The Finance Gourmet

Personal Financial Advice from a former Certified Financial Planner

401k Fiduciary Rule

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Politics sometimes makes it hard to get straight information about important topics relating to your finances. In this case, a court has struck down an Obama era rule that essentially applied the fiduciary standard to certain 401k advisors. According to the Republicans, this is a giant victory for freedom, and business, and enterprise. According to Democrats, this is a giant blow to fairness, and an attack on all hard-working Americans.

As is so often the case when politicians get involved, the reality lies somewhere in between.

What Is Fiduciary Standard?

There is a HUGE amount of case law and statutes about what exactly makes up fiduciary standards, but for our purposes, the easiest way to understand is to compare to the other existing financial standard, suitability.

401k fees savings fiduciary

I spend several years as a financial advisor. During that time, I was under the suitability standard. This meant that investments I recommended had to be suitable for my clients. In other words, I wasn’t supposed to be recommending highly-volatile, high-risk, futures contracts to my widowed, orphaned, school teacher, clients. Practically speaking, this standard had a lot less to do with what I wanted to recommend, and a lot more to do with what my company allowed me to recommend. Basically, mutual funds, or nada.

The fiduciary standard is a higher standard. In this case, the advisor has to recommend investments that are not only suitable, but in the client’s best interest. The distinction on paper is super easy to see:

Investment A is suitable for Client A, but Investment B would be in the client’s best interest.

The suitability standard means the investor could recommend Investment A or Investment B. A good advisor would recommend B either way, but he would only be required to recommend Investment B under the fiduciary standard.

Check out the Zelle reviews.

Why Companies Opposed to Fiduciary Standard?

So, why would any company be against doing what is in the best interest of their clients?

If you want to imagine the worst, those companies want to bilk their clients out of their hard-earned money, and that’s why they are opposed to fiduciary rules: greed and evil, pure and simple.

The reality is that collecting 1% per year to manage someone’s money over a couple of decades is profitable enough, that selecting a sketchy investment here and there probably isn’t worth it to major financial companies.

So, what is the real problem?

Lawsuits.

You remember our paper example of Investment A being suitable, but Investment B being in the client’s best interest? What makes Investment B the better investment? Lower fees? Higher returns? Lower commission? Lower risk?

In the world of investing, there is no such thing as a low-risk, low-fee, high-return, high-liquidity investment. If there were, everyone would just put their money into that and leave it there.

The reality is that risk, return, fees, and so on, are typically levers that move against one another. Lower-risk almost always means lower returns, and vice versa. So, which investment is in the client’s best interest, the one that protects their principal, but may not earn enough return to achieve their goal, or the investment that might give the client what they need, but may have a higher risk? And, how do you sort this out without using hindsight?

Essentially, what this all comes down to is that it is much easier for a client to win a lawsuit against someone who had a fiduciary duty than it is for someone to win a lawsuit against someone with a suitability standard. That’s really it.

See my SoFi reviews.

Is My 401k Safe Now?

Despite a court ruling, your 401k is pretty much just as safe (or not) as it was before the court ruling. Many have fees that are too high, with investment options that also have high fees. Others have better managed investments, and this often a function of how savvy the HR person is that picks and implements the plan, and how big the plan is. It simple costs more per-person to run a small 401k plan than a larger one, so the fees and investment options tend to be better in bigger plans.

In the end, some 401(k)s are better than others, and you should always advocate for a better 401(k) plan when possible, but your 401k plan is the best option for saving for your retirement and you should be loading it up with as high of percentage as possible of your income.

Basic 401k Recipe – How To 401k

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When I was a financial advisor, it always surprised me how often people who didn’t know the first thing about money, investing, or 401(k) plans ended up being so successful at saving for retirement. For them, when they got their first “real” job all those years ago, they signed up for the 401k — because someone told them to — put in 6% of their salary — because that’s how you get the full match — and just chose a basic stock index fund as their investment choice — because that’s all you really need to do right now.

Then, 30 years later, after having contributed 6% into a basic stock index fund every paycheck, during every recession, during every boom, during every bust, they ended up with a pile of money thanks to dollar cost averaging and compound interest — all without ever knowing anything about it.

In contrast, I also met many people who knew “everything” about money. They quizzed me on minutia like where a company becomes a mid-cap stock versus a small-cap stock, or what month the Federal Reserve raised interest rates, but ended up with very little money in their 401k plans. As it turns out, they were “too smart” to leave their money in the market after the internet bubble burst — not realizing that got out too late, and got back in too late, and didn’t save any money during the four years in between.

Set It and Forget It Basic 401k Plan

Look, if you have more than 15 years to retirement, the markets will work out for you eventually. Even if they go down, if you keep your contributions going, the markets will come back over 15 years, and you will have bought low in the meantime.

Basic 401k Recipe

Ingredients:

  • 1 401(k) plan – you have to get this from your employer. There is no such thing as a private 401k plan. (There is a solo 401k plan, but that requires you to have business income.)
  • 401k paperwork or website login
  • List of 401k investment options

Instructions:

Login to your 401k account or fill out the paperwork. Set your withholding at 6%. (If you can’t do 6 percent to start, then set up 2% and increase it every year — or every time you get a raise — until it is 6%.

Choose to invest 100% of your contributions (and any employer match) in a broad market stock index fund. (A total market fund, or a SP 2000 type fund works best).

Let bake until 10 years before retirement.

Should I Use the Basic 401k Recipe?

There are a lot of things to look at, and a lot of options that might lead to better results, but you have to be willing to look into them, and figure them out. If that isn’t where you are right now, then start with the Basic 401k Plan Recipe. The good news is that you can modify the recipe later when you have the time to learn, but you won’t be missing out now, while you don’t have that time or dedication.

IRA Contribution Limits 2017

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Not all tax numbers stay the same over time. Many income limits and other tax numbers are adjusted each year, either for inflation, or by another statutory mandate. These tax numbers include the tax tables and tax brackets for each year, for example. The IRS announces the numbers each fall.

This year is a bit confusing because some of the retirement plan tax numbers were increased by cost of living adjustments. However, other numbers remain unchanged from the previous year because the amount of the change was below the amount legally required to change the figures.

2017 IRA Contribution Limits

irs tax numbers graphicThe 2017 IRA contribution limits were recently published by the IRS. Note that these limits are for contributions made during the 2017 tax year, for use when filing income taxes due by April 2018.

The maximum IRA contribution for 2017 is $5,500. This is the same as the maximum deduction for 2016. The 2017 IRA catch-up contribution amount remains unchanged at $1,000 as well. Only taxpayers over age 50 are permitted to make a catch-up contribution to an IRA account.

Therefore, taxpayers under age 50 may contribute up to $5,500 to their IRA during the 2016 tax year and those over age 50 may contribute up to $6,500. Remember, however, that IRA contributions may be made through April 15th of the following year. In other words, contributions made anytime between January 1, 2017 and April 15, 2018 may be claimed on the 2017 income taxes. This is provided, of course that none of the amount contributed between January and April 15th, was deducted on your 2016 taxes.

Maximum Income for Deductible IRA Contributions 2017

Traditional IRA contributions are tax deductible for taxpayers with incomes below certain thresholds. These income limits are also adjusted each year for inflation. If you, or your spouse, are covered by an eligible retirement plan at work, then for 2017, the maximum adjusted gross income (AGI) for a full IRA contribution deduction is $99,000 for joint filers, and $62,000 for single filers. Taxpayers with high incomes above these amounts will have to calculate the phase-out for their 2017 IRA contributions. Those with incomes higher than $119,000 for married filing jointly, or $72,000 for those filing single, cannot deduct any part of their contribution to a traditional IRA account.

Taxpayers who do not have an eligible retirement plan offered at work, and whose spouse is also not covered by a work retirement plan may take a full deduction for IRA contributions regardless of how much money they earn.

If a taxpayer is not covered by a retirement plan at work, but their spouse IS COVERED, then the income limit for a fully deductible contribution is $186,000 or less. Deductible IRA contributions are phased out in such cases for incomes between $186,000 and $196,000 during 2017.

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Fix RMD Tax Problems With QCD

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You’ve spent a lifetime saving for retirement, and you did a really great job. So great, in fact, that you don’t need to take money out of your IRAs. But, you’ve turned 70 1/2, and now the IRS is forcing you to withdraw money from your IRA every year in the form of a Required Minimum Distribution, or RMD. Is there any way to get around having to take an RMD?

Mitigating Your RMD’s Affect On Your Taxes

The IRS gave you years of tax relief on the funds in your IRA. They only did that to encourage you to save for retirement. Now, that you’re retired (or at least retirement aged) they want their money now in the form of taxes on your IRA withdrawals, but if you played your cards right, you might not ever need to withdraw, and the IRS would have to wait longer for that money. The IRS hates waiting. i hate waiting - inigo montoya

The RMD keeps this from being the case. Once you turn 70 1/2 years old, you have to take some money out every year, and the government is there, waiting to tax it.

Unfortunately, there is no way to get out of having to take a Required Minimum Distribution, but there is a way to minimize it’s impact on your taxes.

A Qualified Charitable Donation, or QCD, is one way to minimize the effect of forced RMDs on your taxes.

As with any charitable donation, you can deduct the donation from your taxes, but the QCD has one extra advantage a regular donation doesn’t. Because the donation is made directly from your IRA account, it does not count as income to you.




An example may help to explain the value.

Let’s say Louis is 71. For easy math, let’s say he is required to take an RMD of $10,000. For more easy math, let’s say that Louis’s adjusted gross income is $100,000.

If he takes the $10,000 RMD and then donates it to charity, the $10,000 counts toward his Adjusted Gross Income, or AGI, increasing it to $110,000. He gets to deduct the $10,000 on Schedule A, Line 16. That increases the itemized deductions reported on Form 1040, Line 40.

But, those deductions are “below the line,” meaning that while they do reduce your tax bill, they do not reduce your AGI. Your AGI, determines what deductions and credits you are eligible for, and any phaseouts of those same tax credits and tax deductions. It also affects the taxability of your Social Security, Medicare premiums, which tax bracket you are in, and whether or not your long-term capital gains are taxable.

below the line deduction charitable contribution When you make a Qualified Charitable Distribution, that donation never becomes part of your income at all.

A QCD is reported like any other IRA distribution on Line 15 of Form 1040. However, Line 15 has two parts, an A and a B.

The A is the total distribution amount. The B is the taxable amount.

When you make a proper QCD, the amount donated is not taxable. The donation is reported on Part A as part of the total distribution, but is not entered on Part B as taxable. As such, the amount never ends up in your income at all, therefore reduces your AGI.

Requirements for Qualified Charitable Distribution

There are several requirements for a QCD. First, a QCD can only be made from an individual IRA. It cannot be made from a SEP-IRA or SIMPLE IRA. Technically, you can make a QCD from a Roth IRA, although in most cases, distributions from a Roth IRA are not taxable already, and Roth IRAs do not have RMD requirements, so there is limited value in making a QCD from a Roth IRA.

A second important requirement is that the QCD distribution must be made directly to the charity without the owner of the IRA ever taking control of the funds. In other words, your IRA custodian must make the check out to the charity, not to you. If you get a $5,000 check, deposit it, and then donate the money, that’s game over. You took a $5,000 distribution, and you are getting taxed on it. (You can still deduct the donation amount.) In many ways, this is similar to a rollover where the check is FBO to the taxpayer, but not deposited by the taxpayer.

Instead, you’ll need to fill out the proper form from your IRA custodian. Many financial institutions and brokerages make QCD forms available on their websites. By filling out the form, you are instructing the custodian to make the proper payment directly to the charity, and not you. If you can’t find the form, make a phone call and tell them that you want to do a Qualified Charitable Distribution. It is fine if the you receive the check and then forward it on to the charity, so long as the check is made out to the charity and not to you. DO NOT CASH OR DEPOSIT THE CHECK.

Also, QCDs may only be made to the usual 501(c)(3) charitable organizations. They may not be made to donor-advised funds, supporting organizations, or private foundations.

Finally, the maximum QCD is $100,000 per year.

Ask your financial planner or IRA custodian for help using a QCD to help with RMD tax affects.



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