|
Some common misconceptions are that all financial advisors know pretty much the same things, and that the number of years in business is a good indicator of an advisor’s level of knowledge. We disagree.
The following scenarios illustrate the value that a knowledgeable, experienced financial advisor can add, beyond advising their client on how to invest their portfolio assets. In fact, one mistake or missed opportunity can eradicate years of good investment performance. These scenarios are not meant to provide specific tax or legal advice as each individual client’s circumstances are unique.
1) NUA Tax Breaks Before Rollover
A corporate executive changes employers and knows that by rolling over his 401(k) plan to an IRA he can delay paying the ordinary income tax that would be due on any distribution from the plan. He will also increase his investment choices beyond the menu of funds available in the plan. That sounds great and on the advice of his financial advisor he receives the paperwork to rollover his entire 401(k) plan, which includes a sizeable position in company stock, to an IRA. Is he missing an opportunity? Fortunately, before signing the paperwork, he decides to get a second opinion. The executive almost missed a valuable tax planning opportunity involving the distribution of employer stock from a qualified retirement plan that could have cost him thousands of dollars in unnecessary taxes. If certain requirements are met, the stock can be distributed, in-kind, from the plan incurring ordinary income tax on just the original cost basis, not the current value. The remaining appreciation will not be taxed until the stock is sold and will then be taxed at the maximum capital gains rate of 15% instead of ordinary income rates.
2) Inherited IRA Account
A man’s mother dies and among her assets he discovers that she owns an IRA account on which he is the beneficiary. He knows that when money comes out of an IRA account it is subject to taxation and remembers that when his father passed away his mother avoided taxation by rolling her husband’s IRA into hers. The man liquidates his deceased mother’s IRA and immediately deposits the funds in his bank IRA designating the deposit as a “rollover” contribution. No one at the bank questions the origin of the deposit. Unfortunately, he was later hit with a big tax bill because the “rollover” strategy he tried to implement is not allowable. Non-spouse IRA beneficiaries cannot “rollover” IRA assets. Had he called us first he would have been advised to establish a separate, Beneficiary IRA which would have allowed him to inherit his mother’s IRA, without taxation, as a trustee-to-trustee transfer, not a rollover.
3) Private Letter Ruling Saves a Pension Account
A retired female physician is overheard describing the horrible financial mistake that she made. She is obviously distraught. When she retired in June she had liquidated her pension account and deposited the funds into her (taxable) brokerage account. She had fully intended to open an IRA account and re-deposit the funds within the 60-day window. Unfortunately, she was distracted by a series of family tragedies and completely forgot to open the IRA. When she realized her mistake she spoke with several financial advisors in town who all told her that once the 60-day window expired there was nothing she could do. In February, she receives a 1099 for an $850,000 distribution. Her tax bill would be over $250,000. Fortunately, the story was not over. Her new financial advisor recommended that she write a letter to the IRS explaining what happened and ask for a private letter ruling. The IRS reviewed her situation and granted her request to re-establish the pension account which she then properly rolled over into an IRA. The woman then told everyone she knew about the advice she had received.
4) Outdated Estate Plan
A couple meets with an estate planning attorney to establish a trust. At the same time they revise their IRA beneficiaries. Their only son Junior is a minor, so they name their trust as the beneficiary of their IRAs with Uncle Bob acting as trustee for the benefit of the minor child. When the couple dies the funds go to the trust and Uncle Bob takes over as trustee just as planned. Junior, however, is outraged. Why? Because Junior is now 35 years old and certainly doesn’t need Uncle Bob to make his financial decisions for him. The couple had never discussed their IRA beneficiaries since they named the trust as primary beneficiary 25 years ago. Sometimes excellent service means just talking about financial issues and asking appropriate questions like, “When was the last time you reviewed your account beneficiaries?”
5) Income In Respect Of Decedent (IRD)
When calculating an individual’s gross estate upon death all property the decedent owns or has an interest in, including income owed to the decedent at the time of death but not yet received, is included. The fair market value of this income is also included in the income tax return of the beneficiary. Because the inclusion of this income in both the estate tax return of the decedent and the income tax return of the recipient can create double taxation, the tax laws provide for a tax deduction under IRC section 691(c). The deduction can reduce the added income tax the beneficiary would bear as a result of including the IRD on its return. Even though this is conceptually simple, taking the federal estate tax deduction on IRD is often erroneously calculated or missed entirely. In the future, as many individuals will become beneficiaries of estates that include IRD, reminding clients of the importance of the IRC section 691(c) deduction is critical.
6) Customized Mortgages
A new home buyer is shopping 30-year fixed rate mortgages and calls a mortgage lender for a rate. The lender quotes their best 30-year rate and is thanked for his service. But what if the homeowner knows that he will be transferred in 3-5 years? Does it make sense to pay a higher monthly payment every month to guarantee that it will not increase for the next thirty years? We take the time to ask a few questions and determine if the home buyer would be better served using a five-year, fixed-to-adjustable rate mortgage. And by coupling the primary mortgage with a home equity line the home buyer could limit his down payment to 10%.
|