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Tag: Roth

Refunds to the Highly Compensated

Refunds to the highly compensated employees (HCE) in a qualified retirement plan can be frustrating to the participants and a challenge to the plan administrator.  Various options exist to improve this situation.  These include:

  • More effectively manage the deferral and refund process
  • Eliminate the issue of refunds caused by testing
  • Allow the participant to continue to individual retirement accounts

This article will discuss these options.

  1. More Effective Management 

If a plan is using the “current year” testing method, consideration could be given to using “prior year” testing.  Under the “current year” option, the data is not finalized until after the end of the year and the HCEs do not know the amount they can contribute until after the testing is completed.

Under the “prior year” option, the data from the previous year is used to provide the maximum deferral amount for each HCE.  This should eliminate excess deferrals that require refunds.

Another option is to notify the HCE at the beginning of the year regarding the estimated maximum deferral.  This is based on the prior year average deferral of the non-highly compensated employees (NHCE) and a review of the current deferrals of each of the HCE.  Of course, this amount may change during the year due to changes in the deferrals of either group.

  1. Consider a Safe Harbor Plan

A safe harbor plan allows the HCE to contribute the maximum allowable deferrals without regard to the average deferrals of the NHCE. There are various safe harbor options that a plan could consider.  These include:

  • Basic Safe Harbor Match (equal to 100% of amount contributed up to 3% of pay, plus 50% of amount contributed, up to the next 2% of pay);
  • Enhanced Safe Harbor Match (must be at least as generous as the basic formula, normally equal to 100% of amount contributed up to 4% of pay);
  • 3% Non-Elective Contribution (NEC); and
  • Qualified Automatic Contribution Arrangement (QACA):
    • QACA Match (equal to 100% of amount contributed up to 1% of pay, plus 50% of amount contributed, up to the next 5% of pay) or
    • QACA 3% NEC.
  1. Options for the Participant

Each HCE has several options to contribute to retirement accounts outside of the qualified plan.  These include:

  • IRA Deductible Contributions:  In most cases, HCEs do not qualify to make deductible IRA contributions.
  • Non-Deductible IRA Contributions:  Most HCEs qualify to make non-deductible IRA contributions.  The maximum contributions to IRA accounts for 2022 is $6,000 plus $1,000 for employees 50 and older. 
  • IRA to Roth IRA Conversions:  Each HCE should carefully consider the strategy of making non-deductible IRA contributions followed by a Roth conversion.  This works extremely well with participants who do not have an existing IRA account.  The non-deductible contribution is made, and the account is immediately converted to a Roth IRA.  The result of this process is that the money ends up in a Roth IRA growing income tax free just as it would have if the HCE elected to defer to the Roth 401(k) account inside the qualified plan.  If the participant has existing IRA accounts with zero basis, this option does not work as well.  In this case, the conversion would create additional taxable income.  This may or may not be an issue based on the current tax bracket and the projected future tax brackets. 
  • Some HCEs have outside businesses that generate taxable income.  In some cases, the HCE has the option of opening a SEP plan and deferring money to the SEP account.
  • Annuity contracts often allow investors to contribute unlimited amounts.  These contributions are after tax and form the basis in the annuity contract.  All the accumulated growth and earnings in the contract grow tax deferred.  Caution should be taken to avoid buying an annuity that has high internal fees and pays high commissions to the salesperson.  Always inquire as to the commissions to be paid, total expenses of the plan, and withdrawal options and penalties. 

Plan administrators should carefully consider the plan design to determine if changes could be made to manage this process more effectively.  HCE should seek guidance from qualified advisors to examine the various options available to assist them in making the critical long-term decisions regarding their retirement planning. 

by: Anthony McCallister, AIF®, J.D.

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To discuss this article further or to learn more about CapSouth Wealth Management, visit our website at www.capsouthwm.com or call 800.929.1001 to schedule an appointment to speak with an advisor.

Investment advisory services are offered through CapSouth Partners, Inc, dba CapSouth Wealth Management, an independent registered Investment Advisory firm. Information provided by sources deemed to be reliable. CapSouth does not guarantee the accuracy or completeness of the information. CapSouth does not offer tax, accounting, or legal advice. Consult your tax or legal advisors for all issues that may have tax or legal consequences. This information has been prepared solely for informational purposes, is general in nature and is not intended as specific advice.

IRA Strategy

IRA Strategy #1

The 50/50 Minimum Strategy:  Maintain 50% of your 401(k) and IRA money in Roth accounts

Why pay taxes today when you can postpone them until years later? The obvious answer is to delay paying taxes as long as possible.  But sometimes the obvious answer is not the best answer.  Let’s consider several assumptions that support the 50/50 Minimum Strategy.

First, if one invests the money that would have gone to taxes, it should compound over time and the total investments, less the eventual taxes to be paid, would potentially be greater than the amount of the Roth conversion, plus earnings.  The problem with this is most people will not diligently invest the money that would have gone to pay the tax.  It is more easily spent in the normal household budget.  And even if it were invested, the potential to keep it invested over a long period of time is dependent on many variables. 

Second is the assumption that a person’s income will be lower in retirement. This is true for many taxpayers.  However, many of our clients remain in a high tax bracket after retirement.  This is especially true if one has large IRA balances that require minimum distributions combined with large investment accounts that create capital gains. 

Third is the assumption that tax rates will remain relatively stable over time.  This is the most dangerous assumption.  Congress has the power to change the tax rates at any time and with the skyrocketing budget and related government debt, it appears likely that tax rates will be higher in the future. So, even if one’s income is lower, the tax rate could be higher. 

How high could tax rates go?  The following chart provides a history of the highest marginal tax rate for 1944 through 2022 for married couples filing jointly:

Years                                                 Highest Marginal Rate#                 Taxable Income Over#

1944 through 1951                           91%                                                 $200,000 (1950)

1952 through 1953                           92%                                                  $300,000 (1953)

1954 through 1963                           91%                                                   $300,000 (1958)

1964                                                  77%                                                   $200,000 (1964)

1965 through 1981                           70%                                                   $180,000 (1974)

1982 through 1986                           50%                                                   $108,300 (1984)

1987                                                  38.5%                                                $80,000 (1987)

1988 through 1990                          28%        (Bubble Rate 33%)           $78,400 (1988)

1991 through 1992                           31%                                                    $70,450 (1991)

1993 through 2000                          39.6%                                                  $288,350 (2000)

2001                                                  39.1%                                                  $297,350 (2001)

2002                                                 38.6%$                                                 $307,050(2002)                           

2003 through 2012                           35%                                                     $388,350 (2012)

2013 through 2017                           39.6%                                                  $444,550 (2017)

2018 through 2022                           37.0%                                                  $647,850 (2022)

#  Rate for Married Couples Filing Jointly

 Information provided by The Tax Foundation, Washington, DC. 20005

The strategy that we have continued to recommend to most of our clients is to approach retirement with a minimum of 50% of their IRA and 401(k) assets held in Roth accounts.  With this approach, an investor takes a balanced approach to the payment of taxes.  Pay taxes at the rates in effect now on the Roth contributions and conversion amounts while delaying the taxes on the non-Roth portion of their deferrals or contributions.  If we err on one side or the other, we prefer to convert more of the retirement assets and pay the taxes at today’s rates as opposed to leaving these assets subject to whatever future rate Congress enacts. 

If a client is charitably minded, we do not recommend converting ALL your IRA assets.  The preferred use of a portion of your IRA assets is to process Qualified Charitable Distributions (QCD) with the pre-tax IRA assets.  After age 70.5, taxpayers may donate money directly from their IRA to qualified charities utilizing the QCD provisions.  The annual limit on QCD donations is currently $100,000. 

ACTION:  Consider adopting the strategy of working towards a minimum Roth balance of 50% of your total retirement assets by your retirement date.  Work with your financial advisor to determine if you should convert a higher percentage. 

To discuss this article further or to learn more about CapSouth Wealth Management, visit our website at www.capsouthwm.com or call 800.929.1001 to schedule an appointment to speak with an advisor.

By: Donald P. Bolden, CFP®, CLU & Lewis Robinson, CPA

Investment advisory services are offered through CapSouth Partners, Inc, dba CapSouth Wealth Management, an independent registered Investment Advisory firm. Information provided by sources deemed to be reliable. CapSouth does not guarantee the accuracy or completeness of the information. CapSouth does not offer tax, accounting, or legal advice. Consult your tax or legal advisors for all issues that may have tax or legal consequences. This information has been prepared solely for informational purposes, is general in nature and is not intended as specific advice. Any performance data quoted represents past performance; past performance is no guarantee of future results.

401(k) Saving

Shocking Reality of 401(k) Saving

I have likely spoken to thousands of 401(k) participants over the past four to five years, in either group meetings or in one-on-one review meetings. The shocking revelation I received is the fundamentals of 401(k) saving do not change.  These best practices, when exercised in a healthy financial environment, can assist a family in accomplishing their retirement goals.  

When I find myself in front of participants, I do not preach the gospel of 401(k)s… I preach saving and preparing for life events.  Your company’s retirement plan is only one of the many tools that you can use to accomplish your goals. Regardless of whether you save in 401(k)s, IRAs, ROTHs, real estate, or other vehicles, the main goal is to earmark dollars for retirement. 

So, the beginning of any conversation is always, “Where do you want to go? What do you want to do? How are you going to get there?”  Amazingly, if you login to your 401(k)’s website, you are normally provided all the tools you need to calculate and model your current financial position and what steps you need to take to replace a portion, or all, of your current income in retirement.  We are all moving somewhere in life.  All retirement plan participants should determine where they want to go and develop a plan to get there.      

Most well laid plans can easily be undermined if we fail to build the proper foundation.  The foundation needed in this case is paved with margin.  Margin is the space you build between your needs and wants, and it provides the proper footing to establish your financial plan.  We recommend striving to live on 75% to 80% of your family’s gross income.  This will make available 20% to 25% of your gross income to save for retirement, for college, for rainy day funds, or for charitable undertakings.  This may require a period of reducing your spend rate, snowballing credit card debt, or increasing earning ability.  Once the margin is built, it will provide the capacity to fund present and future needs and wants.     

In the meantime, develop the habit of savings.  A saving plan normally works best when it is automated.  “We should automate the important.” In normal situations, automating savings moves it from a manual undertaking to an automatic arrangement which puts it out of mind, out of sight. When we do this, we adjust our standard of living accordingly, and then move on with our lives.  Experts say we need to earmark 10%-15% of our gross income towards retirement.  How do we do this?  Start somewhere, anywhere.  And then increase your contribution 1% every six-months or annually.  So, how do we get to a 10%-15% savings rate, “1% at a time”.

These foundational 401(k) savings tips can be applied almost universally across the 401k landscape.  Developing a financial plan to live your best life, building in the foundation of margin, and developing the habit of saving provides a firm footing to reach our retirement goals.  We are all headed towards a date where we will need to live on a stream of income.  Becoming good savers today will make the journey and destination better.

Article by: ANTHONY MCCALLISTER, AIF®, J.D.

To learn more about CapSouth Wealth Management visit our website at www.CapSouthWM.com

If you would like to discuss your 401(k) savings options, request an appointment at www.CapSouthWM.com/contact  or contact our office at 800.929.1001. 

CapSouth Partners, Inc., dba CapSouth Wealth Management, is an independent registered Investment Advisory firm.  This material has been prepared for planning purposes only and is not intended as specific advice. CapSouth does not offer tax, accounting or legal advice. Consult your tax or legal advisors for all issues that may have tax or legal consequences.

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