Fiduciary Is Fun!
(a.k.a. I heart taxes)
(a.k.a. I heart taxes)
The pendulum of life is always swinging. With respect to employees and employers the pendulum swang in the direction of paternalism in the middle 20th Century. Employees and their employers had informal contracts that implied that if employees worked there long enough, their employers would take care of them. That pendulum swung in the other direction for a good part of the last 50 years with employees assuming more and more responsibility for their own wellbeing and employers taking a more hands off approach. Is the pendulum swinging back again?
Some new research from PIMCO, a large asset management firm on the west coast, is suggesting that the pendulum is indeed swinging back at least a little bit. In the last couple of years, more and more research has come out that employees trust their employers more than they used to. They are looking to their employers for help and guidance in a number of areas from better health and wellbeing advice to retirement and financial planning tools. This new research from PIMCO is now showing a further iteration in employees and employers working together.
It has long been known that most employees when they retire have almost no idea how to arrange their assets in such a way as to provide a lifetime of income. And why should they? After all, they have been spending a lifetime accumulating assets and saving, not figuring out how to make their assets last the rest of their lives. It appears that employers are starting to take notice and help out. The PIMCO Study shows that in the Small Plan Market (<$50mm in plan assets), the top client priorities in 2020 are Improving Participant Retirement Education, Evaluating Retirement Income for Participants, and Minimizing Fiduciary Liability, in that order.
So what does this mean, or could this mean, to you as a Plan Sponsor? The first question to ask, of course, is do you have any interest in helping your employees prepare for retirement beyond just helping them save through the retirement or 401k plan? If yes, then it is probably a good idea to begin exploring what this assistance would look like. It should begin with education and helping employees understand how to use their assets in retirement. It could then move to helping employees work with an advisor to put together a plan for transitioning into retirement and living the life they want and can afford.
But where does it truly begin? It begins with working with an advisor with experience in helping pre-retirees plan for retirement. Experience helping employees understand their asset mix and the tax implications of using those assets. Experience with Social Security and estate planning.
If you are concerned with your current advisor’s level of experience, please give me a call. I would love to work with you and your employees as they prepare for a retirement they have earned.
Pete Welsh a/k/a 401kGuy
At first, it doesn’t seem as if this title makes too much sense. Afterall, 401k plans are tax advantaged vehicles and only file informational tax returns. There is no tax owed by a qualified retirement plan. And this is certainly technically correct.
However, most plans now have Roth features which allow employees to have their deferrals taxed prior to them being deposited into the plan. The advantage to Roth is that even though the deferrals are taxed initially, all future earnings on those deferrals can be withdrawn (with a few minor restrictions) tax free by the employee. Pretty niffy. Even so, the vast majority of 401k deferrals (and 403b deferrals) are pretax, meaning that employees will pay ordinary income tax on the deferrals AND all earnings when they withdraw those funds.
So tax planning for your retirement plan is really more of an employee issue versus an employer issue, and what a planning opportunity it is! I am working with one of my clients now in anticipation of conducting employee meetings in early January to focus specifically on this issue.
Some details: After the passage of the Tax Cut and Jobs Act in late 2017, the marginal tax rates for most Americans dropped. The marginal rate is only 12% for a married couple earning no more than $78,950, and it only increases to 22% if that couple earns no more than $168,400. That covers a lot of young couples in this country! In fact, my client has the majority of their employees under 30 and earning around $40,000. Most are basically in the 12% marginal bracket. Is it worth getting the traditional 401k tax break for deferrals for such a group? I would argue NO.
People tend to think Roth or no-Roth and leave it at that. I believe there are some pretty compelling arguments to be made that when employees are early in their career and earnings are more modest that Roth makes absolutely good sense. Later in their career when they might be in the 35% or 37% tax bracket, if they are so fortunate, then traditional 401k deferrals might make sense. You can always change!
So what makes the most sense for your employees? What are you advising them as you enter into a new year? Just as importantly, what is your advisor saying? And does your advisor have the skill set to even make such recommendations?
If you would like an additional perspective and some thoughts on how to position your employees for long term financial success, give me a call. I would love to visit about optimizing tax benefits. Just the thought makes me warm all over!
Pete Welsh a/k/a 401kGuy
I really enjoy working with small business owners - individuals who seemingly face incredible odds and yet still find a way to succeed. Helping such individuals is probably one of the most rewarding aspects of my role as a financial advisor.
Small business owners often have a hard time distinguishing between themselves and their business. After all, they have poured their time and sweat into making the business successful and such devotion can often come at a cost to themselves and their families. I have new client that fits this profile.
I was referred to the business owner because he has “30 employees and needs a 401k plan.” This is indeed true as the company is 10 years old, running successfully, has a relatively loyal workforce and has reached the point where a company sponsored retirement plan makes sense. However, there is so much more to the story.
While getting to know this particular business owner as we discussed options for a company retirement plan, it turns out that he has diligently been reinvesting S-Corp profits into the business. He has organically grown the business and as a consequence is currently debt free. And although this sounds great, it has come at a huge cost.
He has no savings to speak of. He has no retirement funds. He does have a wife and two children under 6, but no life insurance. And amazingly, or maybe not, he has no estate planning documents and no idea what would happen if he passed away other than that his wife, who is not active in the business, would get 100% of a business she does not know how to run.
He has been running his business with a singular focus and has not stepped back to realize that his business and his personal life are two very different things and have different needs. When we had our first planning meeting with his wife present, I can assure you that she recognizes the difference!
So, what’s next? In this case we are examining the corporate returns, balance sheet, and cash flow statement to rework how the business is capitalized and to allow him to begin taking some money out so that he and his family stop living like paupers. We are running life insurance illustrations to protect his family should something happen to him. And we are examining buy/sell options should something happen as well. In short, a top to bottom review.
If you are business owner who has not taken the time to consider both your business and your personal life holistically, know that you are not alone. But also know, that help is available! For a comprehensive plan, give me a call at your convenience!
Pete Welsh a/k/a 401Guy
I started working with a new client last week. The initial conversations were around their desire to establish a retirement plan for their small but growing company. The company was started in 2014 by the 2 founders and is in construction. They have now matured to the point where expanding their benefits offering makes sense and they want to reward the employees who were with them in the beginning and attract new talent. All of this is pretty straight forward, and we will be starting up a new plan for them in the next few weeks.
The interesting part of the conversation occurred after we discussed the establishment of the retirement plan. I asked the two owners about the company and what planning they had done. In particular, I asked about their growth plans, as well as their exit plans, including if one should die unexpectedly. They did not have good answers, but their answers were not that unusual for successful entrepreneurs. They have been working hard at growing the business, making sure that it’s moving forward, but not stepping back to consider longer term opportunities and risks.
One item on which we spent considerable time involved what would happen to the business if one of them were to die unexpectedly? They did admit that they had brought this up to one another in the past, but never moved forward to take action or to visit with anyone about it. When I asked them to “give me a rough number” on what they thought the business was worth today, they both said “$1million” at the same time. This means that if one of the partners were to die that the other would need $500,000 to buy out that interest. That’s $500,000 in cash, today. How much more might be needed in 3, 5, or 10 more years? And neither has the $500,000 needed now.
Additionally, we talked about how the founders have been reinvesting most of their earnings into the business to help it grow. This is great in many respects, but by doing so they have not been doing any planning for themselves. The business is everything, but we all know it might not always be. So the conversation quickly moved to how we can begin to de-risk their personal situations by initiating some financial planning for themselves.
In total, it was a good conversation with numerous next steps. They were concerned where to begin on a couple of action items and I told them that I could work directly with their CPA and Attorney to get the ball moving on the buy/sell agreement. I’m putting together some quotes for consideration and gave them a list of items I need to begin working on their personal situations. By breaking everything down into steps and charting a path forward, both partners felt empowered about taking control.
In many respects, that is how I see my job – empowering you as the business owner to take the steps you know need to be done but are unsure where to start. Give me a call at your convenience and we can begin taking those next steps together.
Pete Welsh a/k/a 401kGuy
Milliman, an actuarial and consulting firm (and a very good one by the way), recently released a report suggesting that the “average” healthy 45-year-old couple that retires at age 65 can expect to pay $1.4mm out of pocket in their retirement years for retiree healthcare. Before anyone gets excited, let’s think about this.
Milliman is full of excellent actuaries who are skilled at “running the numbers.” The problem with running numbers out over many years is you can get some crazy results. I would like to suggest that the results of this report are indeed crazy. I am not going to argue with the way the numbers were calculated; Milliman’s actuaries are much better at math than I. Rather, I am going to suggest the numbers simply don’t make sense from a practical standpoint.
Milliman suggests that the average couple will have $1.4mm in just retiree healthcare costs. However, I can tell you that the average retiring couple will not have $1.4mm in TOTAL, let alone for just healthcare costs. I can appreciate the point being made which is healthcare in retirement is going to cost A LOT of money. Got it. But it’s not going to cost $1.4mm per couple on average because on average couples don’t have $1.4mm.
So, we have come to an impasse. Milliman calculates $1.4mm in cost per couple, but most couples don’t have this amount of money. What do we do? Something has to give, right? And don’t forget, these costs are after Medicare has paid because we are talking about a retired couple. Nothing like pointing out a problem without offering a solution.
I’m not going to suggest that I have the answer to this one, but I can tell you that couples are not going to pay what they don’t have. What is the best that you can do today to plan for this less than rosy future? You can certainly start maxing out your Health Savings Account (“HSA”) assuming you have one. This might be one of the best long-term vehicles to fund retiree healthcare costs. You can also start planning for Long Term Care needs, as a significant portion of retiree healthcare costs are expected to fall into this category.
Want to learn more about how to prepare? Give me a call and let’s have a conversation.
Apparently, we do. At least you should talk about your parent's retirement with them, according to some new research from TIAA. The research just released last month indicates that 53% of Gen Xers and 66% of Baby Boomers are concerned about their parents’ financial security in retirement. The reason why this is a concern is because we get STRESSED OUT about our parents financial situations as they age. I suppose we didn’t actually need any survey to tell us this.
However, the more worried we get, the more it takes a toll on our own health and financial preparedness. The research seems to suggest a trickle down effect showing the more we are concerned about our parents, the more likely we are to lack confidence in our own retirement prospects. And I wouldn’t be surprised if this lack of confidence that we develop flows down to the next generation.
Is there any hope to break out of this cycle? The good news is yes, and it’s not that complicated, but it’s not that easy either. Evidently, we need to talk about our parents retirement WITH THEM. Having a discussion, and the sooner the better, allows both the parents and the children to understand the realities of retirement better. Discussing begets understanding, which begets planning, which, when done well, can alleviate our concerns. It’s not always a full proof strategy, but it is better than doing nothing and presuming the worse.
Now I said those discussions while simple on paper might be difficult in reality. How might such a conversation begin? I would recommend engaging with a good financial planner to who can assist leading a multi-generational discussion at a neutral location. These types of conversations are never easy, but better to have them with a financial professional than over Thanksgiving Dinner. Those never work out well.
There are many ways for a small business owner to fund retirement. Although according to US News in a survey done in 2018, 34% of all small business owners had saved nothing for retirement. That’s not good. And interestingly, 42% of small business owners, according to The Motley Fool, June 2018, are counting on the sale of their business to constitute a major source of retirement income. That’s seems like a pretty big bet to me. Who is going to buy those businesses again?
So what might a small business owner do with respect to planning for retirement? In most pass-through tax entities – S-Corps, Partnerships, and LLCs – the most viable, tax advantaged way to plan for retirement is through a qualified retirement plan. The amount that can be contributed to a defined contribution plan is dependent, in large part, on the owners earned income, but can be as high, for 2019, as $56,000 or 25% of wages, whichever is less.
In working with smaller companies, I often see an owner trying to maximize the contribution at $56,000. Simple math says that $56,000 is 25% of $224,000. In other words, if an owner pays himself anything more than $224,000 in wages, he is not getting any benefit as far as his defined contribution plan is concerned. He would be better off taking amounts above $224,000 as passive income, if that is an option, and paying taxes at a lower rate.
However, if there is a spouse gainfully employed, or a spouse that could be so employed, there could be an argument that we should pay the spouse some of the income that might have otherwise gone to the owner above $224,000. Why would we do this? Those additional wages going to the spouse are now earnings that can be considered for our 25% limitation. We can’t give our owner any more contribution, but if we pay the spouse $100,000, for example, we could make a contribution of up to $25,000 into her account
As you might expect, there are many considerations that must be factored in before we rush to take the action noted above. The additional payroll taxes for the spouse might be steep. But then again, getting a benefit from Social Security might be good. Who knows? The additional $25,000 deduction good, right? Lots to consider. Make sure you work with someone qualified and experienced to walk you through the pros and cons around these scenarios.
In fact, work with me.
The 2018 tax filing year is over for most, but many owners, partners, and members of pass through tax entities are still on extension as they try to make sense of all the tax changes that went into effect for 2018. Many partners and LLC members are still trying to understand what the Tax Cut and Jobs Act of 2017 has done to their net income and taxes. While there were a number of positive changes for high income earners there were also some caps, particularly in the areas of State and Local Taxes (“SALT”).
For those individuals who might be looking at a tax bill that is larger than what was expected, the question could be asked “what can we do now?” The general answer is “not much”, but there is one area of planning that is still available post the close of the year, assuming you are on extension, and that includes making profit sharing contributions to your retirement plan. Such contributions can have a meaningful impact, potentially, on Qualified Business Income (“QBI”) and the available 20% income deduction. These situations are extremely fact dependent, obviously, and everyone’s situation does vary.
There are many ways to make contributions, but for partners and LLC members, the calculation is more than a little complex to say the least. The IRS did create a 21 Step Process for calculating your earnings and your deduction in Publication 560 to help make it a little easier for you. Suffice to say, however, it’s not that easy. But given the importance in getting this tax deduction contribution correct, you should consult an expert.
For those of you looking to explore your tax planning options with your retirement plan and to understand how those changes will impact your personal situation, please reach out to us for a free consultation. We work collaboratively with your tax and legal advisors to get you the maximum deduction.
Pete Welsh aka 401kGuy