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IRS Notice 2014-54 Acquiesces On Splitting After-Tax 401(k) Contributions For Roth Conversion

September 24, 2014 07:01 am 81 Comments CATEGORY: Taxes

While most people who contribute to a traditional 401(k) plan receive a tax deduction for their contributions, some 401(k) plans allow participants to make additional after-tax contributions over and above the deductible thresholds, up to the annual defined contribution plan limit. For those who have already maxxed out other available tax-deferred growth options, the after-tax 401(k) plan was better than nothing.

Upon retirement, though, many retirees sought to take advantage of rules that allow them to roll over their pre-tax 401(k) assets and take their after-tax contributions back, taking the two checks that the plan administrator provides them but rolling them both over – the pre-tax portion to a traditional IRA, and the after-tax to a Roth IRA in an effective tax-free Roth conversion. And the strategy only become more popular after the Pension Protection Act of 2006, which further opened the door to direct Roth conversions from 401(k) plans, and therefore the potential to directly convert “just” the after-tax check.

After years of fighting the strategy and claiming that the pro-rata rule should still apply to such conversions, the IRS has issued IRS Notice 2014-54, reversing its prior position and acquiescing to taxpayers who wish to roll over their 401(k) funds and proactively allocate their pre-tax amounts to the traditional IRA and the after-tax portion to a (tax-free) Roth conversion. While the rules are technically not applicable until 2015, the IRS has even acknowledged that it would be “reasonable” to rely on the approach now, making an open season for the strategy to split out after-tax 401(k) contributions for conversion effectively immediately.

In fact, it appears that the new IRS rules are so open in this regard, that they not only permit the free conversion of after-tax 401(k) contributions into a subsequent Roth IRA, but the availability of this conversion makes it more appealing than ever to make after-tax contributions into a 401(k) plan in the first place (at least after first obtaining the employer 401(k) match and maxxing out available pre-tax or Roth contribution limits). Will the new rules lead to a resurgence of higher-income individuals making after-tax contributions to a 401(k) plan, after maxxing out available alternatives, for the sole purpose of preparing to complete a future tax-free Roth conversion of the contributions down the road?

The Succession Planning Mirage And The Rising Need For Exit And Continuity Planning Of Lifestyle Practices Instead

September 22, 2014 07:01 am 10 Comments CATEGORY: Practice Management

As the average age of financial advisors creeps higher each year, and grows closer and closer to the traditional age of retirement, a growing chorus of voices have warned of the looming onslaught of advisors retiring, the lack of young talent to take over their firms, and thus a wave of advisory firms that will come up for sale resulting in a competitive a buyer’s market that will make advisors regret having waited to sell. Yet despite what has been portended by demographics, the wave of selling has not come, advisory firm merger-and-acquisition activity has remained relatively flat for years, and if anything the drive for larger firms seeking inorganic growth through acquisitions and tuck-ins has led increasingly towards a seller’s market, despite nearly all predictions to the contrary.

Given that industry studies still find the overwhelming majority of advisors have no succession plan (and aren’t taking the steps to create one), it raises the question of whether the entire succession planning crisis may actually be a mirage… for the simple reason that most advisors would be financially better off staying in their practices than selling them anyway, and many find their advisory work a professional vocation so personally fulfilling they wouldn’t want to leave it anyway… especially if the practice can be adjusted to better accommodate their later years’ lifestyle preferences.

Thus, while succession planning may remain relevant for a small subset of firms that really wish to pursue such a strategy and are prepared to execute it, perhaps it’s time for the companies that support financial advisors and the industry at large to recognize that the majority of advisors need support for exit and continuity planning, not succession planning. The focus should be on how to redesign a firm into a lifestyle practice, with ways to ensure that clients are well served even if an advisor stays in their practice until the very end, and that an advisor’s spouse or heirs might even receive some “terminal” value to the practice once they are gone (in addition to enjoying the cash flow from the business along the way)… rather than continuing to collectively attempt to “guilt” advisors into leaving a practice that they don’t want to personally or financially let go of anyway!

Weekend Reading for Financial Planners (Sep 20-21)

September 19, 2014 01:52 pm 1 Comment CATEGORY: Weekend Reading

Enjoy the current installment of "weekend reading for financial planners" - this week's edition kicks off with the recent "Fiduciary Leadership Summit" in Washington DC, hosted by TD Ameritrade and the Institute for the Fiduciary Standard, highlighting "war stories" of consumers injured by gaps in the fiduciary duty for brokers and an interesting response by former regulator Robert Plaze that perhaps the best outcome is not a uniform fiduciary standard for all but simply that the brokerage industry needs its own standalone regulatory reforms. Also in the news this week is a new NASAA working group that will look at revising broker-dealer fee disclosures for consumers after acknowledging that today's fee disclosure documents are too long and confusing, and a recent survey by Gallup that finds "creating a financial plan" is one of the few financial issues that consumers consistently do rely on professional advice more than friends and family.

From there, we have several practice management articles this week, including one from United Capital CEO Joe Duran that the golden age for (small independent) RIAs may soon be ending with rising competitive forces putting the big squeeze on profits and margins, a response to Duran's bleak outlook from RIABiz's Brooke Southall who suggests that many of these competitors (from robo-advisors to Vanguard's Personal Advisor Services) are still ultimately just a drop in the bucket compared to the sheer size of the consumer investor marketplace, and a discussion from Mark Tibergien about whether some advisors actually need to get better at having the conversation with clients about raising fees instead.

We also have several more technical articles this week, including: a discussion of what the "true diversifiers" in a portfolio really are, and whether they're even necessary if there's a risk-managed approach to the equities themselves; a review of a recent T. Rowe Price survey suggesting that retirees may actually be more flexible and adaptable in their retirement spending than is commonly believed; and the last looking at the current use of Monte Carlo analysis, suggesting that perhaps one of our greatest problems is not the limitations of the tool itself but that many of today's Monte Carlo software tools do not provide a sufficient range of reporting on the outcomes beyond just the (insufficient) probability of success/failure alone.

We wrap up with three interesting articles: the first looks at how much of the disagreement amongst even the true finance experts may stem from the fact that our experience with investing and the markets can be dramatically impacted by the year in which we happen to be born (and therefore the investment returns and volatility we witness during our early formative years), and that many finance disputes may simply be a representation of two experts whose views are heavily biased and colored by their own (birth-year-sensitive) personal history and experience; the second looks at how the real significance of the robo-advisor trend may not be their actual competitive threat, but simply that they highlight what quality technology and a great client user experience looks like, and how lacking today's tools for advisors really are; and the last is an analysis from Wealthfront about the behavior of investors in active mutual funds versus index funds during market volatility, finding that passive investors are less prone to portfolio turnover during market volatility and suggesting that despite their lack of human advisors to hand-hold clients, many of today's (passively-based) robo-advisors may experience witness less client churn during the next bear market, not more.

And be certain to check out Bill Winterberg's "Bits & Bytes" video on the latest in advisor tech news at the end, including a summary of the first (Orion-Advisor-Services-sponsored) "hackathon" which brought together programmers from numerous advisor tech companies to try and build the best new useful relevant technology tools and integrations for advisors in just 48 hours! Enjoy the reading!

Valuation-Based Tactical Asset Allocation In Retirement And The Impact Of Market Valuation On Declining And Rising Equity Glidepaths

September 17, 2014 07:01 am 11 Comments CATEGORY: Retirement Planning

For retirees who are more concerned about running out of money in retirement than leaving a large inheritance behind, the optimal retirement asset allocation strategies shift from focusing on wealth maximization and owning as much in equities as you can tolerate (to provide the greatest return on average), to approaches that do a better job of preserving wealth in adverse scenarios (even if it costs excess upside when times are good).

This retirement approach of focusing on minimization to spending risks over maximization of wealth accumulation has led to a wide range of retirement asset allocation and product strategies, including the use of annuities with guarantees, bucket strategies with cash reserves, and most recently the “rising equity glidepath” approach where portfolios start out more conservative early in retirement and become progressive more exposed to equities over time as bonds are spent down in the early years.

The caveat of risk minimization strategies, though, remains the simple fact that most of the time, they turn out to be unnecessary, as the risky event never actually manifests. As a result, tools like Shiller CAPE that allow advisors to understand whether clients are more or less exposed to a potential decade of mediocre returns (which brings about the “sequence-of-return risk” in retirement) can be remarkably effective at predicting when it’s necessary to focus on risk minimization in the first place, and when wealth maximization may be the more prudent course.

In fact, as it turns out, market valuation measures like Shiller CAPE can actually be so predictive of the optimal asset allocation glidepath in retirement, that the best approach may not be to implement a rising equity glidepath or a static rebalanced portfolio at all, but instead to adjust equity exposure dynamically based on market valuation from year to year throughout retirement. While this kind of tactical asset allocation approach is not necessarily a very effective short-term market timing indicator, the results suggest nonetheless that it can help to minimize risk when necessary, take advantage of favorable market returns when available, and have some of the best of both worlds – albeit with the caveat that markets can still deviate materially in the short run from what valuation alone may imply regarding long-term returns!

Effective Succession Planning For Financial Advisors And The Problems With Advisor Compensation Based On Revenue Sharing

September 15, 2014 07:01 am 6 Comments CATEGORY: Practice Management

For years, industry commentators have been anticipating an “onslaught” of retiring baby boomer advisors who will begin to engage in succession planning en masse and sell their firms over the next decade. Yet year after year, the baby boomers get older, and the sellers don’t materialize; with an astonishing paucity of sellers to external buyers and an abundance of buyers, it remains a seller’s market for financial advisory firms.

Yet in a new book, David Grau (founder of FP Transitions, a firm that has potentially already been involved with more advisory firm sales than any other consultant or service provider in the industry today) makes the compelling case that for advisors to be focused on big headline external sales to third parties misses the real opportunity – an internal succession plan executed over a period of years or even a full decade, that ultimately delivers radically more to the founder than a third-party external sale ever could.

In order to harvest the greater long-term value from an effective succession plan, though, Grau points out that advisory firms are still too attached to the wirehouse-style “eat what you kill” revenue-based compensation, that simultaneously destroys value for the business owner and disincentivizes the next generation of owners from wanting to be successors in the first place. Instead, Grau suggests that firms need to shift from compensation based on top-line revenue to a greater focus on compensation built around bottom-line profits, that can ultimately help to both focus the business on maximizing its value, and truly incentivize the next generation of advisor owners to want to step up, buy in, and contribute towards – and be rewarded for – enhancing that long-term value.

Weekend Reading for Financial Planners (Sep 13-14)

September 12, 2014 02:57 pm 0 Comments CATEGORY: Weekend Reading

Enjoy the current installment of "weekend reading for financial planners" - this week's edition kicks off with a call for better regulation of financial planning as a distinct calling unto itself, recognizing that in Massachusetts it's harder to get a license to be a cosmetologist than it is to become a financial planner! There's also an article discussing the recent rumored-to-be-on-a-fast-track NASAA regulatory proposal (now in comment period) that may require state-registered RIAs to adopt more substantive business continuity and succession plans for the protection of their clients.

From there, we have a few interesting new studies and articles on the so-called "robo-advisor" trend, including a Gallup poll that finds investors still prefer dedicated human advisors to financial website solutions by a 2:1 margin (and more affluent individuals favor the human solutions even more), a Spectrem Group study that finds for consumers who do plan to work in an online environment that the robo-advisors may actually be slightly preferable to human advisors engaged virtually (though there may be enough interest for both to succeed), and an interesting discussion from Mark Hurley about how ultimately the technology-will-replace-advisors threat isn't really any more dangerous today than it was in 1999 (when similar comments were made) and that ultimately much of the technology that backs today's robo-advisors will likely end out being used by the rest of the financial services industry (rather than continue to compete with it).

We also have several investment articles this week, including: a look at how some advisors are starting to adopt small allocations of Bitcoin into client portfolios; how Bitcoin does not really function (yet?) as a true currency but as a non-liquid investment asset may still improve risk-adjusted returns for portfolios (at least based on the historical track record for the virtual currency, which may or may not persist in the future); a fascinating look from Howard Marks of Oaktree at how true risk is more about the possibility of permanent loss of capital than about volatility, but that the truer measure of risk is also surprisingly difficult to quantify and apply effectively; and a discussion from Jason Zweig of the Wall Street Journal at the behavioral finance phenomenon of "shared attention" and the fact that who you choose to listen to and follow and get your information from can have a surprisingly powerful effect (good or bad) on your (investment) results.

We wrap up with three interesting articles: the first looks at how the only real way to stay competitive in today's environment is to be a continual learner, or else face stagnation and boredom that can undermine yourself and your company; the second discusses the five essential skills that planners must learn (as distinguished from the technical knowledge we must have to be competent) if we truly want clients to implement our financial advice (hint: it's all about the key skills that create true rapport and trust); and the last is a piece by industry commentator Bob Veres that takes an interesting look at the current regulatory environment and suggests that the real problem is not that we need to apply a new fiduciary standard to brokers but simply that the SEC has allowed the brokerage industry to drift too far from where it once was and should just do a better job enforcing the rules that were originally written which require a clear(er) separation of brokerage firms and investment/financial advice in the first place. Enjoy the reading!