Breaking Down the Industry for Financial Advice

Breaking Down the Industry for Financial Advice

The industry for financial advice is confusing.  Professionals in the business of helping the public with their personal finances work for different types of companies, are compensated in different ways, and have varying standard by which they’re required to treat their clients.

This is my 13th year in the industry.  Though my experience probably gives me more knowledge than the average consumer, there are quite a few I’m confused by all the layers at play.  (Yeah yeah, there’s a joke to be made there).  Whether it’s my cognitive abilities or whether the industry is in fact confusing, this post will attempt to break down & describe the industry for financial advice.  I’ll split this up into a few statistics, how advisors are compensated, one of the major problems this structure creates, and how you might interview an advisor you’re considering.

 

The Numbers

There are a lot of financial professionals in the United States.  FINRA (Financial Industry Regulatory Authority), is the national organization that keeps track of advisor licensing and currently lists about 630,000 representatives registered to deliver financial advice.  Now, many of those are not in the direct business of financial advice.  They may be investment bankers, they may be operational staff, and they may be running narrow products and services like managed futures or commodities strategies.  None of these are what I’d consider to be in the business of providing financial advice or planning services.

Cerulli Associates is a research company that does a much better job putting a finger on the actual number of people delivering some type of financial advice across the country.  Their most recent study estimated about 311,000, which includes professionals across all industry channels.  Of those 311,000, only about 50% deliver financial planning services.  Meaning, there are more or less 155,000 financial professionals in the US directly delivering advice and planning services.  This seems surprisingly low to me, given that there are about 125 million households across the country.  That means that if only half of the households in the US worked with a financial planner or advisor, each advisor would need to serve over 400 households!

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What You Need to Know About the SECURE Act Retirement Bill

What You Should Know About the SECURE Act Retirement Bill

Every now and then, lawmakers in Washington make noise about changing various sections of the tax advantaged retirement accounts I’m so fond of recommending to my clients.  Now that we’re living substantially longer, and a greater portion of our lives is actually spent in retirement, there’s a good argument that we should increase age limits, mandatory distributions, and other rules governing IRAs, 401(k)s and other types of accounts.

I usually don’t pay much attention to this speculation until there’s a bill on the floor that has a strong chance of becoming law.  The majority of the legislation drafted in this area doesn’t get far, and often doesn’t even get out of committee.

Nevertheless, the house and senate have both recently introduced bills that would change how retirement accounts work.  I’m no political expert, and don’t have the foggiest idea what the chances are of one of these bills passing.  But from what I’m reading there’s more momentum for retirement reform now than there’s been in the last several years.  Plus, more than one client asked my thoughts on the subject recently so I felt a summary post would be appropriate.  This post will cover what happened & why it might be important to you.

 

Pending Legislation

In February the senate introduced a bill called the “Retirement Enhancement and Savings Act” (or RESA), aimed at fixing America’s retirement savings problems – both in the public and private sectors.  This isn’t the first bill on retirement reform that’s been introduced recently.  Multiple versions containing similar provisions have been introduced since 2016, which speaks to the growing interest in helping Americans save for retirement.

Meanwhile, the house passed the SECURE Retirement bill (Setting Every Community Up for Retirement Enhancement Act) about a week and a half ago in a 417-3 vote.  This bill contains many of the same provisions as RESA, and the bipartisan support on both sides of congress could mean one of the bills may actually make it into law sometime soon.

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Maximizing Your 199a QBI Deduction as a Specialized Service Business

Maximizing Your 199a QBI Deduction as a Specialized Service Business

As you’re probably aware, we’re working with some new tax laws as of January 1st, 2018.  The tax change that will have the most impact for many business owners out there – particularly owners of pass-through businesses – lies in section 199a.

Section 199a specifies that qualified business income is eligible for a 20% across the board deduction on the owners’ personal tax returns.  20%!  This is a big deduction, and falls in line with all the political rhetoric about making the country a more business friendly environment.

Unfortunately, not every business owner will be able to claim it.  One of the more controversial aspects of section 199a is that the deduction phases out at certain levels of taxable income, if your business is considered a “specialized service business” (SSTB).  In 2019, this phaseout range is $315,000 to $415,000 of taxable income for married people filing jointly, and $157,500 to $207,500 for everyone else.

What exactly is a specialized service business, you ask?  It’s one whose principle asset is the skills or experience of one or more professionals.  This includes medicine, law, accounting, financial services, athletics, and several others.

With the introduction of section 199a & the QBI deduction, there are a number of tax planning opportunities for business owners.  Qualifying for the deduction and maximizing its benefit could easily have a significant impact on business owner’s total tax liabilities.  This post will explore three different types of tax planning strategies owners of specialized service businesses may consider to maximize the benefit of the 199a deduction.

 

Income Reduction Strategies

The first, most logical way to maximize the QBI deduction is to find ways to reduce your taxable income.  The lower you are in the phaseout range, the greater portion of the deduction you’ll qualify for.  Note here that the phase out isn’t based on your adjusted gross income or modified adjusted gross income (which is common for most other phaseouts, like IRA/Roth IRA contributions).  The QBI deduction phases out based on your taxable income, which is after you take itemized or standard deductions.  Here are a couple ideas to consider.

 

Qualified Retirement Plan Contributions

Establishing & funding a qualified retirement plan is usually the low hanging fruit for owners of specialized service businesses.  The best plan structure and form for your situation will depend on a number of factors, of course.  And if you have employees, chances are you’ll need to make contributions on their behalf as well.

The usual suspects here are SEP-IRAs & solo 401(k) plans for those without employees, and 401(k) & profit sharing plans for those with employees.  You can also tack on a cash balance plan or defined benefit plan if you want to be aggressive (and are comfortable with mandatory contributions each year).  In either case, every dollar you contribute to a qualified retirement plan, both as an employee deferral or employer contribution, will be deductible.  And, of course, every dollar you deduct gets you one dollar closer to the beginning of the phaseout range.

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Setting Up a 401(k) to Take Advantage of the 'Mega' Back Door Roth Conversion

Setting Up a 401(k) to Take Advantage of the ‘Mega’ Back Door Roth Conversion

If you’re a personal finance nut you may have heard of a strategy called the “back door Roth IRA conversion.”  This maneuver essentially allows you to contribute money to a Roth IRA, even if your income is otherwise to high to make a direct contribution.  You make a non-deductible contribution to a traditional IRA, convert those funds to a Roth IRA, and presto!  You have cash in the Roth that won’t ever be taxed again.  While it seems like this is a glaring loophole in the tax code, Congress has endorsed the strategy in a conference committee report from the Tax Cut & Jobs Act.

But as great as it is to take advantage of Roth IRAs while you’re in high tax brackets, you’re still limited to the annual IRA contribution maximums of $6,000 per year (or $7,000 if you’re 50 or older).  The “Mega” back door Roth conversion is a similar strategy, but allows for up to $37,000 per year in additional Roth contributions using a 401(k) plan.

 

Why the “Mega” Back Door Roth Conversion Strategy Works

 

The Three Types of 401(k) Contributions

To start, let’s review the three types of contributions you could make to a 401(k) plan.  The first is the most common: your employee deferrals.  You can instruct your employee to defer funds from your paycheck and deposit them on your behalf into the company’s 401(k) plan.  Some plans allow you to make these deferrals on a Roth basis, and the limit in 2019 is $19,000 per year.

The second type of contribution is an employer contribution.  This is anything your employer puts into the plan on your behalf, and includes matching contributions, or contributions based on a percentage of your compensation or company profitability.  It may be subject to a vesting schedule, and is always made on a pre-tax basis.

The third, and widely unknown type of contribution is an after-tax deferral.  Some 401(k) plans allow you to make additional contributions beyond your employee deferral on an after-tax basis, once you’ve reached the $19,000 annual limit.  Note here that 401(k) plans are not required to allow this feature, and not all do.

There are two limitations to annual 401(k) contributions.  The first is the $19,000 limit on employee contributions ($25,000 if you’re over 50 years old).  The second is on the total amount contributed to the plan on your behalf.  This limit is $56,000 in 2019, and consists of the three contribution types listed above.

So, to determine how much you could contribute in after-tax deferrals, you’d need to subtract $19,000 (again, $25,000 if you’re over 50) and the total amount of your employer contributions from $56,000.

Theoretically you could make up $37,000 per year in additional Roth IRA contributions using this maneuver ($56,000 – $19,000).  You’d need to be under 50 though, and you couldn’t receive any contributions from your employer.

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A Review of Providence's 457(b) Plan

A Review of Providence’s 457(b) Plan

In my financial planning firm I work mostly with business owners and medical professionals.  A good number of my clients are employees of Providence, which is one of the major medical providers in the Pacific northwest.  Providence offers its employees a very strong benefits & retirement package.  Employees can contribute to a 403(b) plan on a tax-deferred or Roth basis and Providence contributes to a 401(a) plan on their behalf, depending on compensation and years of service.

Providence also offers a 457(b) plan to its employees.  While it’s convenient to have another tax-deferred savings vehicle available, 457 plans come with some quirks – especially surrounding distribution options once you separate from service.

Recently, one my of my clients and I discussed the possibility of them leaving to take another job.  So to wrap our heads around the ins and outs of the 457 plans, we jumped on the phone with one of Providence’s retirement plan administrators.  The administrator helped to explain the unique features of the plan, which I’ll explain in this post.  Hopefully this review is helpful to anyone thinking about participating in Providence’s 457 plan.

 

A Quick Primer on 457(b) Plans

457(b) plans are sometimes mistakenly considered an alternative to a 403(b) plan.  There is actually some nuance to 457(b) plans, and much of it depends on whether the plan is sponsored by a governmental entity.

457(b) plans sponsored by governments have nearly identical rules to 403(b) plans.  The contribution limits are the same, the distribution options & limitations are the same, and by and large the plans operate in the same way.

Non-governmental 457(b) plans are different, in several ways.  Whereas the contribution limits are the same, the distribution options are not.  For non-governmental 457(b) plans, you are not allowed to roll your balances into an IRA.  Yes, you read that correctly.  Whereas participants in government sponsored 457(b) plans may roll their balances into IRAs after separating from service without triggering a taxable event, participants in non-governmental plans may not.

Instead, as a participant in such a plan you’re limited to the unique distribution options of the plan.  This is worth some investigation, as some plans require full distribution shortly after separating from service.  There isn’t an early distribution penalty for withdrawals prior to age 59 1/2, but withdrawals are still taxed as income.  Think about that for a moment.  You participate in a non-governmental 457(b) plan for years, accumulating potentially hundreds of thousands of dollars in the plan.  Then when you separate from service you’re forced to take everything out, and be taxed on it, in one year.

Another unique difference is creditor protection.  Whereas 403(b) and 403(k) plans are held in trust, 457(b) plans are held in the name of the organization sponsoring the plan.  This seems like a subtle difference, but can be impactful in the event of liquidation.  If the sponsoring organization falls into bankruptcy, your assets in the plan would be exposed to creditors.  The chances of this happening are probably quite small (especially for an organization like Providence), but I’m sure that’s what everyone at WorldCom and Enron thought as well.

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Year End Capital Gains Distributions How to Avoid Getting Slammed

Year-End Capital Gains Distributions: How to Avoid Getting Slammed

With tax season now in the rear view mirror, many of us are licking our wounds after a shellacking from Uncle Sam.  I heard from a lot of people this year that they owed far more to the IRS than they expected to.  Come to find out, the IRS changed the withholding tables with the new tax bill.  Rather than overwithholding throughout the year and getting a refund in April, thousands across the country underwitheld & had to pay out of pocket.

Another item factoring into last year’s fat tax bills was capital gains.  Mutual funds and ETFs distribute capital gains back to shareholders, which are taxable based on the amount of time the fund owned the holding.  As an investor, receiving an unwanted taxable distribution can be inconvenient.

As a reader recently put it: “For the second year in a row I’ve gotten killed with large capital gains from my mutual funds, resulting in a large tax bill.  Aside from owning stocks on my own, how can I eliminate or minimize these capital gains?”

Today’s post will answer this exact question.  For those of you who’ve seen the adverse tax consequences of capital gains distributions, read on to learn a few strategies you could use to minimize the bite.

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Pros & Cons of Long Term Care Insurance 3 Top Arguments For & Against

Pro’s & Con’s of Long Term Care Insurance: 3 Top Arguments For & Against

I have a good number of clients who are in their mid-50s, and hearing from friends and colleagues that they should consider obtaining long term care insurance.  They’ll often quote stats about the staggering percentage of us who will need long term care services at some point in our lives, or the mention the high cost of services.

These are valid points.  But there are equally valid reasons NOT to obtain a policy.  I’ve written on long term care insurance in the past, and how to determine whether you’re a good candidate for it.  Since this is a topic that comes up in my practice with some frequency, I thought I’d devote another post to the top arguments for and against long term care insurance.  If you’re reviewing your own situation and wondering whether to obtain coverage, you should consider these six points.

Let’s start with the top arguments FOR obtaining long term care insurance:

 

1) There’s a Good Chance You’ll Need Care at Some Point

Long term care services are described (in insurance policies) as requiring help in two of six “activities of daily living”.  The six activities are:

  • Eating
  • Bathing
  • Dressing
  • Getting on and off the toilet
  • Getting in and out of bed or a chair
  • Maintaining continence

Needing help with two of these six activities is a triggering event for long term care policies.  Policyholders in this situation can make claims on their policies.

The stats say that 68% of us will require long term care (needing help in two of the six areas) at some point in our lives.  This is a staggering number.  And with longevity rising around the world, I wouldn’t be surprised to see that number climb over the next 20-30 years.

While not everyone will need help for a long period of time (many will only need some assistance for a couple weeks, maybe after recovering from surgery) chances are pretty good you’ll need a hand at some point.  Rather than relying on family or friends, long term care policies can pay for professional help in your home or a stay in a facility.

 

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8 Considerations When Protecting Your Business With Life Insurance

8 Considerations When Protecting Your Business With Life Insurance

I read a stat recently that stated 71% of small businesses depend heavily on a few individual owners and/or employees.  This number makes quite a bit of sense, once you consider the limited resources most small businesses have to work with.  It also presents a great deal of risk.  Losing a key employee, manager, or professional could easily be the death knell for businesses without much bench strength.

To protect themselves, their families, and their businesses from this possibility, many business owners use life insurance.  As you probably know, life insurance comes in many shapes, sizes, and forms.  Depending on your business and objectives, there is probably a way to minimize the risk of your or your colleagues’ premature death using life insurance.

There is a lot to write about on this topic – in part because there is such a wide variety of life insurance products available.  This post will review 8 considerations when protecting your business with life insurance.  If you’re dipping your toe into the subject for the first time, this is a good place to start.

 

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What's an Appropriate Cash Reserve in Retirement?

What’s an Appropriate Cash Reserve in Retirement?

Cash flow is one of the first topics I like to cover when working with new financial planning clients.  Cash flow is so fundamental to the rest of your household finances that it’s really helpful to understand how much money is coming in every month and how much is going out.  With this in place we can begin to wrap our heads around concepts like your capacity to take risk, disability insurance needs, and other components of a typical financial plan.

We can also use this information to determine how big your cash reserve should be.  There are many different names for a cash reserve: cash buffer, cash safety net, emergency fund, and so on.  Regardless of what you might call it, the objective is to keep enough cash on hand so that no matter what happens in your life, you don’t need to sell investments at an inconvenient time (i.e. during corrections or market crashes).

The easiest way to view your cash reserve is as a function of monthly living expenses.  Simply multiply your monthly living expenses by the number of months you feel comfortable with and voila!  That’s how big your cash reserve should be.

During your “accumulation” or working years, most financial planners recommend a cash reserve of somewhere between 6 and 24 months’ worth of living expenses.  Where you fall on that spectrum depends on a several different factors:

  • Your capacity and willingness to take risk
  • How many incomes you have in your household
  • How consistent your income is
  • How many dependents rely on your income
  • What your disability insurance situation looks like

In retirement the situation is quite a bit different.  You’ve already amassed the amount you need to quit working, and are obviously not concerned with the possibility of being laid off.  Instead, the biggest issue is avoiding having to sell assets at an inconvenient time.

It’s a challenging line to walk.  You want to keep enough cash on hand to cover unexpected expenses and avoid selling stocks in periods of market turmoil.  But you also don’t want to keep more in cash than you need to.  Keeping too much is a drag on your portfolio, and inflation will slowly eat it away over time.  The right amount of cash for you in retirement depends on a different set of factors, which I’ll cover in this post.

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How to Take Advantage of Your Retirement "Gap Years"

How to Take Advantage of Your Retirement “Gap Years”

Often when I bring up the idea of retirement “gap years” in meetings, my clients’ minds wander toward a family member who’s decided to take a year off between high school and college.  Then they shake their head in disbelief about how millenials are often encouraged to backpack around for a year to mature and “find themselves”.  Another moment of reflection about how the world’s changed, and that’s about when their attention snaps back to refocus on our meeting.

No, retirement gap years don’t have anything do with finding yourself or maturing.  They have to do with the years between retirement and age 70.  Many people will see their taxable income fall to lower levels once they stop working, and spike once they turn 70.  Thus, the retirement income “gap”.

Here’s why.  For those of us with assets in qualified retirement accounts like 401(k) plans or IRAs, 70.5 is the age when the IRS begins imposing mandatory distributions, which will be added to your taxable income.  Once you begin collecting Social Security you’ll also be taxed on either 50% or 85% of the benefits, depending on where that taxable income falls.  If you’re one of the many people waiting until age 70 to collect, that’s two extra sources of taxable income added simultaneously, and recurring every year thereafter.

Thanks to our progressive tax system, the years you find yourself in a lower tax bracket can be a great opportunity to reduce taxes over the rest of your life.  This post will explore how.

How to Take Advantage of Your Retirement "Gap Years"

 

The Opportunity

As you know, we have a progressive tax system here in the U.S.  The higher your taxable income, the higher the rate you pay.  As I write this, the tax brackets for single & married people filing jointly are:

How to Take Advantage of Your Retirement "Gap Years"

Notice the big jumps here – our marginal tax rates don’t increase evenly.  10% & 12%, 22% & 24%, and then 32% and higher.  The increases from 12% to 22%, and again from 24% to 32% are significant, and present a convenient opportunity when planning for retirement.

Think of a typical retirement timeline.  If you plan to stop working at 65 years of age, chances are your taxable income will be higher at age 64 than it will be at age 66.  Then a few years later at age 70.5, you’ll enter RMD territory.  The IRS will force you to take a certain amount of money out of your tax deferred retirement accounts every year, or face a stiff 50% penalty.

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