Nerd's Eye View blog

Understanding The Two 5-Year Rules For Roth IRA Contributions And Conversions

January 1, 2014 07:01 am 93 Comments CATEGORY: Taxes

While Roth IRAs are very popular as a retirement savings vehicle due to their tax-free growth treatment, they also have several unique rules associated with them to ensure that their favorable tax status is not abused. In particular, there are two different 5-year rules associated with Roth accounts to prevent them from being taken advantage of; the first 5-year rule applies to Roth contributions and determines whether earnings will be tax-free, while the second 5-year rule applies to Roth conversions and determines whether conversion principal will be penalty-free.

Each of the 5-year rules are measured from the beginning of the tax year for which they apply, which means in reality tax-free earnings or penalty-free conversion principal may be accessible in less than 5 years in certain circumstances. And because the Roth rules aggregate all accounts together for the purposes of determining the tax treatment of various distributions, it's necessary to track the various 5-year rules and the amounts they're associated with, regardless of whether they are held separately or mingled together into a single account.

Ultimately, being able to effectively navigate the various Roth 5-year rules creates several planning opportunities as well. For some, taking advantage of the Roth conversion 5-year rule is a way for those well under age 59 1/2 to tap their IRA funds "early" without an early withdrawal penalty. For others, the reality is that the Roth conversion 5-year rule is a moot point anyway, because they already meet another exception to the early withdrawal penalty (e.g., already being over age 59 1/2). However, in all cases, the 5-year rule for contributions must be met before any Roth earnings can actually be tapped tax-free; fortunately, though, because any first-time contribution or conversion can start the clock, clients who are concerned about the 5-year rule can make a contribution to a Roth (or to a traditional IRA and then convert it) to start the time window now, and ensure they'll never need to worry about it in the future!

Top 13 Nerd’s Eye View Blog Posts Of 2013

December 30, 2013 07:01 am 0 Comments CATEGORY: Nerd's Eye View

As we come to the end of 2013, I'm thankful to all of you, the readers who continue to visit Nerd's Eye View more and more often and share this content with your friends and colleagues (which is greatly appreciated!). The continued growth of this blog led to its re-designed launch at the end of this summer, and you'll continue to see enhancements coming in 2014 (if there's something you think we're still missing, please let us know in the comments!).

As busy as the year can be between life and work, though, I realize that many of you don't have the time to keep up with everything that's written here, and the ever-present challenge of blogging is that articles, once published, quickly vanish into the archives, never to be seen again outside of an occasional Google search from time to time. Accordingly, I've compiled for you this list of the 13 most popular articles I wrote this year on Nerd's Eye View (along with our most popular guest post!). So whether you're new to the blog, or simply haven't had the time to keep up with everything, I hope that some of these will (still) be useful or of interest to you!

Thanks for a great 2013, and looking forward to an even better 2014!

Weekend Reading for Financial Planners (Dec 28-29)

December 27, 2013 01:01 pm 0 Comments CATEGORY: Weekend Reading

Enjoy the current installment of "weekend reading for financial planners" - this week's reading kicks off with the latest news on the fiduciary front, that the Department of Labor may have delayed its latest rule reproposal to next August because incoming Labor Secretary Tom Perez is trying to rally support in Congress for the rule and preemptively address Democrat concerns about whether middle-income families may be cut off from financial advice as a result of higher regulatory costs. Also in the news was the striking announcement that Vanguard has collected a whopping 98% of all net inflows to U.S. equity funds this year, and rumblings continue about the recent Schwab announcement that they will offer a money-back guarantee for the last quarter's AUM fees for any advisory clients who are unhappy and whether this will set a new accountability precedent for advisors.

From there, we have a number of practice management articles, including some suggestions on how to handle the situation when an advisor/employee leaves, when it's time to think about hiring a professional manager for an advisory firm, the emerging rise of regionally-dominant "super ensemble" RIAs that have $5M+ of revenues and often $1B+ of AUM, and the 2013 "Best In Technology" awards from advisor tech guru Bill Winterberg.

We also have a pair of technical financial planning articles this week: the first looks at some of the traps and pitfalls of properly valuing life insurance policies that are being transferred to ILITs (given that the gift valuation rules are 50+ years old and life insurance has evolved greatly since then!); and the second is a discussion of the prospective benefits and caveats of a Department of Labor proposal that would require all defined contribution account statements to show an estimate of lifetime income that would be available at retirement given the current value and ongoing savings.

We wrap up with three interesting articles: the first is a look at some of the latest research on how we make choices, the fact that more choices can actually make it harder for clients to move forward, and the role that planners can play to help clients make better choices; the second examines the typical marketing of financial planners, noting that most appeal to a prospective client's analytical side, despite a growing base of research that makes it clear that people are more compelled to buy a product or service that appeals to their emotions instead; and the last is an interview with Ric Edelman about his firm, which now boasts a whopping $12B of AUM and 22,000 clients, focused entirely on the mass affluent, with plans to grow significantly more in the coming years... notwithstanding the fact that most large firms still insist that the mass affluent cannot be served profitably! Enjoy the reading!

Owning Deferred Annuities In Trusts And Preserving Tax-Deferral Treatment

December 25, 2013 07:01 am 28 Comments CATEGORY: Annuities

Annuities have long enjoyed preferential treatment under the tax code - so extensive, that they merit an entire portion of the tax code, IRC Section 72, all to themselves. The favorable rules are generally intended to support the use of annuities as a vehicle for retirement savings and/or retirement income... and as such, the rules generally only apply in situations where annuities are owned directly by individual, living, breathing human beings who may in fact someday retire (known in the tax code as "natural persons").

Accordingly, whether annuities owned by trusts still enjoy tax-deferred growth depends upon the exact details of the trust. The rules do allow that when a trust owns an annuity "as an agent for a natural person" the contract can still keep its tax-deferral treatment, such as when it's owned by a revocable living trust; even if merely all the beneficiaries of the trust are natural persons, such as with a bypass trust for the benefit of a surviving spouse and children, favorable treatment is still available. However, if other beneficiaries are involved - even and including charities - a trust-owned annuity may lose its preferential treatment.

An even more complex point of intersection between annuities and trusts is when annuity contracts are transferred to/from a trust. The problem is a key section of the tax code designed to prevent the unrealized gains of annuities from being shifted to another individual through gifting; as a result, if an individual transfers an annuity "without full and adequate consideration" its gains are immediately recognized. By this rule will not apply to transfers to a revocable living trust, or most types of transfers out of a trust, in the case of some common estate planning techniques - like gifting an annuity to an Intentionally Defective Grantor Trust (IDGT) - the situation remains unclear, and clients and their advisors must be cautious not to accidentally create an unfavorable taxable event!

The Real Reason Most Financial Planning Firms Have No Career Track

December 23, 2013 07:01 am 3 Comments CATEGORY: Practice Management

In recent years, it has been increasingly popular to lament the lack of career tracks at most financial planning firms, especially as financial planning struggles in the aggregate to attract enough new advisors to fill the shoes of those likely to retire in the coming decade.

Yet for all the furor about the need for career tracks, relatively few firms have established them so far, and the ones that have tend to be the largest of the advisory firms. Yet indirectly, that perhaps is the point - it takes a certain size and scale to be able to craft a career track in the first place, and most firms are simply not large enough to do so.

Of course, that doesn't mean there are no opportunities in financial planning. For the subset of firms that are enjoying some healthy growth - where 15% compound growth rates double the firm every 5 years - there are an ever-growing array of opportunities available.

Nonetheless, what this suggests is that as long as most advisory firms are small, trying to create fully fleshed out career tracks may be unrealistic anyway. Instead, the real focus should be on firms that are growing, which may increasingly become an imperative for those practices that want to attract and retain the top talent, and the new question for new planners should shift away from "what is the career track at this firm" to instead focus on "what are this firm's plans for growth" instead.

Weekend Reading for Financial Planners (Dec 21-22)

December 20, 2013 03:01 pm 0 Comments CATEGORY: Weekend Reading

Enjoy the current installment of "weekend reading for financial planners" - this week's reading kicks off with some of the latest industry news, including a new filing from the CFP Board in its lawsuit with the Camardas asking the court to either throw out the lawsuit or at least narrow the scope of the Camardas' information requests as being a "fishing expedition" (if the court declines the motion, depositions of key CFP Board staff members will begin in the coming weeks); there's also an interesting announcement from Schwab that they will begin rebating the last quarter's worth of fees for any unhappy advisory clients (will other financial advisors feel compelled to match the offer for their own clientele?), and an interesting study from TIAA-CREF suggesting that Gen Y may actually be even more receptive to financial advice and willing to change their behavior than baby boomers.

From there, we have a number of "trends and predictions" articles that are so common towards the end of the year, including a white paper about "transformations" that broker-dealers must make to survive and be competitive as the differences between B/Ds and RIAs continue to blur with the movement towards AUM business models, a look at some of the big regulatory changes coming in 2014 (beyond just fiduciary and harmonization, look for increased focus on protecting clients from identity theft and business continuity plans for advisory firms), some of the biggest tech trends coming for advisors (big focus on the cloud and software integrations), and a broader look at four 4 trends that will impact advisors for many years to come (from demographics to technology and more).

We also have a few more technical articles this week, including a discussion from actuary Joe Tomlinson on some of the latest research debates on the best asset location strategies, an interesting (and high quality) analysis of some of the flaws in the Shiller P/E10 ratio and how to fix them, and a broad look at how estate planning is changing in a world of 'permanent' exemptions that have removed most clients from the reach of Federal estate taxes (shifting the focus to income tax planning, step-up in basis opportunities, and asset protection).

We wrap up with three interesting articles: the first discusses the recent acquisition of David Loeper's Wealthcare Capital and their Financeware financial planning software by a private equity firm, which is notable not just because they are investing into growing the company, but because they may also try to re-assert Loeper's patents related to financial planning (which some have gone so far as to call a risk to all financial advisors); the second is an article looking at the challenges that average Americans have with trying to save, and how it may be less a matter of their attention span or focus and more than the sheer urgency of spending interruptions prevents them from ever focusing on the less-urgent-but-still-important financial goals; and the last is an interview with indexing legend John Bogle, who suggests that the ETF industry has taken indexing "too far" and that he wouldn't advocate investing in almost 97% of today's ETFs! Enjoy the reading!

Why Qualified Charitable Distributions From IRAs Are Often Not Best For End Of Year Contributions

December 18, 2013 07:01 am 13 Comments CATEGORY: Taxes

While charitable giving should always be done first and foremost for charitable and not tax purposes, the Internal Revenue Code does afford a number of different tax strategies for charitable giving. In recent years, the opportunity to complete "Qualified Charitable Distributions" (QCDs) directly from IRAs to a charity have been especially popular, in part because QCDs not only allow for "spending" amounts in IRAs without ever paying any taxes, but also because QCDs satisfy an individual's Required Minimum Distribution (RMD) obligations (and since QCDs are only available to those over age 70 1/2, there must be an RMD to satisfy!).

However, the reality is that while QCDs from IRAs do have favorable tax treatment, they are generally still less favorable than donating appreciated securities to satisfy charitable goals. While the former allows for entirely pre-tax charitable contributions (directly from an IRA), the latter effectively provides a "double tax" benefit, as contributions are deductible (making them pre-tax) and donations of appreciated securities permanently avoid taxes on the associated capital gains. As a result, while QCDs from an IRA are better to satisfy charitable goals than just writing a check or giving cash, using appreciated securities is still better (and the greater the appreciation, the more they come out ahead!).

Notwithstanding this difference in treatment, QCDs are still preferrable in situations where the deduction for donating appreciated securities might be limited - for instance, if the deductions in total will exceed the charitable contribution AGI limits (including the 5-year carryforward), where deductions have been already capped at 80% due to the Pease limitation, or for those who have so little in the way of itemized deductions that it would be better for them to simply claim the standard deduction (and donate separately via QCDs if desirable). And of course, sometimes the dollar amounts involved simply don't make it worthwhile to go through the hassle of donating appreciated securities. Thus, ultimately, whether QCDs or donating appreciated securities will be more tax-efficient depends upon the facts and circumstances of the situation; nonetheless, all else being equal, QCDs still tend not to be the best charitable giving option available!

Crafting a Compelling Job Description For Your Next Financial Planning Hire

December 17, 2013 07:01 am 3 Comments CATEGORY: Practice Management

Hiring a new financial planner can be a challenge, especially for firms that have never hired a professional staff member before. Even for larger firms that have hired successfully in the past, the process can be daunting. Yet in many cases, a difficult hiring process can be exacerbated with a key mistake coming right out of the gate: not having a compelling written job description (or worse, not having any job description at all).

In this guest post, financial planner recruiter Caleb Brown shares his insights about what it takes to craft a compelling job description for a prospective financial planning hire. It's a look at all the key areas a job description should cover - from a proper "what's in it for the candidate" introduction, to a position summary, current responsibilities, future responsibilities, and what should be discussed as qualifications and benefits - along with some helpful hints, and tips of things to avoid.

If you're thinking about starting the process of hiring a financial planner, this should be a helpful starting point for what to consider when crafting the job description for that future hire. Alternatively, if you've already started the process of hiring, but have been struggling to find the right person - or anyone at all - this article may be a helpful look at whether the problems might be stemming from a job description that is not compelling in the first place.

The Real Hidden Cost That Has Been Inhibiting Financial Planning For The Masses

December 16, 2013 07:01 am 16 Comments CATEGORY: Planning Profession

As financial planning slowly and steadily builds itself towards being an established profession, there has been an increasing focus on the importance of figuring out how to widen the scope of financial planning to reach more of the masses. Although notably, it seems that recent efforts to expand the reach of financial planning services is not purely altruistic; the reality is also that there are simply a lot more CFP certificants around than there used to be, making it increasingly appealing for advisors to seek out new audiences to grow their businesses, rather than compete in the same bloody red ocean of their competition.

Yet notwithstanding the growing desire to reach the masses, financial planners have struggled to extend their services. The promise of the web and the potential efficiencies of technology create the potential to bring down the cost of financial planning and make it more accessible to the masses, even as planners now find that they may soon be in competition with the technology itself seeking to deliver parts of those services directly to the public in the form of "robo-advisors."

However, the reality is that the real inhibitor to bringing financial planning to the masses is not about the use of technology to drive down the cost of delivering financial planning. The real challenge is how difficult it remains to get new clients in the first place, especially given that so many financial planning firms have relatively little cash flow available for broad-based marketing programs. The end result - the real challenge in bringing financial planning to the masses is not about the cost to deliver it, but the incredibly high cost necessary to get those clients in the first place! When we figure out how to bring down the cost to acquire clients, we will figure out how to truly bring financial planning to the masses.

Weekend Reading for Financial Planners (Dec 14-15)

December 13, 2013 01:01 pm 1 Comment CATEGORY: Weekend Reading

Enjoy the current installment of "weekend reading for financial planners" - this week's reading kicks off with a "no-news" article... that after four months since the CFP Board's "fee only" controversies began, there are still not yet any formal talks amongst NAPFA, the FPA, and the CFP Board about how to resolve the differences in compensation definitions, or address the fact that a number of FPA and NAPFA members appear to be currently out of compliance with the current rules.

A number of other practice-management and industry-related articles are highlighted this week as well, including: the first practice management study released by the FPA's new Research and Practice Institute which found that only 46% of financial planners even have a retirement plan for themselves; a renewed push by the Financial Planning Coalition (along with AARP, CFA, IAA, and NASAA) to advocate for legislation to assess user fees on RIAs to enhance oversight (in lieu of allowing FINRA or another SRO to take over); rising scrutiny by the SEC on so-called "reverse churning" where advisors put clients into AUM fee arrangements but have so little trading that clients may be charged far more than they would have been by just staying in a commission-based account; new fees that many custodians are charging to advisors who try to trade away to get better price execution on ETF trades; and an announcement by BrightScope that its Advisor Pages offering will now be free to advisors who want to update the essential information, with premium features available for those who want to pay more to further engage in marketing through the platform.

From there, we have a several more technical financial planning articles this week, including an analysis by Wade Pfau comparing variable withdrawal rate strategies from Jon Guyton and David Blanchett, a look at how recent changes for reverse mortgages may make them less appealing to financial planners even as reverse mortgages are becoming more recognized in research as a financial planning tool, and a look at how for many financial advisors their health insurance premiums may go up next year as premiums are shifted to be based on each plan participant's individual age (which means older advisors who saved on premiums by having younger employees who brought down the average age of the plan will no longer enjoy such savings).

We wrap up with three interesting articles: the first looks at how some big trends, from industry consolidation and pressured profit margins to generational shifts and technology will threaten advisors to "adapt or die" (with lessons from Blockbuster video as an example of a company that failed to recognize their own industry trends and adapt accordingly); the second is a satire article from Vanguard announcing new "AlphaBet" ETFs as a demonstration how simple data mining and research biases can create new ETF products that have no reasonable expectation of sustaining their results (advisors beware of backtest-based new ETF offerings!); and the last is a discussion from the NY Times of Britain's new "Ministry of Nudges" that is applying behavioral finance and research principles to help better implement government policies, with some very notable successes. Enjoy the reading!