The Risks of Tapping Your Retirement Fund for an Alternative Use

Americans are more apt to ‘bet it all’ not worrying about the consequences. These strategies most often end up in failure leaving you and your family with nothing. Remember a qualified retirement plan can protect your assets from creditors, in the event of bankruptcy.

Internal Revenue Service (IRS)
Internal Revenue Service (IRS) (Photo credit: cliff1066™)

The strategies to do so and not run afoul of I.R.S. regulations are varied, but the main one is to start a business and have it adopt a 401(k) plan. The existing 401(k) plan is rolled into the new one, which is invested in the new business. Voilà — instant financing. The downside, however, is that there is no money for retirement if the business fails.And there is evidence that most of these businesses do fail. The Internal Revenue Service terms one form of this scheme as a Rollovers as Business Start-Ups plan, or perhaps with some unintended irony, a ROBS plan. In 2009, the I.R.S. studied ROBS plans and found that most of these businesses had gone bankrupt, losing the person’s retirement savings. In most cases the money was lost before the business even got off the ground. Nonetheless, the I.R.S. does not prohibit ROBS plans, but it has called for more scrutiny of the structure.

This has not diminished the ardor of franchisers and other investment advisers selling such plans. They aggressively market them to would-be entrepreneurs. Figures are hard to come by, but the chief executive and co-founder of Guidant, David Nilssen, recently told The New York Times that inquiries about these types of plans were up 196 percent in 2011 from 2009.

There is no short cut to wealth. Well that is not actually true, a very small portion succeed. However, for most investors this strategy leads to bankruptcy.

Please comment or call to discuss how this affects you.

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Why this is the year to start your small business 401(k) before the September deadline

Accelerate your retirement savings now or risk being left behind. No one knows what changes are coming in the tax code.

IRS building on Constitution Avenue in Washing...
IRS building on Constitution Avenue in Washington, D.C.. (Photo credit: Wikipedia)

Most small business owners that start a 401(k) plan opt for a special design called a Safe Harbor 401(k).  The Safe Harbor enables small-business owners and any highly compensated employees to make the maximum contribution ($17,000 for those under 50 years of age; $22,500 if 50+) either tax-deferred or after tax in the Roth 401(k) regardless of income in 2012 and on-going.This can be a big personal tax break for owners and employees that choose to participate alike.  An owner in the 25% tax bracket who contributes the $17,000 max tax-deferred would save $4,250 in taxes for 2012 – four to eight times more than what the plan costs to setup.

And there is more good news.  Businesses with less than 100 employees who are starting their first 401(k) qualify for up to a $500 tax credit each year for the first three years the plan is in place.  This helps offset administrative costs from providers that typically run between $1,000 and $2,000 a year.  Also, employee matching is tax deductible for the business.

To take advantage of these generous tax incentives, the safe harbor does require employers to provide a nominal match to employees.  The match satisfies the safe harbor and automatically satisfies IRS non-discrimination testing so any employee can max out contributions.  While there are 401(k) options that do not require a match, restrictions on contributions may apply.

Many small business owners are afraid to invest in the equity markets, given the past volatility and uncertainty. This is a mistake and explains why many people lose money in the equity markets. In a retirement plan you must think long term.

Please comment or call to discuss how you business can benefit from a 401(k) plan.

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What is a 401K?

Of course you’ve heard of a 401k, but what exactly is it, and how do you manage one successfully?  401k plans are an excellent addition to your retirement planning and serve as a dual-feeding investment between you and your employer.  And even though there is an equal monetary deposit between both you and your employer, there are other aspects of the 401k plan that may or may not bode well for your financial plan.  In the very least, we will break down the nuts and bolts behind the 401k and give you the tools you need to decide whether it is right for you.

First and foremost, what is a 401k, and how does it work?  401k plans are retirement savings plans sponsored by your employer.  It allows employees to invest and save a portion of their paycheck before taxes are deducted.  Taxes are then taken out once the money is removed from the account.  With a 401k, you decide how your money is invested.  Most plans offer a spread of mutual funds composed of stocks, bonds, and money market investments. The most popular option tends to be a combination of stocks and bonds, which gradually become more moderate as you reach retirement.

Next comes the question of how much you should invest.  If your employer is matching your timely investment percentage each paycheck it would benefit you greatly to keep your 401k contribution at a feasible amount.  Obviously, manage your finances and ensure that you have enough to live and enjoy life, but keep in mind that retirement planning is important.  If your employer is offering a 50-50 contribution you should take advantage of the plan; don’t leave cash on the table.  The most popular contribution is 3% of your salary.  So, if you earn $50,000 a year and contribute 3%, your personal contribution will be $1,500 and your company’s contribution will be $1,500.  Although you can contribute over 3%, your company cannot, and this is where the possible drawbacks begin.

The IRS mandates contribution limits for 401k accounts.  As noted, your company will not contribute over 3%, and the total dollar amount that can be contributed—including both your contributions and your employers’—cannot exceed 100% of your salary.  In most cases, you can’t tap into your employer’s contributions immediately.  There are complex rules about when you can withdraw your money and costly penalties for pulling funds out before retirement age.  This is why most employers hire investment administrators to oversee your account.  It is their job to inform you of updates about your plan and its performance, manage the paperwork and assist you with requests.  You can also go to your administrator’s web site or call their help center if you need further assistance.

The final question is which type of 401k you should invest in.  Most companies offer a traditional 401k, where the less common plan is a Roth 401k.

Traditional 401k:

  • Wages are contributed before taxes from each paycheck, like a deferred salary.
  • Taxable income drops by the amount you contribute.
  • You pay income taxes on contributions and earnings upon withdrawal.
  • No access to your funds before age 59 ½ or if you leave your employer at age 55 or older.
  • If you dip in early, expect a 10% penalty — on top of the usual tax bill.

Roth 401k:

  • Contributions are made with money that’s already been taxed.
  • No taxes paid upon withdrawal.
  • Better flexibility: free access to your money as long as you’ve held the account for 5 years.

As you can see, there are benefits and drawbacks to both 401k retirement plans.  It is essential to survey your finances and what types of savings plans are right for you.  401k plans are great because of the contributions made by your employer, and the flexibility of deciding how much you’d like to contribute.  Don’t hesitate to ask if you have any further questions or comments regarding 401k plans or financial management in general.


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Tax Organization Tips for Small Businesses

If tax season were like Christmas, you’d definitely file doing your taxes under “last-minute shopping.”  Not only is it time to prepare last year’s taxes, but it’s also important to get this year’s taxes rolling as well.  Compiling tax data last minute can be stressful and confusing.  And trying to throw together important information regarding the success of your business under pressure will surely lead to costly mistakes.  Here’s a list of helpful organization tools that can cut your tax preparation time in half:

  • Don’t store all your tax records in one file.  Keeping your tax records all in one place can lead to lost items and mismanagement.  Try purchasing organizational containers like plastic tubs and label them with the tax year.  Items like vendor files, appointment books, bank records Insurance policies, capital asset files, investment accounts, real estate and capital improvement files are important tax documents that need to be filed together under the same tax year.
  • Track your mileage.  If you use your vehicle or cell phone for business you’ll want to track your usage accordingly.  While cell phones can be easily archived through your bill, your vehicle is different.  The IRS asks for your total mileage on the tax return, so try keeping a notebook in your vehicle and tracking your mileage for each trip.
  • Collect all of last year’s tax documents.  If you haven’t done this yet, create income tax files for last year and this year – and make them stand out.  Throughout the year as taxable transactions occur, collect all documents in the file.  Filing documents like third-party reporting documents such as 1099s, K-1s, W2s, 1098s, etc., and receipts for tax deductable transactions immediately when you receive them will make data compilation much easier.  After archiving these throughout the year you can simply grab the file, a back up of your QuickBooks data, and head out to your tax pro.
  • Go green!  Welcome to the 21st century!  Now welcome your bookkeeping system as well, and purchase up-to-date digital accounting software.  Most accounting software programs are easy enough for the non-accounting professional to use.  Now tax return preparation, financial and tax planning are simplified because of the comprehensive reports generated by a decent accounting program.  Imagine not having to peruse through your filing cabinet for hours at a time, and simply pulling it up on your computer instead.  Furthermore, these digital files are easily transferable and take up less space.  Although, beware of the caveat – computer crashes are not uncommon, and losing all your important files in a “virtual fire” can ruin you and your business.  Be sure to implement a routine backup plan where the files can be stored outside of your hard drive.

There are myriad tips that can help you and your business organize your taxes throughout the year, making last-minute tax preparation less of a headache.  If you have tips of your own that you’d like to share please let us know!

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Give Your Retirement Plan an Annual Checkup

Just like your annual physical to protect your health your company retirement needs an annual checkup. Regulations are in a constant state of flux, plus there are advancements within the industry. Remember the 401k is becoming the sole source of retirement for most Americans and should be offered as such.

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Regular Plan MaintenanceIn addition to conducting an annual plan review, plan sponsors should perform regular maintenance to ensure seamless plan operations. This includes staying current on regulations, watching out for common mistakes and reporting to the federal government as required. Plan sponsors are responsible for establishing a program of internal controls, including monitoring and oversight controls surrounding the retirement plan.

A retirement plan committee can help the monitoring and oversight function. However, the committee won’t be effective unless it conducts regular meetings. These oversight meetings should not only review investment results but also check that internal controls related to plan administration are effective and operating appropriately to assist in identifying and detecting operational failures. The retirement plan committee should be well versed in all aspects of the plan, including review of investment performance, keeping current on law changes and monitoring of third-party administrators.

Employers where hiring an ERISA 3(38) Investment Manager does not work, the establishment of a retirement plan committee is recommended. Be certain that this committee meet regularly and documents all meetings. This is necessary in the event of an IRS audit.

Please comment or call to discuss this process.

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DOL & IRS Ramping Up Enforcement

The DOL & IRS are ramping up enforcement efforts for retirement plan compliance.

The Obama administration has been increasing the IRS and DOL staff to combat the large number of retirement plans that it says are not compliant with retirement planning rules and regulations.

The DOL says 77% of 401(k) plans are non-compliant in some form.

At a recent conference John Carl president of the Retirement Learning Center discussed the increased enforcement efforts.   While 2009 was a bad year for the economy, Carl said, it wasn’t so bad for DOL — it added 997 employees that year — with 70% of those employees added to its enforcement division. The department’s Employee Benefits Security Administration (EBSA), for instance, saw a 28% budget increase in 2009, and EBSA added 29 enforcement personnel.

The targets for the IRS are U.S. companies owned by foreign entities; 403(b) plans; and small business owners.

The IRS is coming.

Please comment or call to discuss how this could affect you and your organization.

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Secrets of the 401(k) Millionaires

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The secret to a million dollar retirement account is not picking the right stocks or timing the market. The secret is have a disciplined savings strategy and a risk adjusted globally diversified portfolio. Most people are emotional about their investments and should rely on professionals to make their investment decisions. It also helps to believe in free markets and that markets are efficient, although not perfect. You cannot make up for a lack of saving by speculating.

That figure, based on data from the Employee Benefit Research Institute, may depress those with sums closer to the median 401(k) balance of roughly $60,000 — and for good reason. Even among employees 55 and up who’ve been contributing to the same 401(k) plan for more than 20 years, just 2% are estimated to have cracked the $1 million mark, says Jack VanDerhei, EBRI’s research director.

To some, the other 98% show that the 401(k), the principal vehicle for American retirement savings, is at best inadequate, and at worst, a colossal failure. Even Ted Benna, the man credited with developing the first 401(k) plans out of an IRS tax loophole in 1981, now concedes that they’ve grown overly complex, with too many options, too high fees, and too many ways to cash out one’s nest egg.

Even some 401(k) providers don’t disagree. With traditional pensions, employers hired teams of experts to make the kind of tough investing decisions now entrusted to individual employees, says Catherine Golladay, vice president of participant services for Charles Schwab. “Left to their own devices, most people do not have the knowledge or the discipline to do this themselves,” she says.

The real secret to a $1 million dollar 401(k) balance is disciplined saving and a disciplined investment process. Plan participants cannot make up for a lack of either by speculating with their retirement funds.

Please comment or call to discuss how this affects you and your retirement savings.

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3 of 4 retirement plans don’t review compliance regularly:

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The retirement crisis will not go away by plan sposnors ignoring the plan. A periodic review by an independent fiduciary will minimize the plan sponsors fiduciary risk and provide an excellent plan for their employees. This small function will help employers attract and retain talented employees.

Although plan executives “have significant concerns about their retirement plans, relatively few are taking all the steps available to fully manage these risks,” said the report on a survey of 245 plan executives. “Additionally, organizations are tackling some issues reactively rather than proactively.”Sixty-two percent said they will conduct a review if they or one of their advisers “identifies events that suggest new risks,” the report said, while 49% will conduct a review if they receive notice of a pending audit from the Internal Revenue Service or Department of Labor.

Although sponsors “tend to spend a fair amount of time” on assessing investments, “they spend less time on compliance of plans and operations,” Robyn Credico, Towers Watson senior consultant and defined contribution practice leader for North America in Arlington, Va., said in an interview. Ms. Credico is one of the report’s authors.

The small to mid sized firms have a tendency to ignore the compliance issues of their company retirement plan. Most mistakenly believe their service provider is handling this for them. This mistake can cost them and their employees.

Please comment or call to discuss how this affect you and your company plan.

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Three 401(k) Reforms That Can Help Save America’s Retirement

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The most efficient way to improve the retirement situation in America is to provide incentives to business owners. The more the governement is involved the less efficient this and any other system will be.

1. Double the Incentives That Help Small Businesses Get a 401(k) StartedUncle Sam currently offers a solid incentive for business owners with less than 100 employees to start a 401(k) plan.  However, to create a splash in awareness and encourage more small businesses to move forward with a 401(k), the federal government can do more.

Currently, the IRS provides an annual $0.50 per dollar tax credit up to $500 per year during the first three years of a new 401(k) plan to help offset the setup and administrative costs; the value of this credit over three years equals up to $1,500.  A company with 25 or less employees can reasonably expect to pay between $1,000 to $2,000 a year in administrative fees.  Other related expenses such as matching contributions are also tax deductible for the business.

To create a step change in helping businesses start a plan, the government would be wise to double the incentive by providing a dollar for dollar credit for up to $1,000 for the first three years but only if the company starts a plan by 2013. After that, the credit would expire back to its previous lower level.  Deadlines like this help create serious consideration of employers without a plan.  This could be communicated by the IRS via the news media and directly in their regular tax communications with employers. And while not every small business would jump at the opportunity, it could create significant movement for those who have put it off and have always wanted to provide the benefit for their employee (and themselves).

These type of incentives will help small businesses establish and commit to a company sponsored retirement plan. In order to prevent the federal government from nationalizing the retirement system, small businesses need to take on this awesome responsibility.

Please comment or call to discuss how this affects your company.

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401(k) plan participation could fall victim to proposed health care affordability test

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This is another example of government intervention having unintended results. Business owners who wish to make the government smaller need to improve the retirement plan they offer their employees. This requires the assistance of experts in the field.

Use of wages disincentive for 401(k) programs

But in a letter sent Tuesday to the IRS, the American Benefits Council said using wages, as reported in Box 1 of the W-2 wage and income statement, to determine if the required premium contribution is affordable “seems to create a possible disincentive for employers regarding programs and features designed to increase employee participation” in 401(k) plans.

That’s because Box 1 wages are reduced by the amount of an employee’s pretax contributions to a 401(k) plan, the Washington-based ABC said in its letter.

“Thus, for example, someone who defers amounts into a 401(k) plan will have lower wages reported in Box 1 of the Form W-2 and, as a result, his or her employer-provided coverage…is more likely to be unaffordable when compared to another employee that makes fewer or no elective deferrals,” ABC said in its letter.

Given the increased likelihood of failing the affordability test and being hit with stiff financial penalties, employers might pull back on programs, like automatic enrollment, that lead to increased employee participation in 401(k) plans, the group added.

A simple remedy to the problem, ABC suggested to Treasury Department regulators, would be—for the purpose of satisfying the W-2 health care premium affordability test—to allow employers to count employees’ pretax benefit plan contributions as wages.

The saving rate for retirement is far too low now, let’s not make it worse. Will this result in Americans relying more on the government for their financial futures?

Please comment or call to discuss.

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