to conversion. This growth is subject to taxation at ordinary income tax rates. For example, if you converted $22,000 ($20,000 contributions + $2,000 investment growth over the period), you’ll owe income tax on the $2,000.

We suggest speaking with a Merriman advisor to determine if your retirement plan allows additional after-tax contributions, how to fit it within your budget and its impact on your retirement savings goals.


References: Internal Revenue Service. (2018, November 2). Retirement Topics – 401(k) and Profit-Sharing Plan Contribution Limits. Retrieved from https://www.irs.gov/retirement-plans/plan-participant-employee/retirement-topics-401k-and-profit-sharing-plan-contribution-limits

How to report a backdoor Roth IRA contribution on your taxes

How to report a backdoor Roth IRA contribution on your taxes

Updated June 25, 2019

By: Geoff Curran & Jeff Barnett

When you are thinking about how to put your hard-earned dollars to work, it’s important to consider every avenue for tax-advantaged savings. Backdoor Roth IRA contributions are great tools for high earners to take advantage of Roth IRAs even after passing the income limits for standard contributions, and the steps for making backdoor Roth IRA contributions are pretty simple. However, the documentation and tax forms for the process can be confusing, and you may run into trouble when it comes time to report everything to Uncle Sam. Whether you work with a professional tax preparer, use tax software such as TurboTax or complete your taxes by hand, understanding the mechanics of the money movements can help ensure you file your taxes correctly. 

Let’s walk through each step in the backdoor Roth IRA process to illustrate the moving parts. You got here by making too much money to deduct Traditional IRA contributions or to contribute to a Roth IRA normally. However, there is no income limit on converting a Traditional IRA to a Roth IRA, which is the crux of the backdoor Roth IRA.

Step one of the Backdoor Roth IRA is making a non-deductible contribution to your Traditional IRA. It’s your responsibility to report the non-deductible contribution to your Traditional IRA at tax time on IRS form 8606, Nondeductible IRAs. Form 8606 helps track your basis and avoid paying additional tax on your non-deductible contribution as you convert the balance to a Roth IRA.

The second step after making your non-deductible Traditional IRA contribution is converting your Traditional IRA balance to a Roth IRA. You will owe tax on any earnings in the Traditional IRA before converting, but from that point on, those dollars are now Roth IRA assets and aren’t subject to future tax. Use Form 8606 for calculating the taxable amount from the conversion if you had any earnings in the Traditional IRA.

Around tax-time, you’ll receive a 1099-R from your custodian showing the distribution from your Traditional IRA that was converted to your Roth IRA the previous year. Later in the year you’ll also receive an information reporting Form 5498 that shows the contribution you made to the Traditional IRA and the amount that was converted to Roth. We recommend keeping Form 5498 for your records, but you don’t need to report Form 5498 in your tax filing.

Now that we have walked through the steps, let’s look at an example of how to report a backdoor Roth IRA contribution. Tom, a 35-year-old physician in the Pacific Northwest and diehard Seahawks fan, is working on his Married Filing Jointly tax return after making a $6,000 non-deductible Traditional IRA contribution last year that he converted to his Roth IRA. Tom didn’t have any other Traditional IRA assets aside from his non-deductible contribution in 2018, and he didn’t have any earnings in his Roth IRA conversion. Part 1 of Tom’s Form 8606 is filled out below.

Next let’s look at Part 2 of Tom’s Form 8606, where the conversion portion is reported. If line 18 is 0, as it is in this example, none of the conversion ends up being taxable.

 

 

 Note: Our example uses the increased 2019 IRA contribution limit ($6,000 for individuals under age 50) on the 2018 tax year forms. The 2019 tax year forms won’t become available until January 2020.

Tom won’t end up owing any taxes on his Backdoor Roth IRA, and his correct reporting of the contribution and conversion will avoid running afoul of the IRS. However, tax forms and reporting can be a daunting challenge. If stressors like tax law changes, new forms and confusion around the whole process keep you from sleeping soundly, reach out to a Merriman advisor to discuss whether a backdoor Roth IRA makes sense for you. You might even have other options available for tax-advantaged savings that you haven’t considered. Check out Mega Backdoor Roth Explained to see how you might be able to do a backdoor Roth in your employer 401(k) plan. We love navigating complex issues like these and giving guidance to elevate your finances.    

 

 

References:

Internal Revenue Service. (2018, November 1). About Form 5498, IRA Contribution Information (Info Copy Only). Retrieved from https://www.irs.gov/forms-pubs/about-form-5498

Internal Revenue Service. (2019, February 27). About Form 8606, Nondeductible IRAs. Retrieved from https://www.irs.gov/forms-pubs/about-form-8606

Internal Revenue Service. (2019, April 18). About Form 1099-R, Distributions From Pensions, Annuities, Retirement or Profit-Sharing Plans, IRAs, Insurance Contracts, etc.. Retrieved from https://www.irs.gov/forms-pubs/about-form-1099-r