IRS Provides Guide for New Tax Law

Last week the Internal Revenue Service (IRS) issued a new publication to help taxpayers learn about the recent tax reform law and how it affects their taxes.  The IRS estimates they will need to create or revise more than 400 taxpayer forms, instructions and publications for the filing season starting in 2019 — more than double the number of forms it would create or revise in a typical year.

While the 2018 Tax Cuts and Jobs Act includes tax changes for both individuals and businesses, this publication  —  Tax Reform Basics for Individuals and Families— is specifically geared to individual taxpayers. According to the IRS, the publication breaks down the law in easy-to-understand language and highlights the changes that taxpayers will see on their 2018 federal tax returns they file in 2019.

Specifically, the new guide provides important information about:

  • Increasing the standard deduction
  • Suspending personal exemptions
  • Increasing the child tax credit
  • Adding a new credit for other dependents
  • Limiting or discontinuing certain deductions

IRS Tips to Prepare for 2018 Federal Tax Filing

Federal Income Withholding

What You Need to Know

  • Due to tax changes in the Tax Cuts and Jobs Act, many taxpayers’ withholding went down in early 2018, giving them more money in their paychecks in 2018.
  • You may receive a smaller refund – or even owe an unexpected tax bill – when you file your 2018 tax return next year, especially if you did not adjust your withholding after the withholding tables changed.Other changes that affect you and your family include increasing the standard deduction, suspending personal exemptions, increasing the child tax credit, adding a new credit for other dependents and limiting or discontinuing certain deductions.

What You Need to Do

  • Use the IRS Withholding Calculator to perform a paycheck checkup to help you decide if you need to adjust your withholding or make estimated or additional tax payments now.
  • Use your results from this calculator to submit a new Form W-4, Employee’s Withholding Allowance Certificate, to your employer.
  • Make estimated or additional tax payments if the withholding from your salary, pension or other income doesn’t cover the 2018 income tax that you’ll owe for the year. Form 1040-ES, Estimated Tax for Individuals also has a worksheet to help you figure your estimated payments.

To download IRS Publication 5307, Tax Reform Basics for Individuals and Families, Click here.

“Good” Inflation: Rising rates and falling stocks

Over the past week, the Dow fell by 4%, more than halving its ytd gains through Friday 1/19 (all time high).   Bonds continued the decline started in mid-December, bringing losses during the current ‘bond rout’ to -5.7% year to date.  That is a one week decline in the Dow of 4% and a four-week decline in long-bond prices of 5.7%.  Balanced investors have seen stocks gain and bonds lose, putting most investors (moderately conservative to moderately aggressive) at a mild gain or loss so far this year.  Generally, diversification across asset classes reduces volatility when bonds go up, stocks generally are weaker and vice versa.    When the classes move together differentiation across risk profiles diminishes.  Stocks remain in a strong uptrend and given the substantial gains over the past few months, equity centric investors should be able to take this in stride (or they shouldn’t be equity-centric) as 4% is a small blip in a strong multi-quarter uptrend awash in investor optimism, all-time low cash levels, all-time high exposure to stocks and financial assets and expectations of higher wages, earnings and GDP growth.   In this light, a rebound, or ‘buy the dip’ would not be surprising.  The new feature though is that volatility has returned.

The ‘bond rout spilling into equities’ explaination has to do with relative attractiveness.  If rates keep rising, bond prices are hurt, while becoming more attractive (due to higher yields) to equity investors, putting pressure on equity prices.  At some point, earning safe interest attracts enough investors from stocks to weaken stock prices.  The S&P 500 dividend yield is now 1.8%, similar to what can be found offered on 18 month CD.

Rate have climbed due to rising inflation expectations.  Inflation is expected to, finally, exceed the 2% goal set by the Federal Reserve ‘in the coming months’.  Current thinking is that a tight labor market is pushing AHE (average hourly earnings, +2.9% Jan ’18 vs Jan ’17), combined with more take home pay (via tax reform), will result in more spending from consumers and investment from business.  This will take time but markets have already priced it all in.  Just like the stock market has priced in exceptional earnings growth to match its exceptional valuations.  The chart below shows us that we’ve been in a tightening labor market for years without being able to hold above 2.0% inflation but briefly.

infl vs unemplmnt

Given the new feedback loop between stocks and bonds, perhaps we shouldn’t be so excited about inflation, even if its ‘good’.  On the bright side, the past few years has seen 3.25% as a top in 30yr bond yields and perhaps a decline in rates near term may help both bond holders and stock investors alike.

Diversified – Real Income

The Real Income™ portfolio strategy does not use leverage, derivatives, or short-selling. Portfolios are constructed with 25-35 securities consisting of various types of liquid REITs.

The property types include apartments, regional malls, shopping centers, lodging, office, industrial, self-storage, data centers/tech, and a variety of health care related facilities. All portfolio companies are classified into one of three categories, and portfolios maintain allocations to each within the following risk categories:

  • Core (40% to 70%): Companies with superior balance sheets, established track records, and moderate growth
  • Value Add (20% to 50%): Companies with moderate leverage, established track records, and high growth potential, both internal and external
  • Opportunistic (0% to 25%): Companies with high leverage, unproven track records, and high growth potential, both internal and external.

For the most recent portfolio update, click this link: Real Income Portfolio 09-30-2017

Why the growth in Cash Balance Plans?

The Pension Protection Act of 2006 (PPA) is long and hard to read, but it played a crucial role in establishing cash balance plans as a viable and legally recognized retirement savings option. Before 2006, cash balance plans faced frequent legal challenges. Those bringing the suits argued that cash balance plans violated established rules for benefit accrual and discriminated against older workers. The rulings on these cases were inconsistent, and many business owners were reluctant to risk establishing a plan that just didn’t have firm legal footing.

The Pension Protection Act ended this uncertainty about the legality of cash balance plans. The legislation set specific requirements for cash balance plans, including:

  • A vesting requirement: Any employee who has worked for their company for at least three years must be 100% vested in their accrued benefits from employer contributions.
  • A change in the calculation of lump sum payments: Participants in a cash balance plan can usually choose to receive a lump sum upon retirement or upon the termination of employment instead of receiving their money as a lifetime annuity. Before 2006, some plans used one interest rate to calculate out the anticipated account balance upon retirement, but, when participants opted to receive an earlier lump sum, the plan called for using a different interest rate to discount the anticipated retirement balance back to the date of the lump sum payment. This could lead to discrepancies between the hypothetical balance of the account (as determined by employer contributions and accumulated interest credits) and the actual lump sum payout, an effect known as “whipsaw”. The PPA eliminated the whipsaw effect by allowing the lump sum payout to simply equal the hypothetical account balance.
  • Clarification on age discrimination claims: A cash balance plan does not violate age discrimination legislation if the account balance of an older employee is compared with that of a similarly situated younger employee (i.e. with the same length of employment, pay, job title, date of hire, and work history), and the older employee’s balance is equal to or greater than the younger employee’s.

There are, of course, many other points included in this lengthy piece of legislation, but the takeaway is this: the Pension Protection Act of 2006 removed the legal uncertainty surrounding cash balance plans and made them a much more appealing option for small business owners.

The number of cash balance plans in America more than tripled after the implementation of the PPA. Additional regulations in 2010 and 2014 made these hybrid plans an even better option, and we anticipate that their popularity will continue to grow. There are thousands of high-earning business owners out there who can reap huge, tax-crushing benefits from implementing cash balance plan – they just have to know about them first.

 

Current Real Income Portfolio Yield: 5.74% as of 7.29.17

The NAMCOA Real Income Portfolio is an actively managed diversified portfolio with an objective of providing income from dividends.

Structured as a separately managed portfolio to minimize client fees and other costs, the portfolio focuses primarily on Real Estate Investment Trusts, but can invest up to 30% in preferred stock and floating rate interest products. The portfolio targets to invest in 25 to 35 equities. The portfolio DOES NOT use any leverage or derivatives.

  • These performance figures are NET of its all management fees and trading costs, meaning no other fees, commissions, hidden charges or surprises.
  • The minimum account size starts at $100,000.
  • Distributions can be reinvested or taken in cash.
  • Clients have 24/7 online access to view their account and portfolio positions at either Fidelity or Interactive Brokers.
  • The portfolio is liquid any business day, but is subject to market fluctuations.

See attached portfolio fact sheet and other risk disclosures.

For more information, contact Walter Hester at whester@namcoa.com

 

 

400% Top-Line Deductions?

Despite the explosive growth and substantial tax benefits of cash balance plans, most Americans are unfamiliar with one of the best tax-deferred savings opportunities in existence. When combined with a 401(k) profit-sharing plan, cash balance plans substantially increase the contribution limits for retirement plans, sometimes increasing available top-line deductions by over 400%. This means that participants, particularly older contributors, can accelerate their retirement savings and simultaneously take advantage of significant tax savings.

Cash balance plans are classified as “hybrid” retirement plans: defined benefit plans (think traditional pension plan) that function like defined contribution plans (think 401(k)). Like a defined benefit plan, the ultimate benefit received is a fixed amount, independent of investment performance. The plan sponsor directs investments and ultimately bears investment risk. What sets a cash balance plan apart, though, is its flexibility and hybrid nature that makes its function appear similar to that of a 401(k).

When businesses choose to add a cash balance plan, they generally do so on top of an existing 401(k) profit-sharing plan. This allows high-earning employees to put away more money for retirement at a much faster rate while providing significant tax savings.

Those who stand to benefit the most from a cash balance plan include:

• Professionals with high incomes such as doctors, engineers, lawyers, orthodontists, etc.

• Business owners over 45 looking to substantially increase their retirement savings in the coming years

• Highly-profitable companies

• Business owners wanting to contribute more than the traditional 401(k) limits to their retirement while accruing substantial tax savings

For Americans earning over $400,000 per year, cash balance plans are a game-changer. With the potential for hundreds of thousands of dollars in annual tax savings, a closer look is well worth the time.

Cash Balance Plans

Source: Ascensus Consulting, Inc.

More professional practices (and practice groups) should look into Cash Balance Plans.

In corporate America, pension plans are fading away: 59% of Fortune 500 companies offered them to new hires in 1998, but by 2015, only 20% did. In contrast, some legal, medical, accounting, and engineering firms are keeping the spirit of the traditional pension plan alive by adopting cash balance plans.

Owners and partners of these highly profitable businesses sometimes get a late start on retirement planning. Cash balance plans give them a chance to catch up.

Contributions to these defined benefit plans are age dependent – the older you are, the more you can potentially sock away each year for retirement. In 2016, a 55-year-old could defer as much as $180,000 a year into a cash balance plan; a 65-year-old, as much as $245,000.

These plans are not for every business as they demand consistent contributions from the plan sponsor. Yet, they may prove less expensive to a company than a classic pension plan, and offer significantly greater funding flexibility and employee benefits compared to a defined contribution plan, such as a 401(k).

How does a cash balance plan differ from a traditional pension plan?  In a cash balance plan, a business or professional practice maintains an account for each employee with a hypothetical “balance” of pay credits (i.e., employer contributions) plus interest credits. There can be no discrimination in favor of partners, executives, or older employees; the owner(s) have to be able to make contributions for other employees as well. The plan pays out a pension-style monthly income stream to the participant at retirement – either a set dollar amount or a percentage of compensation. Lump-sum payouts are also an option.

Each year, a plan participant receives a pay credit equaling 5-8% of his or her compensation, augmented by an interest credit commonly linked to the performance of an equity index or the yield of the 30-year Treasury (the investment credit can be variable or fixed).

Cash balance plans are commonly portable: the vested portion of the account balance can be paid out if an employee leaves before a retirement date.

As an example of how credits are accrued, let’s say an employee named Joe earns $75,000 annually at the XYZ Group. He participates in a cash balance plan that provides a 5% annual salary credit and a 5% annual interest credit once there is a balance. Joe’s first-year pay credit would be $3,750 with no interest credit as there was no balance in his hypothetical account at the start of his first year of participation. For year two (assuming no raises), Joe would get another $3,750 pay credit and an interest credit of $3,750 x 5% = $187.50. So, at the end of two years of participation, his hypothetical account would have a balance of $7,687.50.

An employer takes on considerable responsibility with a cash balance plan.  It must make annual contributions to the plan, and an actuary must determine the minimum yearly contribution to keep the plan appropriately funded. The employer effectively assumes the investment risk, not the employee. For example, if the plan says it will award participants a fixed 5% interest credit each year, and asset performance does not generate that large a credit, the employer may have to contribute more to the plan to fulfill its promise. The employer and the financial professional consulting the employer about the plan determine the investment choices, which usually lean conservative.

Employer contributions to the plan for a given tax year must be made by the federal income tax deadline for that year (plus extensions). Funding the plan before the end of a calendar year is fine; the employer just needs to understand that any overage will represent contributions not tax-deductible. The plan must cover at least 50 employees or 40% of the firm’s workforce.

Cash balance plans typically cost a company between $2,000-5,000 to create and between $2,000-10,000 per year to run. That may seem expensive, but a cash balance plan offers owners the potential to keep excess profits earned above the annual interest credit owed to employees. Another perk is that cash balance plans can be used in tandem with 401(k) plans.

These plans can be structured to reward owners appropriately. When a traditional defined benefit plan uses a safe harbor formula, rank-and-file employees may be rewarded more than owners and executives would prefer. Cash balance plan formulas can remedy this situation.

Benefit allocations are based on career average pay, not just “the best years.”  In a traditional defined benefit plan, the eventual benefit is based on a 3- to 5-year average of peak employee compensation multiplied by years of service. In a cash balance plan, the benefit is determined using an average of all years of compensation.

Cash balance plans are less sensitive to interest rates than old-school pension plans. As rates rise and fall, liabilities in a traditional pension plan fluctuate. This opens a door to either over-funding or under-funding (and under-funding is a major risk right now with such low interest rates). By contrast, a cash balance plan has relatively minor variations in liability valuation.

A cash balance plan cannot be administered with any degree of absentmindedness. It must pass yearly non-discrimination tests; it must be submitted for IRS approval every five years instead of every six. Obviously, a plan document must be drawn up and periodically amended, and there are the usual annual reporting requirements.5

Ideally, a cash balance plan is run by highly compensated employees (“HCE”s) of a firm who are within their prime earning years. Regarding non-discrimination, a company should try to aim for at least a 5:1 ratio – there should at least be 1 HCE plan participant for every 5 other plan participants. In the best-case scenario for non-discrimination testing, the HCEs are 10-15 years older than half (or more) of the company’s workers.

If a worst-case scenario occurs and a company founders, cash balance plan participants have a degree of protection for their balances. Their benefits are insured up to their maximum value by the Pension Benefit Guaranty Corporation (PBGC). If a cash balance plan is terminated, plan participants can receive their balances as a lump sum, roll the money over into an IRA, or request that the plan sponsor transfer its liability to an insurer (with the pension benefits paid to the plan participant via an insurance contract).

Cash balance plans have grown increasingly popular. Some businesses have even adopted dual profit-sharing and cash balance plans. Maybe it is time for your business to look into this intriguing alternative to the traditional pension plan.

Employers must use 401k’s to attract millennial talent

A study from Fisher Investments 401(k) Solutions found that 80 percent of millennials say they would prefer to work for a company that offers a 401k plan, dispelling a commonly-held belief that millennials are not as interested in 401k plans as other generations.

However, despite their high levels of interest, millennials also tend to be (understandably) less educated on the ins and outs of retirement planning, with the same percent (80) failing Fisher’s 401(k) IQ in the Workplace Quiz. That’s higher than the 70 percent of general respondents who earlier failed the same workplace quiz, missing at least three of the nine basic questions.

“We’re encouraged that the vast majority of millennials recognize that 401k plans can be indispensable to meeting their long-term savings goals,” Nathan Fisher, managing director and founder of Fisher Investments 401(k) Solutions, said in a statement. “However, when you get down to the nuts and bolts of planning, it becomes clear there’s an education gap”.

The Fisher study also found that millennials are more likely than other groups to receive and trust information about retirement planning from individual contacts, whether they be friends, relatives or co-workers, countering the view that younger savers are more reliant on internet-based information and advice.

In fact, nearly one in three millennials trust a friend or family member’s advice on retirement planning most. In keeping with their desire for individual attention, millennials are more likely than other age groups to wish their retirement provider would reach out to them personally, and to know more about their company’s 401k plans.

Millennials at small businesses (which Fisher defines as those with between 5 and 200 employees) tend to be less engaged in retirement planning, with nearly one in four saying they are not enrolled in a plan.

Those who are enrolled in a plan are also less likely to receive information from their 401k provider than their counterparts at larger companies, and, perhaps most troubling, they are less likely to trust the 401k plan offered by their employer.

The survey also found some stark differences between millennial women and men. Millennial women are much less confident in their ability to pick the right investments and save enough for retirement than their male peers. They are also less likely to be enrolled in their company’s 401k plan and more likely to fail the 401(k) IQ Quiz.

“This study really strikes at the heart of the assumptions many employers and planners have about the millennial generation,” Fisher continued. “While they are very technologically savvy, millennials are in fact the most likely generation to seek individual rather than web-based information about their retirement plans. We were also surprised to find that a significant gender gap continues to exist when it comes to investing and retirement planning, something that employers and 401k providers must address.”