Just two weeks ago the consensus was that we were going to experience a continuation of the bull market at least into the early part of this year. This is still our view. Although the stock market is a leading indicator, at this time this correction does not appear to be a recession driven correction.
Is 2018 the Year of the Roth 401(k) or the Roth IRA?
Much of the emphasis of the Tax Cuts and Jobs Act(TCJA) passed in December 2017 affected individual income taxes. However, there are also impacts on investment strategies.
From an individual standpoint, the primary feature of the TCJA is a reduction in income tax rates. Except for the lowest rate of 10% all other tax brackets go down starting with the top rate which drops from 39.6% to 37%.
Table 1: 2018 Tax Rates for Married Filing Jointly and Surviving Spouses
However, in general, it is safe to say that most people will see a reduction in their federal income taxes in 2018. Of course, this may prompt a review of many of the decisions investors make with taxes in mind.
Most people are pretty excited to see their taxes go down this year! However, the long-term consequences of the tax decrease should be considered. While the TCJA was passed with the theory that it would stimulate growth such that tax revenues would grow enough to make up for the increased deficit created in the short term by tax cuts, few serious people believe that. The most likely result is that we will experience a small boost in growth in the short term and that federal deficits and the National Debt will seriously increase thereafter.
In the opinion of the non-partisan Committee for a Responsible Federal Budget, not even the expectation of additional short-term growth is enough to temper the seemingly irresistible growth in the federal debt.
Increased deficits will make it more difficult to fund our national priorities, whether it is defense, social security, healthcare, or investment in our national infrastructure. Therefore, I expect that we will initiate another tax discussion in a few years, most likely resulting in tax increases, in addition to the automatic tax increases that are embedded in the TCJA.
With federal income tax rates down in 2018 and our expectation that individual taxes will start increasing after 2018, now may be the time to consider a Roth instead of a Traditional account. The consideration of current and future tax rates remains the same. It just so happens that with lower tax rates in the current year, it becomes marginally more attractive to consider the Roth instead.
Consider the case of Lisa, a married pharma executive, making $225,000. This places her in the 24% federal tax bracket. In 2018, her $10,000 Traditional 401(k) contribution reduces her income taxes by $2,400. In 2017, Lisa would have been in the 28% tax bracket. Her $10,000 Traditional 401(k) contribution would have resulted in a $2,800 reduction in income taxes. Hence, Lisa’s tax savings in 2018 from contributing to his 401(k) goes down by $400 compared to 2017.
Table 2: Tax savings on a 401(k) contribution with $180,000 taxable income
From a tax standpoint, contributing to a Traditional 401(k) is still attractive, just a little less so. To optimize her lifetime tax liabilities, Lisa may consider adding to a Roth 401(k) instead, trading her current tax savings for future tax savings. If Lisa were to direct the entire $10,000 to the Roth 401(k), her 2018 income taxes would increase by $2,400 compared with 2017. Why would Lisa do that? If she expects future income tax rates to go back up, she could save overall lifetime taxes. It may be an attractive diversification of her lifetime tax exposure.
For instance, suppose now that the national debt does grow out of hand and that a future Congress decides to increase tax rates to attempt to deal with the problem. Suppose that Lisa’s retirement income places her in a hypothetical future marginal federal tax rate of 30%. In that case, she will be glad to have invested in a Roth IRA in 2018 when she would have been taxed at a marginal rate of 24%: she would have saved on her lifetime income taxes.
Of course, if Lisa’s retirement marginal tax rate ends up being 20%, she would have been better off saving in her Traditional 401(k), saving with a 28% tax benefit in her working years and paying retirement income tax at 20%.
Note also that Lisa would not have to put the entire $10,000 in the 401(k). She could divide her annual retirement contribution between her Roth and her Traditional accounts, thus capturing some of the tax advantages of the Traditional account, reducing the tax bite in the current year, and preserving a bet on a future increase in income tax rates.
Another possible course of action to optimize one’s lifetime tax bill is to consider a Roth conversion. With a Roth conversion, you take money from a Traditional account, transfer it to a Roth account, and pay income taxes on the distribution in the current year. As we know, future distributions from the Roth account can be tax-free, provided certain conditions are met . A distribution from a Roth IRA is tax-free and penalty free provided that the five-year aging requirement has been satisfied and at least one of the following conditions is met: you have reached age 59½, become disabled, you make a qualified first-time home purchase, or you die. (Note: The 5-year aging requirement also applies to assets in a Roth 401(k), although the 401(k) plan’s distribution rules differ slightly; check your plan document for details.) Because tax rates are lower in 2018 for most individuals and households, it makes it marginally more attractive to do the conversion on at least part of your retirement funds.
Consider David, a single pharma marketing communications analyst. With $70,000 in taxable income, he is now in the 12% marginal federal income tax bracket, down from the 25% federal income tax bracket in 2017. He is working on his part-time MBA in 2019 and expects his income to jump substantially as a result. Additionally, David, a keen student of political economy expects his taxable retirement income to be higher than his current income and overall tax rates to go back up before he reaches retirement. David now has a sizeable Traditional IRA.
For David, the opportunity is to convert some of his Traditional IRA into a Roth IRA. To do that, David would transfer some of his Traditional IRA into a Roth IRA. He would pay income taxes on the conversion amount at his federal marginal rate of 22%. David would only convert as much as he could before creeping into the next federal tax bracket of 24%. If he feels bold, David could contribute up to the 32% federal tax bracket. Effectively this means that David would stop converting when his taxable income reaches $82,500 if he wanted to stay in the 22% tax bracket, and $157,500 if he wanted to stay in the 24% tax bracket.
In this example, if David were to convert $10,000 from his Traditional IRA to his Roth IRA, he would incur $2,200 in additional federal income taxes. If David expects to be in a higher tax bracket in retirement, he would end up saving on his lifetime income taxes.
David could combine this strategy with continuing to contribute to his Traditional 401(k), thus reducing his overall taxable income, and increasing the amount that he can convert from his IRA before he hits the next tax bracket. If he were to contribute $10,000 to his Traditional 401(k) and convert $10,000 from his Traditional IRA to a Roth IRA, you could view this as a tax neutral transaction.
Table 3: Balancing a Traditional 401(k) and a Roth Conversion
This strategy may work best for people who expect to have a reduced income in 2018. Maybe it is people who are back in graduate school, or people taking a sabbatical, or individuals who are no longer working full time while they wait to reach the age of 70 and start collecting social security at the maximum rate.
It is worth remembering that Roth accounts are not tax-free; they are merely taxed differently . That is because contributions to a Roth account are post-tax, not pre-tax as in the case of Traditional accounts. You should note that the examples in this article are simplified. They do not take into account the myriad of other financial, fiscal and other circumstances that you should consider in a tax analysis, including your State tax situation. The examples suppose future changes in taxes that may or may not happen.
The mental picture I use is that of flying. The six hour trip from Boston to LA is great when it is all smooth sailing. The plane seems to be flying itself and you pay more attention to the movie you are watching than thinking about the age of the aircraft or training of the pilot and crew.
But the first time there is a little air bump and maybe lighting strikes your plane you immediately tense up and fix your gaze on the crew. Are they calm? Do they seem competent? Is this their first rodeo?
You form a mental image of what you want your pilot to look like. Calm and collected for starters. But mainly experienced. We all want to see Captain Sully at the helm.
Clearly, we all would love smooth capital markets forever. But the close friend of return is always uncertainty. The two are inseparable even though they may not always be in direct contact. In times of turbulence you want experience at the helm and a solid understanding of how the two are intertwined.
How do we think of uncertainty in the capital markets? There are as many ways of defining uncertainty as there are opinions as to who the greatest quarterback in history is (we all know it is Tom Brady, right) but without hopefully appearing too cavalier we think that it is useful to think of uncertainty as a normal distribution of potential outcomes.
We fear the left tail where things go terribly wrong, we accept the middle of the distribution as textbook risk/return, and we think that our own brilliance (just joking) has led us to the right tail of the distribution.
In 2017 equities, in particular, had a monster year with the S&P 500 up over 25% and many international markets up even more. The year turned out much better than expected. What do we expect for this coming year?
Our baseline assessment is fairly benign as we discussed last month in our Capital Market Overview. A quick review is in order.
We expect equities to again do better than bonds. We also expect international assets to outperform domestic strategies. We expect robust global growth. Our most likely scenario for this year is for continued growth, subdued inflation and no major equity or bond market meltdown. In our judgement there is about an 80% probability that such a scenario plays out in 2018.
On the downside we expect the low volatility that has accompanied capital markets recently to once again revert back to risk on/off.
Our baseline assessment is fairly benign
We expect to see more large jumps in market prices caused by low probability events lurking in the left hand side of the distribution. The press calls these events Black Swans. Our best assessment is that there is about a 15% probability of seeing a Black Swan event in 2018.
On the other end of the uncertainty distribution you have what we call Green Swans – events, low in probability that when they happen are wildly positive for investors. We attach a 5% chance of experiencing such extreme positive events over the current calendar year
1. An inflation spike caused by a sustained rally in commodity prices
Inflation in the US is currently running a bit above 2% and market participants do not expect to see any major revisions over the next two decades (see the Philadelphia Federal Reserve estimate of inflationary expectations).
In our view, forecast complacency has set in and the risks are to the upside. Traders would describe the low inflation trade as over-crowded. Maybe it is time to re-think what happens if the consensus turns out to be wrong.
The immediate effect of an upward spike in inflation would be a rise in bond yields. Equities would probably take a short-term hit but the primary casualties would be found in the fixed income market.
What could cause a sustained surge in commodity prices? One, could be a supply disruption say in the oil market. Another could be related to the resurgence of global growth and continued demand for commodities such as iron ore and copper. Third, a depreciating US dollar leading to commodity price inflation.
2. A spike in capital market turmoil caused by a geo-political blowup
The blowup could be anywhere in the world but most political commentators point to North Korea and Iran as the most likely centers of conflict.
Another possibility is a cyberattack endangering public infrastructure facilities especially if it is sovereign sponsored. Third, Jihadi terrorism on a large scale and on high profile targets. And last, the outcome of the Special Counsel investigation into Russian meddling.
All of these events have blowup potential. While the probability of any of these events happening in 2018 is low, the magnitude of the capital market response is likely to be large and negative especially for equity markets. Global economic growth would also, no doubt, loose some of its momentum.
3. An avalanche of bond defaults in the apparel and retail industries in the US and/or a debt bomb crisis in China
It is no secret that the US apparel and retail sectors are going through massive consolidation driven in part by the shift to online shopping. It is widely acknowledged that the US retail market is over-built.
According to the Institute of International Finance global debt hit a record last year at $233 trillion. Debt levels as a percentage of global GDP are higher today compared to 2007. Figuring prominently in the debt discussion is China.
Global Debt Reaches a Record in Q3 2017 Source: IIF, IMF, BIS
The IMF recently issued a warning to the Chinese authorities about the rapid expansion of debt since the 2008 Financial Crisis. The rapid expansion in debt has funded lesser quality assets and poses stability risk for global growth according to the IMF.
Estimates by Professor Victor Shi at UC San Diego put Chinese total non-financial debt at 328 percent of GDP. Other estimates are even higher leading to an overall picture of rising liabilities and numerous de facto insolvencies. The robust GDP growth in China and the tacit understanding of the monetary authorities of the extent of the problem will hopefully keep the wolves at bay.
The implications of a debt scare for investors would be quite dire. Investors have had plenty of experience with debt crisis in recent years – Greece and Cyprus come to mind as Black Swan events that temporarily destabilized global capital markets. A Chinese debt scare would no doubt be of greater impact to global investors. Emerging market debt spreads would certainly blow up.
What about the right hand tail of the uncertainty distribution – the Green Swans?
These are wildly positive events for investors that carry a low probability of happening. What type of Green Swan events could we hope for that would lead capital markets to yet another year of phenomenal returns?
1. Positive global growth surprise possibly brought on by the recently enacted US tax reform
The US is the largest economy in the world and still remains a significant engine of global growth. Could we be surprised by a spurt in US economic growth this year?
According to the Conference Board US real GDP is expected to growth 2.8% in 2018. Could we see 4% growth? The President certainly hopes so. Not that likely. The last time that US GDP growth was above 4% was in 2000.
What could give us the upside scenario for growth? Maybe a jump in consumer spending (representing 2/3 of GDP) driven by real wage growth and lower taxes.
Another possibility is a surge in investment by US corporations driven by cash repatriations and recently enacted corporate incentives.
We view both scenarios as likely but providing only a marginal boost to growth. As they say we remain cautiously optimistic, but would not bet the farm on this.
2. A spurt in exuberant expectations driven by the cryptocurrency craze
Fear of missing out (FOMO) takes over repricing all investments remotely tied to the cryptocurrency craze along the way. We saw a similar scenario play out in 1999 in the final stages of the Technology, Media and Telecom (TMT) bubble.
In those days TMT stocks were no longer priced according to traditional fundamentals but instead on the idea that laggard investors would buy into the craze and drive prices even higher. Lots of investors succumbed to FOMO in the final stages of the bubble.
Photo by Ilya Pavlov on Unsplash
The recent price action of Bitcoin and most other cryptocurrencies has a similar feeling to the ending stages of the TMT bubble. It is almost as if Bitcoin and its cousins are being discussed along with the latest Powerball jackpot.
No doubt fortunes have been and will continue to be made in cryptocurrencies. Blockchain technology which underlies the crypto offerings is here to stay, but we worry about the lack of investor education and the speed of the price action in late 2017. Whatever happened to Peter Lynch’s “buy what you know” approach?
What would be our best estimate for capital markets should the cryptocurrency craze gain further momentum in 2018? First, technology stocks would continue out-performing. Chip suppliers such as Nvidia and AMD would continue to see massive growth.
Companies adopting blockchain technologies would see their valuations increase disproportionally. In general, animal spirits would be unleashed onto the capital markets making rampant speculation the order of the day. The primary beneficiary would be equity investors.
History tells us that it is almost certain that after 8 years of an economic expansion and stock market recovery we should see an outlier type of event in 2018. What shape and form it will take (or Swan color) we don’t know.
Preparing for tail risk events is very expensive and under most scenarios not worth bothering with.
Black Swans create great distress for investors, but the opportunity cost of playing it too safe is especially high today given prevailing interest rates that fail to keep up with inflation.
The fear of missing out (FOMO) during Green Swan events is also a powerful investor emotion. Again playing it too safe can result in many lost opportunities for capturing significant market up moves.
Investing in capital markets is all about weighting these probabilities and focusing on a small number of key research-driven fundamental drivers of risk and return.
How you structure your portfolio and navigate the uncertainties of capital markets is important to your long-term financial health. Putting a financial plan in place and having an experienced Captain Sully-type as your captain during times of turbulence should reassure investors in meeting their long-term goals.
Note:The information herein is general and educational in nature and should not be construed as legal, tax, or investment advice. Views expressed are the opinions of Insight Financial Strategists LLC as of the date indicated, based on the information available at that time, and may change based on market and other conditions. We make no representation as to the accuracy or completeness of the information presented. This communication should not be construed as a solicitation or recommendation to buy or sell any securities or investments. To determine investments that may be appropriate for you, consult with your financial planner before investing. Market conditions, tax laws and regulations are complex and subject to change, which can materially impact investment results.
Individual investor performance may vary depending on asset allocation, timing of investment, fees, rebalancing, and other circumstances. All investments are subject to risk, including the loss of principal.
Insight Financial Strategists LLC is a Registered Investment Adviser.
Incorporating Sustainable Investing Principles Into Your Portfolio
The term “sustainable investing” is often used interchangeably with “socially responsible investing”. In general, these terms describe an approach to investing that combines traditional financial methods to portfolio construction with the desire to simultaneously create positive societal outcomes.
What might these societal outcomes be? The industry has gravitated to three broad areas of impact – Environmental, Social and Governance (ESG).
We are all exposed to these various areas in our daily lives and many of us care deeply about some of these issues. For the most part, we have channeled our beliefs into action through charitable giving and volunteering efforts.
Sounds too good to be true? Large institutional investors have been able to achieve both financial and societal returns for a long time, but only in recent times have investment strategies been designed to enable individual investors to achieve the same objective.
How has sustainable investing changed in the last few years? More recently, investors have looked at ways to create positive social outcomes within their financial portfolios. The focus has shifted toward emphasizing investments with the dual objective of superior risk adjusted financial returns along with demonstrably positive environmental, societal and/or governance outcomes.
Doing well while doing good
“Doing good while doing well” is the basic rationale why investors are increasingly interested in enhancing how they manage their portfolios by including non-financial metrics such as environmental, societal and governance factors.
Probably the oldest way of using non-financial criteria to evaluate companies involves the area of corporate governance. This is the G in ESG. Board composition, executive compensation practices and sustainability disclosure criteria are just three areas of increasing investor attention.
One of the concerns of early investors in SRI approaches was that excluding companies deemed to be “bad actors” would significantly restrict one’s investment opportunities and returns would commensurately suffer.
Recent empirical studies show that returns need not suffer especially when risk-adjusted.
Research from Morningstar depicted below highlights a segment of socially responsible funds compared to the broad universe of US equity mutual funds. The general conclusion is that socially conscious funds tend to have a higher representation among 3 and 4 star funds and lower proportions in the tails.
While not a ringing endorsement, the Morningstar research at least points out that there is no empirical reason to suspect that socially conscious funds underperform the general universe of US mutual funds.
Certain ESG issues are important from a societal standpoint but have a tenuous relationship to financial metrics such as company profitability or asset valuation. For example, preserving the Costa Rican Toucan is a worthwhile societal goal, but few publicly traded companies have a direct financial link to such an effort.
Recent research by Harvard professors Khan, Sarafeim and Yoon identified a large variation in long-term measures of company financial success when evaluating companies on material ESG metrics. Their conclusion is that companies with superior sustainability practices outperform companies with poor practices. *
How can individual investors incorporate sustainable investing strategies into their overall portfolios? Our take is that properly constructed portfolios incorporating financial as well as non-financial ESG criteria are competitive on a risk-adjusted basis over short holding periods while providing significant positive upside over the long-term.
Our belief is that investors will benefit long-term from lower levels of business risk in their holdings as well as potentially higher stock returns.
Companies with superior ESG practices tend to provide greater transparency in their disclosures, be better prepared to deal with adverse events when they happen, and be more open to adapting their business models around environmental, social and governance issues likely to be material over the long-term.
Implementing ESG portfolios requires additional research and caution. While a growing universe of investment vehicles exist in the form of mutual and exchange traded funds there are wide differences in liquidity, composition and cost. Properly conducting due diligence on the various sustainable investing offerings requires an above-average experience and know-how of financial materiality issues.
At Insight Financial Strategists we have done significant research on sustainable investing and believe that these strategies are here to stay and will deliver on the goal of “doing good while doing well”.
Please schedule a time to discuss with us your financial planning and investment needs and how a sustainable investing approach might fit your requirements.
Note: The information herein is general and educational in nature and should not be construed as legal, tax, or investment advice. Views expressed are the opinions of Insight Financial Strategists LLC as of the date indicated, based on the information available at that time, and may change based on market and other conditions. We make no representation as to the accuracy or completeness of the information presented. This communication should not be construed as a solicitation or recommendation to buy or sell any securities or investments. To determine investments that may be appropriate for you, consult with your financial planner before investing. Market conditions, tax laws and regulations are complex and subject to change, which can materially impact investment results.
* “Corporate Sustainability: First Evidence on Materiality” by Mozaffar Khan, George Serafeim, and Aaron Yoon, Harvard Business School Working Paper No. 15-073, March 2015.
Individual investor performance may vary depending on asset allocation, timing of investment, fees, rebalancing, and other circumstances. All investments are subject to risk, including the loss of principal.
Insight Financial Strategists LLC is a Registered Investment Adviser.
Eliminating the deductibility of alimony payments from taxable income is one of the features of the Republican House Tax Reform bill. It is very significant to both payors and recipients of alimony.
The Goddess Nemesis
Written into the fabric of the GOP tax proposal is a change in how alimony is taxed. People paying alimony could lose “the greatest tax deduction ever.” And that could ultimately affect those receiving alimony, too.
Since details of the new tax overhaul bill were released on Nov. 2, people of all income levels and ages have been trying to figure out how they could be affected going forward. One group of folks not likely to be happy: those paying alimony.
Section 1309 of the House bill would eliminate the deductibility of alimony. Killing the alimony deduction is one of the smaller revenue targets for the House Republican tax bill, yet it is exceedingly significant to the people affected.
Under current rules, alimony payors may deduct their payments from their taxable incomes, thus lowering their income taxes. In return, recipients pay income taxes on their alimony income. Because payors are usually in higher tax brackets and recipients in lower tax brackets, families can save money on taxes by shifting the tax burden to the lower earner. The saving can help increase cash flow for divorcing couples. They can then decide how to allocate the savings: to the payor or the recipient … or the court can do it for them.
Killing the alimony tax deduction raises only about $8 billion over 10 years
According to the House, abolishing the alimony deduction would not be a large revenue generator. By killing the alimony tax deduction, the alimony tax bill raises only about $8 billion over 10 years. That is because the tax increase on payors is offset by a tax decrease for recipients. For them, alimony income would no longer be taxable.
This wrinkle could have a significant impact on divorce settlements. For many payors, saving taxes on alimony payments is the one pain relief that comes with making the payments. According to John Fiske, a prominent mediator and family law attorney, “Alimony is the greatest tax deduction ever.” Without the deduction, payors will find it much more expensive and more difficult to agree to pay.
For example, in Massachusetts alimony payors usually pay 30% to 35% of the difference in the parties’ incomes. For a payor in the 33% federal tax bracket, the House tax bill increases the cost of alimony by nearly 50%.
The entire set of laws, guidelines and practices around alimony are based on its deductibility. Passage of the House Republican tax bill is likely to lead to a mad scramble in the states to change the laws and guidelines to adjust alimony payments downward to make up for the tax status change.
The likely net result: although recipients would no longer pay tax on alimony income, abolishing the tax deductibility of alimony is likely to reduce their incomes even further as divorce negotiations take the new, higher tax burden on payors into account.
According to a 2017researchpaper at Harvard Business School, employees who have the option to contribute to a Roth 401(k) instead of a traditional 401(k) tend to contribute the same amount to either account. Given that a Roth 401k tends to result in more money taken out of your paycheck every week or month than a traditional 401k, that’s unexpected!
Take the case of Priya, a 49-year-old single mom. She makes $135,000 a year and lives alone with her son. Not counting her employer’s match, Priya saves $350 per pay period in her traditional 401k, totaling $9,100 a year. Absent other considerations, her $9,100 contribution reduces her annual taxable income from $135,000 to $125,900. As a result, since her taxable income is less, she will pay less income taxes.
Roth 401ks and Roth IRAs are not tax-free: they are merely taxed differently
What if she would reduce her Roth contribution to keep her current cash flow constant? In that case, it is not clear that Priya’s after-tax income in retirement would be higher or lower with a Roth 401k than with a traditional 401k. Answers would require further analysis of her situation.
According to John Beshears, the lead author of theHarvard study, one possible explanation for his finding is that people are confused about the tax properties of the Roth . Another possibility could be that people have greater budget flexibility than they give themselves credit for. Either way, employees should seek additional support before making this very important decision.
A prior version of this article appeared in Kiplinger and Nasdaq.com
You probably get a regular health checkup, you get your teeth cleaned twice a year, you get a second opinion for major health issues. You may even get a second opinion when you buy a boat or a vacation home!
The second reason is the potential to obtain better guidance in adjusting the asset allocation to a more appropriate level that takes into account your own individual goals and risk tolerance. Although 401(k) plans may offer appropriate investments and some educational information about those options, 401k plan sponsors do not usually make available truly personalized advice to plan participants.
Regardless, there are mistakes that you need to avoid in the process of rolling over your 401(k). To avoid those mistakes, it is important to be able to recognize them. (Click here to receive the Top Mistakes in 401(k) Rollovers fact sheet.)
It should be noted that one reason to keep your retirement assets in your 401(k) plan is that costs are often, but not always, lower in 401(k)s. However, without an appropriate investment plan, lower costs may not bear fruit.
In general it is a good idea to get advice from a Financial Planner who is a fiduciary. You may think that your financial advisor is obligated to do what is best for you, the client. However, not all are not obligated to act in your best interest (whereas a fiduciary would be), and may advise higher fee products, or proprietary products sold by the firm he or she represents or products that do the job.
In April 2016 the Department of Labor rolled out a new regulation that is to take effect in 2017 mandating that all investment professionals working with retirement plan participants and IRA owners shall adhere to a fiduciary standard for all retirement accounts for which they provide investment advice. For purposes of the DOL rule, retirement accounts include 401(k)s, IRAs, and Roth IRAs among others. The Department of Labor estimates that the investing public would save $4 billion a year with the new fiduciary rule. As you might expect, the fiduciary rule is opposed by affected Wall Street interests that are seeking to water it down or eliminate it entirely.
The Trump administration issued an executive order on February 3, 2017 to review the rule. While the Trump administration would like to roll it back, the industry is moving ahead with implementation, potentially regardless of possible regulatory about faces. Hence the future of the rule is unclear at this time.
you always have the option to roll over to an IRA that you can manage
Of course, whether or not this regulation takes effect in 2017, you can still benefit from working with a fiduciary advisor. If the advisor you are working with is not working to a fiduciary standard – i.e., with your best interests in mind, seek out someone who is. It’s important: after all you are dealing with your money and your future standard of living in retirement.
In the current regulatory environment, fee-only Financial Planners at Registered Investment Advisor firms usually serve as fiduciaries, and are required to always act in your best interests – they must avoid conflicts of interest, and cannot steer plans and IRA owners to investments based on their own, rather than their clients’ financial interests. In contrast, brokers, insurance agents and certain other investment professionals only have a responsibility to recommend securities that are “suitable.”
Making sure that the investment professional you are working with is acting in your best interest may help you invest your retirement funds more appropriately. Note that the Securities and Exchange Commission (SEC) has not promulgated similar regulations for non-retirement investment accounts so if you are not dealing with a fiduciary advisor, you run the same risk of potentially higher costs or merely suitable investments. In fact if you have an IRA and a brokerage account with your financial advisor, he or she may end up being a fiduciary on one account and not a fiduciary on the other account. How is that for confusing?
We started the year in the middle of a correction, as the S&P500 lost 13.3% between November 4, 2015 and February 11, 2016.
However, supported by a slow but continuing economic recovery, rising corporate profits and low interest rates, 2016 ended up being a pretty good year for the financial markets with the S&P500 rising 11.96%.
Concerns over China, falling oil prices, surging junk bond yields, recession fears, the rising dollar, Brexit, a four-quarter profit recession, a contentious U.S. election, weakness in U.S. manufacturing, and eurozone banking worries all conspired against bullish sentiment during various times of the year.
While the pundits credited a solid market prior to the election to the expectation that Clinton would win, we were surprised by the reaction to Trump’s win and the consequent exuberant market rally. Most of the year’s gains happened in the fourth quarter after the election.
So what about 2017?
Trump and the Republican Congress have made many promises, some of which appear to help sustain the financial markets. In particular the move to tax reform and limit regulations will probably be implemented and is viewed very positively by the business community.
Some proposals such as rebuilding infrastructure have the Congress and Trump at odds. Historically, infrastructure has not been a strong Republican concern. It remains to be seen whether a significant bill can pass Congress.
Some other initiatives are more problematic and could have consequences that have not yet been factored in the financial markets. The move to limit legal immigration and the intent to expel millions of undocumented immigrants could have a ripple effect throughout the economy, including Silicon Valley and the agriculture industry.
Talking about altering trade patterns, starting with the elimination of the TPP and various noises about import tariffs goes counter to decades of bipartisan free trade efforts. It is not clear what the net impact of these policies, which have not yet been fully defined, will have on the economy. However, restricting free trade is not a positive.
Last but not least, Republicans have a political imperative to deal with health care. Will they show the intestinal fortitude to go through with a full repeal of Obamacare, as has been talked about? A full “repeal now and replace later” could create chaos for States, employers, insurance companies, the healthcare industry, and the public. We’ll have to wait and see to evaluate the net effect.
The financial markets are demonstrating optimism in the midst of all this political turmoil, although we don’t know if the clouds on the horizon carry rain or not. Regardless the US economy is strong and resilient; it will survive our dysfunctional politics.
This post is extracted from our January 2017 newsletter. Please write to let us know that you would like a copy
People will often feel very proprietary about their retirement accounts. They will reason that because the account is in their name only, as opposed to the house which is usually in both their names, they should be able to keep those accounts. Most of the time, this is flawed reasoning. The general rule is that assets that are accumulated during marriage are considered marital assets regardless of the titling.
However, there are cases when part of a retirement plan can be considered separate. This often depends on state law, so it is best to check with a specialist before getting your hopes up.
2. Can I Divide a Retirement Account Without Triggering Taxes?
Since there are so many different retirement accounts, the rules to divide them vary widely. Plan administrators will often recommend their own “model” QDRO. It usually makes sense to have a QDRO specialist verify that the document conforms to your interests.
In addition, that money that was set aside for retirement will no longer be there for that purpose. Although you might tell yourself that you will replace that money when you can, that rarely ever happens.
However, if you have no other choice, it so happens that divorce is one of the few exceptions to the penalty rule. A beneficiary of a QDRO (but not the original owner) can, pursuant to a divorce, take money out of a 401(k) without having to pay penalties. However, you will still have to pay income tax on your withdrawal. Note that this only applies to 401(k)s. It does not apply to IRAs.
4. How Do I Compare Retirement Accounts with Non-Retirement Accounts?
Most retirement accounts contain tax-deferred money. This means that when you get a distribution, it will be taxable as ordinary income. At the other end of the spectrum, if you have a cash account, it is usually all after-tax money. In between you may have annuity accounts where the gains are taxed as income, and the basis is not taxed; you may have a brokerage account where your gains may be taxed at long-term capital gains rate; or you may have employee Restricted Stock which is taxed as ordinary income. All of these accounts can be confusing.
In order to get an accurate comparable value of your various assets, you will want to adjust their value to make sure that it takes the built-in tax liability into account. Many divorce lawyers will use rules of thumb to equalize pre-tax and after-tax accounts. Rules of thumbs can be useful for back-of-the-envelopes calculations , but should not be used for divorce settlement calculations, as they are rarely correct.
Because these calculations are not usually within a lawyer’s skill set, many lawyers and clients will use the services of a Divorce Financial Planner to get accurate calculations that can form a solid basis for negotiation and decision making. It is usually better to know than to guess .
5. Should I Request a QDRO of My Spouse’s Defined Benefit Pension?
Another key consideration is that defined benefit plans are complex. Although they have common features, they are each different from one another, and each come with specific rules. You will be well advised to read the “plan document” or have a Divorce Financial Planner read it and let you know the key provisions.
A common provision is that the benefit for the alternate payee can only start when the plan participant starts receiving benefits and must stop when the plan participant passes away. It is all good for the plan participant. But what if as a result of that, the alternate payee ends up losing his or her pension benefits too early?
Hence a key issue of valuing defined benefit plans is that a true valuation is more than just numbers. It also involves a qualitative discussion of the value of the plan, especially for the alternate payee. Some Divorce Financial Planners can handle the valuation of interests in a defined benefit plan easily and the discussion of the plan. Others will refer you to a specialist.