Category Archives: What Nick’s Reading

3 Steps to Calculate Your Shell 80 Point Benefit Restoration Plan Pension Lump Sum

Realistically, it is a complicated and often confusing process to calculate Shell’s 80 Point BRP Pension, and it requires an actuary to do the math accurately.

 

However, Shell employees can calculate a rough estimate that enables them to understand the potential magnitude of how the change in rates may impact their lump sum benefits.

 

STEP ONE: Calculate the Value of the Shell 80 Point Pension

The first step is to calculate the value of the Shell 80 Point Pension according to the formula, which you can find in the Shell Benefit Book.

 

The Shell 80 Point Pension formula is 1.6% * average final compensation * years of service.

 

For this example, let’s assume the Shell employee’s average final compensation is $600,000, years of service is 30, and age at retirement is 60.

 

If we do the math, the pension is valued at 1.6% * $600,000 * 30 = $288,000 / year, or $24,000 / month.

 

The dilemma is that an employee in such a financial situation will not receive an 80 Point Pension of $24,000 per month because a substantial portion of their benefit will be saved in the BRP plan since they are a highly compensated employee.

 

 

STEP TWO: Log In to Fidelity NetBenefits & Perform a Pension Calculation

Once we calculate the total value of the pension, we log onto to Fidelity NetBenefits and do a pension calculation.

 

For this example, let’s say that NetBenefits is showing a Shell 80 Point Pension of $11,000 per month. We know the difference ($24,000 – $11,000 = $13,000) is roughly the ‘monthly annuity value’ of the BRP pension. As we discussed previously, the BRP is paid out as a lump sum, not an annuity.

 

The easiest way to estimate the Shell 80 Point BRP Pension lump sum value is to revisit NetBenefits. The dilemma is that NetBenefits is not set up to show Shell employees the difference in value a change in interest rates may have on their BRPs, which is essential for this analysis.

 

 

STEP THREE: Estimate the Value of the Shell 80 Point BRP Pension Lump Sum

The next step is to walk through how the math works to perform a rough calculation of the estimated value of the BRP Pension lump sum. Essentially, it comes down to the basic time value of money.

 

Since the lump sum is the present value of future estimated monthly BRP annuity payments, we need to calculate a summation of all future BRP theoretical annuity payments over the employee’s estimated life expectancy discounted by the applicable rate. 

 

PV = PMT1/(1+r)¹ + PMT₂/(1+r)2 … PMTn/(1+r)n.

 

Remember, as interest rates go up, the pension value will go down, and vice versa.

 

interest rate vs pension

 

Of course, to properly do this we need to know life expectancy and the appropriate discount rate to use. For this example, let’s use the Social Security’s Life Expectancy Calculator as our approximation of life expectancy. As we can see in the table, a 60-year-old male born in 1958 has a life expectancy of 23.2 years.

 

 

Life Expectancy Calculator

 

The discount rate used in the Shell 80 Point BRP Pension is the Minimum Present Value Segment Rates published by the IRS. Specifically, Shell uses the rates from September 30th of the 2017 year for any pension that began in the 2018 year.  

 

I am going to state that one more time because it is so important. Shell uses the rates from September 30th of the prior year for any pension that begins in the current year.

 

For example, let’s say you retire November 30, 2018, and begin your pension on December 1, 2018. In this situation, your pension will be calculated based on the segment rates as of September 30th, 2017—the prior year.

 

In comparison, if you retire December 31st, 2018 and begin your pension on January 1st, 2019, then the segment rates to use for discounting is based on September 30th, 2018.

 

Another important note is that the blended rate is three different rates instead of one rate. First Segment is the rate used to discount the first five years. The Second Segment rate is used to discount years six through fifteen. The Third Segment rate is used to discount any pension payments paid out after year fifteen.

 

To learn more about the impact of interest rate changes on your Shell BRP Pension Lump-Sum, walk through our real life examples by reading our previous blog, You Could Increase the Value of Your Shell 80 Point BRP Pension by More Than $200K by Retiring 31 Days Earlier.

 

Or, take some time to review your retirement options by scheduling a free consultation with one of our Shell benefits specialists

 

 

Related Posts:

You Could Increase the Value of Your Shell 80 Point BRP Pension by More Than $200K by Retiring 31 Days Earlier

How Waiting 15 Days to Retire May Save You $50,000 in Taxes on Your BRP Payouts

Non-Qualified Retirement Plan Tax Risks the Corporate Professional Should Avoid

Sequence of Return Risk

Will You Optimize Your Employee Benefits Elections This Fall? Here’s What You Should Consider BEFORE Open Enrollment

 

 


nickNick Johnson, CFA®, CFP®

CONNECT WITH ME ON LINKEDIN

 

Nick Johnson believes that financial planning is more than numbers on a balance sheet and a standardized process. People are unique and should be treated as such.

 

As Vice President and Wealth Manager at Willis Johnson & Associates, his goal is to really get to know his clients, all the while providing a proactive approach to comprehensive wealth management.

 


 

 

Willis Johnson & Associates is a registered investment advisor. Information presented is for educational purposes only. It should not be considered specific investment advice, does not take into consideration your specific situation, and does not intend to make an offer or solicitation for the sale or purchase of any securities or investment strategies. Investments involve risk and are not guaranteed. Be sure to consult with a qualified financial advisor and/or tax professional before implementing any strategy discussed herein. Insurance products and services are offered or sold through individually licensed and appointed agents in various jurisdictions.

What Nick’s Reading | You Could Increase the Value of Your Shell 80 Point BRP Pension by More Than $200K by Retiring 31 Days Earlier

 

Most of our Shell clients do not realize that their pension can be impacted by interest rates. Specifically, their Shell 80 Point Benefit Restoration Plan (BRP) Pension.

 

For high income earners that have spent their entire careers at Shell, properly managing this impact may amount to saving hundreds of thousands of dollars—especially for those that are planning on retiring in the near term.

 

This article will walk you through how interest rates impact your Shell 80 Point Benefit Restoration Plan Pension payout and what you can do about it.

 

A Brief History of Interest Rates

Economists have been continually calling for interest rates to increase for nearly a decade and now, we are beginning to see this happen. 

 

As you may know, the Federal Funds Rate (FFR) for 2018 started at 1.42% on January 4, 2018 with three rate hikes so far, not including the additional rise in rates we will likely experience by the end of this year. The FFR reached 2.18% on October 16, 2018.

 

Likewise, on January 2, 2018, the 10-Year U.S. Treasury started the year off at 2.46% and increased to 3.16% by October 16, 2018. Compared to historic trends, we are at unprecedented low levels of rates.

 

Note, this does not mean rates will go up immediately. Economists have been wrong for a number of years, and just because we have seen a major movement in rates this year doesn’t mean they will keep going up next year. However, we do know that the rise in rates we have already experienced from September 2017 to September 2018 is going to impact the value of pension lump sums for our Shell clients retiring in the near future.

2018 Intere

 

Wait My Shell 80 Point Pension is an Annuity, Interest Rates Shouldn’t Affect Me!

 

Yes, your Shell 80 Point Pension is required to be paid out as an annuity. You cannot take it as a lump sum. Interest rates primarily affect lump sum pension payouts.

 

What you may be forgetting is the 80 Point Benefit Restoration Plan (BRP) Pension. If you are a highly compensated employee of Shell Oil and are on the 80 Point Shell Pension Plan, it is likely that Shell is making contributions to the Shell 80 Point BRP Pension on your behalf. When you retire, Shell pays a lump sum benefit to your BRP Pension approximately 90 days after your retirement date (6 months if you are considered a key employee). The Shell BRP Pension is immediately taxed at distribution. If you want to learn more about how to minimize taxes, read my article on Shell BRPs and taxes.

 

The Shell Benefit Restoration Plan Pension is a non-qualified pension plan, meaning it does not receive the same preferential tax benefits as your qualified pension.

 

For most retirees, this means the Shell BRP Pension is paid out within 90 days of retirement and immediately taxed. You cannot roll your BRP over into your 401(k) or IRA. You cannot elect to defer receiving proceeds from your BRP over time (unless you have an Old Money contribution, or made prior to benefit elections in 2007).

 

Changing Your Retirement Date May Save You More Than $200,000 in Taxes on Your Shell 80 Point BRP Pension Lump Sum Payout

 

November 30th Retirement Date

 

For this example, let’s assume the Shell employee meets the following criteria:

 

a) 60-year-old retiring November 30th

b) Pension starting on December 1st

c) Average Final Compensation is $600,000

d) Thirty years of service with Shell

e) The value of both the traditional 80 Point Pension and BRP Pension is worth $24,000/month

f) Netbenefits is showing a traditional 80 Point Pension of $11,000/month

g) Life Expectancy is 83.2 years

 

If we run the math on the above example, then the value of the lump sum BRP Pension is worth around $2,629,000.

 

Let’s briefly walk through how the math works to perform a rough calculation of the estimated value of the BRP Pension lump sum. Essentially, it comes down to basic time value of money. Since the lump sum is simply the present value of future estimated monthly BRP annuity payments, we need to calculate a summation of all future BRP theoretical annuity payments over the employee’s estimated life expectancy discounted by the applicable rate. 

 

PV = PMT1/(1+r)1 + PMT2/(1+r)2 … PMTN/(1+r)N.

 

Remember, as interest rates go up, the pension value will go down, and vice versa.

 

The Recent Changes in Segment Rates and Their Impact on Your Shell 80 Point BRP Pension Lump Sum Payout

 

You may have noticed that rates from September 2017 through August 2018 have risen significantly. The September 2017 rates will not be published until October 12, 2018, but we can estimate what they will be with a reasonable degree of accuracy.

 

Note, higher interest rates mean a lower value for your Shell 80 Point BRP Pension lump sum.

 

Segment Rates

December 31st Retirement Date

Let’s re-run the above example and change the Shell employee’s retirement date to be 31 days later than the previous example.

 

a) 60-year-old retiring December 31, 2018

b) Pension starting January 1, 2019

c) Average Final Compensation is $600,000

d) Thirty Years of Service with Shell

e) The value of both the traditional 80 Point Pension and BRP Pension is worth $24,000/month

f) Netbenefits is showing a traditional 80 Point Pension of $11,000/month

g) Life Expectancy is 83.2 years

 

If we re-run the example with a December 31, 2018 retirement date and a pension start date of January 1, 2019, then the value of the lump sum is worth approximately $2.4 million—that is a difference of around $229,000! Simply by retiring 31 days earlier, this Shell employee could save hundreds of thousands of dollars!

 

Who Can Benefit From This Shell 80 Point BRP Pension Strategy?

Those who should be considering this strategy are Shell employees who are planning to retire in the next 18 months, but are also able to retire at an earlier date. This strategy may not fit those taking voluntary severances as Shell may have requirements for their termination date, and the severance can be worth a substantial amount as well.

 

We are helping our Shell clients who are looking at retiring in the next 18 months to analyze their choices considering today’s rising rates so they can make the best election decision for their situation. Of course, taxes, other financial assets, personal goals, and financial needs all come into play. That’s why we perform a comprehensive assessment with our clients, instead of simply looking at one item.

 

If you are looking at retiring in two to five years, and are concerned about how rising rates may affect your lump sum pension, don’t over react. The value of your pension will increase by working longer and no one knows exactly how much rates are going to rise.

 

Please note, this a general education article illustrating some of the ways we help our clients make complex financial decisions. Before you make any decision, we recommend you work with a fiduciary financial advisor and seek confirmation about your pension benefits and choices from Shell HR. There are numerous employees at Shell who have varying pension rules due to acquisitions, obtaining U.S. citizenship, being on the APF pension plan instead of the 80 point, as well as additional factors. It is best to confirm how your retirement date affects your pension before making any decisions.

 

If you have questions about your Shell benefits and would like to get a second opinion, contact one of our advisors who specialize in helping Shell employees make the most of these retirement savings tools.

 

 


nickNick Johnson, CFA®, CFP®

CONNECT WITH ME ON LINKEDIN

 

Nick Johnson believes that financial planning is more than numbers on a balance sheet and a standardized process. People are unique and should be treated as such.

 

As Vice President and Wealth Manager at Willis Johnson & Associates, his goal is to really get to know his clients, all the while providing a proactive approach to comprehensive wealth management.

 

 


 

 

Willis Johnson & Associates is a registered investment advisor. Information presented is for educational purposes only. It should not be considered specific investment advice, does not take into consideration your specific situation, and does not intend to make an offer or solicitation for the sale or purchase of any securities or investment strategies. Investments involve risk and are not guaranteed. Be sure to consult with a qualified financial advisor and/or tax professional before implementing any strategy discussed herein. Insurance products and services are offered or sold through individually licensed and appointed agents in various jurisdictions. 

What Nick’s Reading | Why Your Financial Advisor Should Be Your Wrong Decision Watch Dog: Guarding Your Investments Against Emotional Influence

I was in Dallas last week attending Fidelity’s Inside Track conference, an educational event for Registered Investment Advisors (RIAs) who utilize Fidelity’s platform.

 

These conferences have top-tier technical specialists speaking on a variety of subject matter, which I love, but they also allow me to step away from the office and gain a different perspective on the advisory business and the value we provide to our clients.

 

While at the conference, I had the opportunity to network with others from successful advisory practices and listen to expert insight regarding today’s financial planning industry. This information prompted me to reflect on the unique value-add provided by top-notch financial advisors like ourselves. Despite what most people think, this value differentiator is not money management, financial planning, or even tax advice—though I do believe we add significant value to each of those areas.

 

Ron Carson (from the Carson Group) has said that “our job as advisors is to keep people from doing the wrong thing at the wrong time.” David Geller from JOYN put it another way, “Money is emotional. No matter how analytical you are, you can’t rationalize your way out of emotional concerns.”

 

Today, there is a growing concern in our industry regarding expense ratios and cost. So much of the world is debating over the effectiveness of passive versus active management, and passive managers are winning. They are seeing considerable inflows—primarily from retail accounts (the average investor’s accounts). What’s not part of the conversation, and should be, is how the major determinate of long-term investment success is not the difference between the 0.1% expense ratios on passive funds and the 0.75% expense ratios on active funds, but the timing and selection penalty that the average investor incurs when they make poor investment choices about when and what to buy and sell in the market. I like to refer to this loss as the “emotional gap.”

 

The below study produced by Dalbar illustrates the cost penalty incurred from investment expenses (2.9%) that reduce the investor’s net of fee returns compared to the market.* However, what’s an even greater and widely unbeknownst concern is the timing and selection penalty (6.7%). Again, I often like to refer to this as the “emotional investor penalty.”

*Refer to Vanguard’s blog for more details on the Dalbar study.

 

The stock market, funds, and fund owners

 

The Average Investor’s BIG BAD Decision: Behavioral Decision Making and Its Effect on Investment Returns 

 

It’s not unusual for investors to make one truly bad decision every few years. This decision can be something that seems harmless at the time, like feeling uncomfortable about the current market and deciding to wait it out.  We frequently observed this kind of emotional decision making in 2011 as many people suffered from post traumatic stress following the 2008 recession. They thought the market had run a huge amount from the bottom, which resulted in their preference to sit in cash, bonds, or an overall much more conservative allocation than they would have in otherwise normal times. Having cash in the bank provided reassurance, but what it did not provide was growth. As a result, the opportunity loss investors experienced from 2012 to 2018 was massive and is unlikely to be compensated for in future years.

 

The nearly 300% run in the S&P 500 in 2018 from the bottom in March of 2009, as well as the fact that we are now in the longest bull market in history, has elicited concern among a number of our clients who are worried about the market’s future.  I have talked to some clients who believe it makes sense to dump all of their international holdings. Others believe that bonds do not make any sense and we should simply be holding cash. Still, others see this bull market as never ending and have asked if we should be rotating all of their conservative fixed income positions to aggressive equities.  

 

Impact of Emotional Investing

 

The dilemma with the emotional influence on investment decisions is that it can feel subtle but have an outsized impact. For example, there is a general consensus among investors that:
• Trump and his tweets will cause the economy to tank
• Interest rates are going to go up (which, believe it or not, has been the consensus and been wrong for almost a decade as seen below)
• International equities should not be part of the portfolio due to recent poor performance

 

What all of these thoughts turn into is poor asset allocation and timing decisions—the “emotional gap.”

 

Forecasters Have Been Expecting Rates to Rise

 

One of the conference’s more intriguing data points was presented by Fidelity. They illustrated how investors tend to buy what is working and sell what is not. In light of this strategy, let’s take a look back at the 2009 market crash. As you may know, Fidelity is a giant in the 401(k) world. As such, they have a massive amount of data concerning how 401(k) plan participants are investing. According to Fidelity, at the peak of the market in 2007, baby boomer 401(k) participants who were not working with an advisor were allocating about 74% of every dollar contributed to equities.

 

At the bottom of the market in 2008, these same plan participants were only allocating 64% of every dollar contributed to equities—that’s a 10% decrease. Now, that may not sound like much, but the absolute best time to be purchasing stocks is near the bottom of the market. According to Fidelity, baby boomer plan participants that were working with advisors only saw a 1% decrease in equity allocation from before 2008 to the bottom of the market, while retail investors suffered a 10% decrease. In this case, the financial advisors were able to convince clients who were reacting emotionally to take a potentially large mistake and turn it into small ones. As a result, the advisors reduced the negative impact of emotional decision making and increased the long-term value of their clients’ investments. For a majority of client-advisor relationships, this is viewed as a success and is a common example of how proactive advisors can provide value to their clients through active consulting and custom financial planning.

 

Your financial advisor should work to remove emotion from your financial life and assist you in making prudent decisions based on complete information instead of gut-checks or the most recent news headlines. The industry is aware of this. For example, Vanguard, the original leader in low cost investing, has been hiring a record number of CFPs to assist in advising clients because they know having low cost investment options alone will not result in optimal long-term returns. Robo-investing mammoths such as Betterment and Personal Capital have been hiring advisors that investors can call and consult with before adjusting their portfolio. This service functions to help investors avoid emotional decision making that can significantly impact their financial future. Dimensional Fund Advisors (DFA) only sells their passive plus mutual funds that focus on five-factor beta based on modern portfolio theory to investors through advisors. They do this because they know that to keep clients from making irrational choices with their timing and asset allocation decisions, clients need a watchdog advisor.

 

Whether or not you’re concerned about the long-term optimization of your investments, it is always worth getting a second opinion about your future financial health. Contact us to schedule a meeting with a Willis Johnson & Associates professional today. 

 

 


nickNick Johnson, CFA®, CFP®

CONNECT WITH ME ON LINKEDIN

 

Nick Johnson believes that financial planning is more than numbers on a balance sheet and a standardized process. People are unique and should be treated as such.

 

As Vice President and Wealth Manager at Willis Johnson & Associates, his goal is to really get to know his clients, all the while providing a proactive approach to comprehensive wealth management.

 


Willis Johnson & Associates is a registered investment advisor. Information presented is for educational purposes only. It should not be considered specific investment advice, does not take into consideration your specific situation, and does not intend to make an offer or solicitation for the sale or purchase of any securities or investment strategies. Investments involve risk and are not guaranteed. Be sure to consult with a qualified financial advisor and/or tax professional before implementing any strategy discussed herein. Insurance products and services are offered or sold through individually licensed and appointed agents in various jurisdictions. 

What Nick’s Reading | How Waiting 15 Days to Retire May Save You $50,000 in Taxes on Your BRP Payouts

Published: July 19, 2018

I was recently working with a Shell executive client, let’s call her Lynn, who had been putting in long hours on a challenging assignment and was ready to retire by September 30, 2018.

 

I worked with her to optimize a number of items in her financial plan, but the election that made the biggest difference to her — a difference of more than $50,000 in tax savings — was persuading Lynn to retire on October 15th, only 15 days later than her original September 30th retirement date.

 

Lynn came to see me for a second opinion. She wanted to be sure that her finances were properly set up for success and that she had everything in place to be financially independent in retirement. She told me how she planned to enjoy the Thanksgiving holiday with her family at her mother’s house on the East Coast, and take her husband and grown children to Prague for Christmas.

 

She had been with Shell for the entirety of her career, working her way up to an executive role, but had not been able to spend as much time with her family as she would have liked, for a number of years. Our goal in assisting Lynn was to grant her wish of retiring in time to spend the holidays with her loved ones, while optimizing her retirement income via strategic tax-saving moves.

 

Understanding Excess Benefit Plans and BRP Payout Rules

Lynn was an exceptional saver throughout her career. Her disciplined saving, combined with Shell’s contributions to her Shell Pension BRP and Shell Provident Fund BRP, put her in great financial shape for retirement.

 

If Lynn retired on September 30th, her annual income would be $600,000, a summation of her base salary, bonus, and Shell Performance Shares that vested earlier in 2018.
Between her Shell Provident Fund BRP and Shell Pension BRP, Lynn had an excess of $1,000,000 in Benefit Restoration Plans (BRPs).

 

 

Tax-Saving Retirement Strategy:  Timing Your Shell Provident Fund BRP and Pension BRP Payout

The Shell Provident Fund Benefit Restoration Plan (BRP) is a type of non-qualified excess benefit plan that is all pre-tax money. At Shell, the BRP pays out 90 days after retirement.*
*Note: There is an exception if you are designated a key executive at Shell. If that is the case, the BRPs are distributed six months after termination.

 
Why is this important? Because if you retire 90 days or more from December 31st, your BRP funds will be paid out that same year, the tax year in which you retired. However, by retiring less than 90 days from December 31st, you can retire one year, and have your BRP funds paid out the following tax year.

 
In the year the BRPs are distributed, they are taxed at earned income tax rates. Thus, the higher your taxable annual income when BRPs are paid out, the higher the marginal tax bracket you will fall into for that year, and the higher percentage of taxes you will pay on the Benefit Restoration Plan funds you receive.

 
If Lynn would have received the $1,000,000 of compensation at the end of the year, the funds would have been stacked on top of the $600,000 of compensation she had already received. The entirety of the $1,600,000 funds would have been taxed at the max ordinary income bracket of 37% for 2018, in addition to the 0.9% Additional Medicare Tax stacked on top of the Medicare Rate of 1.45%.

 
Since Lynn’s income is over the Social Security Wage Base of $128,400, in this scenario her $1,000,000 BRP distribution would not be subject to social security tax rates as the 6.43% tax is only applied to the first $128,400 of earned income.

 

 

BRP Payout Taxes and the Timing of Distributions: How Postponing Your Retirement Date Can Reduce Taxes on Excess Compensation Plans

Lynn’s decision to wait until October 15th to retire enabled her to push her Shell Provident Fund BRP and Pension BRP distributions from 2018 to the 2019 tax year. Postponing retirement allowed Lynn to utilize lower marginal rates for the first $600,000 of the BRP distributions and save a substantial amount in taxes as a result.

 
The only downside for Lynn is that she would be required to pay Social Security taxes of 6.45% up to the Social Security Wage Base, which is currently $128,400 on her 2018 earned income of $633,000 and her 2019 BRP payout of $1,000,000. Despite paying the additional Social Security tax on her BRP distribution, pushing the Provident Fund BRP and Pension BRP payout out to the following tax year would result in substantial tax savings for Lynn—totaling an excess of $50,000.

 

If Lynn decided to retire on September 30, 2018, her Shell BRP funds would be subject to the 37% ordinary income tax rate when distributed in 2018, as her total taxable annual income would exceed the $600,000 limit for married couples filing a joint tax return. Lynn’s Shell Provident Fund and Shell Pension BRP would be paid out in the 2018 year, given Lynn’s retirement date is more than 90 days before the year’s end.

 
Remember, at Shell, the BRPs pay out 90 days after retirement.*

 
As a result, her annual income would be a summation of her $600,000 in existing compensation for 2018 and her $1,000,000 Shell Provident Fund and Pension BRP payout, totaling $1,600,000 in annual taxable income. Thus, Lynn’s total annual income tax for 2018 would be $565,810.

 
If Lynn chose to retire just 15 days later, on October 15th, her Shell BRP payout would be distributed in 2019 and the funds would be taxed at a lower marginal rate. Her income for 2018 would be $633,000, the extra $33,000 due to the fact she worked one more pay period than she would if she retired in September. Lynn’s taxable income for 2019 would be the $1,000,000 payout from her Shell Provident Fund and Pension BRP. Thus, her income tax for 2018 would be $185,426 and her income tax for 2019 would be $327,460, totaling $512,886 of income tax for the 2018 and 2019 tax years.

 
Lynn would pay $52,924 less income tax if she chose to delay her retirement date only 15 days, and she can still enjoy the holiday vacations she planned for her family.

 
While it’s important to understand your company’s compensation plans and benefits, it’s also important to understand how your retirement savings options can be utilized in the most tax-efficient way. As we have demonstrated using Lynn’s situation, something as simple as the date you retire can open the door to tax-advantaged saving opportunities.

 
If you’re uneasy and think you may be missing something in your current plan, consult with your financial advisor, or contact a member of the Willis Johnson & Associates team to learn more about how to create a financial road-map that maximizes your retirement savings by strategically aligning your company benefits with your long-term financial plan.

 

Related Articles:

What Nick’s Reading | How Restricted Stock Works & What You Should Consider for Your Financial Plan

What Nick’s Reading | What You Need to Know When Contributing to Your Company’s 401(k) Plan

Financial Fact | Non-Qualified Retirement Plan Tax Risks the Corporate Professional Should Avoid

Thoughts From Willis | What it Means to Have a Proactive Versus a Reactive Advisor

What Nick’s Reading | Sequence of Return Risk

What Nick’s Reading | Withdrawing Money During Your Retirement Years in the Most Tax-Efficient Way

 

 


nickNick Johnson, CFA®, CFP®

CONNECT WITH ME ON LINKEDIN

 

Nick Johnson believes that financial planning is more than numbers on a balance sheet and a standardized process. People are unique and should be treated as such.

 

As Vice President and Wealth Manager at Willis Johnson & Associates, his goal is to really get to know his clients, all the while providing a proactive approach to comprehensive wealth management.

 


Willis Johnson & Associates is a registered investment advisor. Information presented is for educational purposes only. It should not be considered specific investment advice, does not take into consideration your specific situation, and does not intend to make an offer or solicitation for the sale or purchase of any securities or investment strategies. Investments involve risk and are not guaranteed. Be sure to consult with a qualified financial advisor and/or tax professional before implementing any strategy discussed herein. Insurance products and services are offered or sold through individually licensed and appointed agents in various jurisdictions. 

What Nick’s Reading | What You Need to Know When Contributing to Your Company’s 401(k) Plan

Published: June 15, 2018

Company 401(k) contributions are one of the most valuable retirement perks offered by employers, but unless you understand the nuances of how your company’s plan works, you may miss out on key benefits.

 

Many professionals assume it’s both saving-savvy and financially proactive to save more in your company 401(k) earlier in the year. The sooner you get the money in your 401(k), the more time the funds have to grow, and the more tax-deferred earnings you save over time, right?  Not always…

 

This approach may work for those saving in a company plan that offers an employer match accompanied by a true-up provision, but it doesn’t work for everyone.

 

In fact, I recently worked with a new client who had been employed at BMC Software for over 10 years. He used the “save more, save early” approach when determining how he would disperse his contributions throughout 2017. Let’s call this client ‘Paul’.

 

As part of our comprehensive planning process, we reviewed Paul’s 401(k), the BMC Software Inc., Savings and Investment Plan. We sifted through quite a bit of data, including his 2017 year statement—and that’s where we noticed he only received 1.6% of his income in matching employer contributions when he was eligible to receive up to 5% per year. We immediately identified this as a red flag, as we work with a number of new clients from BMC who, like Paul, are misled by similar generalizations.

 

Due to the way Paul contributed to his plan, he only received $4,583 from BMC, when he was eligible to receive up to $13,750.

 

That’s a $9,167 difference in his annual savings!

 

We didn’t go back and check, but based on how Paul has been telling us he contributed, we’re fairly positive he had been missing out on the ‘free’ $9,167 for several years. The important takeaway from Paul’s situation — one we actively communicate to clients — is the importance of following a financial road-map custom to you and your retirement journey. The end goal is to create a comprehensive plan that facilitates a tax-advantaged retirement future while making the most of your employee benefits along the way.

 

However, this can be a challenge for professionals like Paul who may not have the time to manage their career while ensuring their financial strategy capitalizes on every opportunity in their employer’s retirement plan. Let’s walk through Paul’s situation and some of the math behind his unrealized employer contributions to better understand why he missed out on these funds and how he can take full advantage BMC’s benefits going forward.

 

What to Consider When Contributing to Your Employer’s 401(k) Plan: Employer Matching Contributions, IRS Limits, the True-Up Provision, & Where You May be Missing Out on ‘Free’ Money 

Why was Paul’s company 401(k) contribution strategy a dilemma? To understand why front-loading his contribution was limiting, it’s necessary to understand BMC’s benefits plan and how that impacted Paul’s saving strategy when contributing to BMC’s 401(k) plan.

 

First, it’s important to note that page 42 of BMC’s 2017 US-Benefits Guide states, “BMC matches 100% of every dollar you contribute, up to 5% of your eligible pay each pay period.” In other words, Paul must contribute every pay period to receive a match every pay period, and BMC will only contribute a match of up to 5% of Paul’s income for each corresponding pay period in which he saves in the BMC plan.

 

To get the 5% per paycheck match, Paul must contribute at least 5% of his income that pay period to his company 401(k). So, if he only contributes 3%, he will only get a 3% match from BMC. In contrast, if he contributes 21%, BMC will still only match up to 5% of his income for each pay period in which he makes the 21% contribution.

 

Further, BMC’s employer contribution rule is clearly stated on page 42 of the company’s benefit book, “…as soon as your contributions reach the annual IRS limit ($18,000 in 2017, $18,500 in 2018), your contributions and matching contributions will end.”

 

In light of this rule, it’s also important to remember that the BMC Software Inc., Savings & Investment Plan is a per paycheck matching plan without a true-up provision.

 

So, if an employee reaches the annual IRS contribution limit within the first few months of the year, they will be restricted from making any future contributions and will not receive an employer match for the year’s remaining pay periods. In addition, BMC will not reimburse the employee, or ‘true-up’ the difference in missed contributions at the end of the year, which is why it’s necessary for employees like Paul to have a firm grasp of their plan’s unique stipulations. Once the matching opportunity is missed, there’s no going back, and years of overlooking these benefits can be a hard pill to swallow.

 

Let’s take a deeper dive into Paul’s predicament and break down some of the math involved…

 

⇒ Paul’s Annual Income/12 Months = $270,000/12 = $22,916.67/month.

⇒ The maximum BMC is going to contribute to Paul’s 401(k) per month is 5%, or $1,145.83/month.

⇒ BMC Matching Contribution per Pay Period X 4 Months = $1,145.83 X 4 = $4,583.33.

 

What happens to Paul’s contributions from January to April 2017?

 

For the first four months of 2017, BMC was contributing, $1,145.83 per month. After April, neither Paul nor BMC were able to contribute to his BMC Software Inc., Savings and Investment Plan for the remainder of 2017. Why? Once Paul’s contributions reached the annual IRS limit ($18,000 in 2017) his contributions and BMC’s matching contributions end.

 

Therefore, if Paul maxes out the IRS pre-tax $24,500 pre-tax and catch-up contribution limit by April, he does not receive an employer match for the rest of the year. As noted previously, BMC’s retirement plan does not include a true-up provision. Even though BMC’s matching contributions are cut short, the company will not compensate Paul for the money he could have received had he not maxed out his contribution limit so early in the year.

 

To reiterate, when Paul contributed to the BMC plan, he only received $4,583 in matching contributions from BMC for the entirety of 2017, when he could have easily received nearly $14,000. Had he known about the fine print in his employee benefits book, Paul could have accumulated thousands of dollars more per year, not including the corresponding tax-deferred earnings.

 

How Can You Distribute Your Annual 401(k) Contributions to Receive the Full Employer Match?

What should Paul do to maximize his annual contributions to his BMC Savings and Investment Plan for the 2018 year? First, he needs to determine the best way to distribute his contributions throughout the year so that he is contributing at least 5% of his income per pay period to his employer plan. Let’s walk through how he can do this.

 

BMC knows their matching contribution set-up is confusing and employees inadvertently miss receiving employer dollars as a result. To help solve this problem, they built the BMC 401(k) Deferral Calculator so employees can better estimate how to maximize their employer contributions. The BMC 401(k) Deferral Calculator is one of the easiest ways to do this. Paul can simply go to the website, enter his info, and the calculator will make recommendations specific to his situation similar to the results below.

 

Another way Paul can calculate his recommended contribution is by dividing the maximum annual pre-tax contribution ($18,500 for 2018) by the lessor of his annual income, or the IRS 401(a)(17) employee contribution limit ($275,000 for 2018):

 

⇒IRS Annual Pre-Tax Contribution Limit/Paul’s Annual Income = $18,500 / $275,000 = 6.73%

 

Since the BMC Savings Plan only accepts contribution increments of 5%, Paul should set his annual allocation to be 7% for the year. This way, he reaps the benefit of a 5% employer contribution all year.

 

*Note: We recommend our clients annually adjust their 401(k) contributions at the very beginning of the year for simplicity. We generally assist them to make the changes annually.

 

The True-Up Provision and Overlooked Employee Benefits 

Not all matching plans are as complicated as the BMC Software Inc., Savings and Investment Plan. Some plans have a true-up provision that ensures the company will ‘true-up’ any missed employer contributions at year’s end, even if an employee front loads their contribution at the beginning of the year. What’s nice about plans with a true-up provision is that as long as you’re maxing out your employer plan contributions, you’re also receiving the most money possible from your employer’s contributions.

 

According to a 2015 report, only 45% of employers that match contributions have a true-up provision in their employer-sponsored retirement plan!

 

This means nearly half of employees saving in an employer 401(k) do not have the safety net of a true-up provision and may risk making the same mistake as Paul. However, let’s be honest, who actually reads their company’s employee benefits book (other than us)?

 

*Note:  if a company’s benefits plan includes a true-up provision, we still normally recommend that our clients disperse their contributions throughout the whole year so that they don’t wait untill year end to receive their employer’s matching contribution.

 

Simple Contribution Plans and the Shell Provident Fund

In my opinion, the simplest and best 401(k) plans are those where the company makes a simple contribution to an employee’s 401(k) plan that is independent of the employee’s contribution.

 

For example, if you have been employed with Shell for nine years or more, the company will contribute 10% of your eligible pay to your employer-sponsored 401(k) plan, also known as the Shell Provident Fund. It doesn’t matter what amount you contribute to the 401(k) or when you make the contribution. If you are eligible, Shell will contribute 10%.

 

Unfortunately, not all plans are as easy to manage as the Shell Provident Fund and require knowledgeable management to fully take advantage of the employee benefits offered. Expert advice can help you identify the discrepancies and limits your company 401(k) plan entails, and leverage a contribution strategy that maximizes your annual retirement savings. Before you make a final decision, consult your financial advisor for advice, or meet with one of our financial professionals to get a second opinion on your company 401(k) contribution strategy.

 


nickNick Johnson, CFA®, CFP®

CONNECT WITH ME ON LINKEDIN

 

Nick Johnson believes that financial planning is more than numbers on a balance sheet and a standardized process. People are unique and should be treated as such.

 

As Vice President and Wealth Manager at Willis Johnson & Associates, his goal is to really get to know his clients, all the while providing a proactive approach to comprehensive wealth management.

 


Willis Johnson & Associates is a registered investment advisor. Information presented is for educational purposes only. It should not be considered specific investment advice, does not take into consideration your specific situation, and does not intend to make an offer or solicitation for the sale or purchase of any securities or investment strategies. Investments involve risk and are not guaranteed. Be sure to consult with a qualified financial advisor and/or tax professional before implementing any strategy discussed herein. Insurance products and services are offered or sold through individually licensed and appointed agents in various jurisdictions. 

What Nick’s Reading | Avoid Paying 2X the Tax on Non-Deductible IRA Contributions

Published: May 9, 2018

I hate to see people pay taxes twice, but it happens more often than you might think.

 

We see this most often among new clients who overlook the tax on non-deductible IRA contributions and their growth.

 

When we work with clients, especially new ones, we like to review their tax returns. A tax return tells us a lot about someone: 1) How many after-tax accounts they have, 2) If they are charitably inclined, and 3) What deductions they take. One of the sections we always check is Form 8606. This form tells us if they have non-deductible money (basis) in their IRA, which we consider to be a huge red-flag.

 

Why is it concerning to have non-deductible money in your IRA?  For one, we prefer our clients to have the contribution basis in a Roth IRA so all future growth is tax-free. In addition, individuals risk paying taxes on their basis twice at some point in the future if they keep the non-deductible basis in their IRA. In this article, we will outline the basics regarding traditional deductible IRA contributions and non-deductible IRA contributions, their corresponding tax implications, and how an in-depth understanding of how to navigate their tax discrepancies can help you avoid leaving money on the table as you save for retirement.

 

How do you get non-deductible money (basis) in your IRA?

We often work with our Shell, Chevron, Marathon Oil, and BMC clients to help them understand why they have non-deductible basis in their IRAs, and what they can do to mediate the tax risk they face as a result. 

 

Let’s say you are a successful professional or executive in the Houston area.  You are a saver. After paying your necessary expenses, you put all the money you can aside to prepare for retirement. After maxing out the pre-tax contribution on your company’s 401(k) plan, you resort to putting your extra funds in an IRA in an attempt to sock additional dollars away for your golden years. The dilemma here is that your household income is too high to contribute to a deductible IRA, so the $13,000 IRA contribution you made for you and your spouse ($6,500 each) ends up being non-deductible. 

 

Suddenly, ten years have passed and you now have over $100,000 of basis in your IRA. You are a natural saver and have been diligent about setting your extra money aside for retirement. That’s great! However, without careful planning, you may pay taxes on the contributed funds twice. Why? Let’s first review how traditional deductible IRA contributions work before diving into the complexities of a non-deductible IRA contribution.

 

How do traditional deductible IRA contributions work?

A traditional IRA has two primary advantages: 1) Tax-deductible contributions on the entire contribution amount as long as you’re not covered by an employer’s retirement plan and over the income limit, 2) Earnings on the contribution’s growth are tax-deferred. When you make a deductible IRA contribution, you receive a tax deduction for the money you contributed, effectively making this a pre-tax contribution. The contribution funds grow tax-deferred while in the IRA, but you will be subject to paying taxes on the growth upon making withdrawals throughout retirement.

 

For example, consider that your household income is only $100,000 and you qualify for an IRA deduction. You and your spouse (both age 50 or over) each contribute $6,500 to an IRA ($13,000 total). You are able to deduct the $13,000 from your taxes. For your tax-return, your $100,000 household income went down by $13,000 and is now only $87,000. The $13,000 contribution to your deductible IRAs effectively reduces your taxable income by $13,000!

 

How do non-deductible IRA contributions work?

Non-deductible IRA contributions work a bit differently and are often the result of the contributor’s household income being too high, thus exceeding the IRA deduction limits. For example, if you’re married and your income is over $101,000 –$63,000 for individuals– your IRA contribution is not fully deductible.  You can always contribute to an IRA, but you cannot receive a deduction for the (entire) contribution, thus the funds are treated like after-tax money.

 

How are non-deductible IRA contributions taxed when withdrawn?

With a non-deductible IRA contribution, you are putting after-tax money into an IRA and any growth on the contribution is still tax-deferred. When you eventually withdraw from your IRA, the contribution will come out tax-free, but you will have to pay taxes on the growth. At least that’s how it works, in theory, assuming you have handled the administration of tax Form 8606 each and every year!

 

The dilemma with IRAs is that unlike your company’s 401(k) plan, YOU are in charge of tracking the source (in this case the basis) of all non-deductible contributions. You must record current and historical contributions each and every year on Form 8606 of your tax return. This form shows the IRS the amount of after-tax (non-deductible) contributions you’ve made each year, and without it, your IRA basis will be taxed AGAIN when you withdraw the funds in retirement.  Essentially, if you miss one year, you may find yourself paying twice the taxes in another. Note: This is your job to track, not your custodian’s.

 

What should you do when you have non-deductible basis in your IRA?

We had this exact issue arise with a Shell Oil executive we recently on boarded to our firm. As part of our comprehensive planning process, we reviewed his tax return and noticed there was an $89,000 basis of non-deductible IRA contributions, with another $42,000 in his spouse’s IRA. The total value of his individual IRA was a little over $300,000. That’s $211,000 of taxable growth over time on the initial contribution of $89,000! So, how can he avoid paying taxes on both the contribution ($89,000) and the growth ($211,000) in retirement?

 

The solution we used for this client’s situation was to roll the growth into a 401(k) plan and convert the basis into a Roth IRA account via a Roth conversion.

 

One of the benefits at Shell Oil is that their 401(k) plan, the Shell Provident Fund, accepts incoming rollovers. This means that we can roll the $211,000 of growth into the Shell Provident Fund, so that the earnings are held in the client’s 401(k). This strategy reduces the client’s basis held in his IRA to $89,000 of non-deductible after-tax money. Since the entirety of the money left in his IRA is non-deductible (after-tax money), we then used a Roth Conversion to move the non-deductible money from his IRA to a Roth IRA, which is funded by after-tax income contributions and allows the growth to be withdrawn tax-free. 

 

Whereas before, the client would have paid on the initial contribution of $89,000 to his IRA AND the contribution’s earnings, he can now withdraw the contribution and its earnings without being subject additional taxes beyond the initial contribution tax already applied. In other words, he will only pay taxes the non-deductible IRA contribution one time.

 

What are the benefits of your IRA contribution basis being in a Roth IRA?

Assuming you follow this strategy, you will no longer be required to track your IRA contribution basis on Form 8606 after the 2018 tax year, meaning you will not be at risk for being taxed twice. What’s even more exciting is that any future growth from the $89,000 basis will never be taxed in a Roth IRA! Tax-free growth for life!

 

If you currently have non-deductible funds in an IRA, you may want to consider speaking with your financial advisor about what you can do to avoid paying more taxes that you have to. However, you should first make sure your financial advisor isn’t giving you conflicted advice. Too often, do I see “advisors” recommending clients NOT to roll the pre-tax into the 401(k) and the basis into the Roth IRA, solely so they can continue managing –and billing on– the client’s IRA! This advice is likely in the advisor’s best interest, not yours!

 

Note: there are situations when rolling pre-tax money to a 401(k) isn’t the right fit, such as when there are limited investment options, or when expenses are really high in the 401(k). However, such situations are becoming increasingly rare.

 

If you would like more information regarding how to handle non-deductible basis already in your IRA, take advantage of our free, 90 min consultation. During this meeting, a WJA financial professional will take an in-depth look into where you are today, where you want to be tomorrow, and how you can use strategic financial planning to reach your retirement goals.

 

Related Articles:

What Nick’s Reading | How to Compare: Roth Contribution vs. Roth Conversion vs. Roth Re-Characterization

What Nick’s Reading | Withdrawing Money During Your Retirement Years in the Most Tax-Efficient Way

What Nick’s Reading | Saving Non-Roth After-Tax Contributions

What Nick’s Reading | The Power of a Backdoor Roth IRA Contribution

Financial Fact | Deadline Alert: IRA, Roth IRA, and Backdoor Roth IRA Contributions for the 2017 Tax Year

Thoughts From Willis | Building Your Financial Planning Team

What Nick’s Reading | Tax Cuts & Jobs Act: The Basics

 

 


nickNick Johnson, CFA®, CFP®

CONNECT WITH ME ON LINKEDIN

 

Nick Johnson believes that financial planning is more than numbers on a balance sheet and a standardized process. People are unique and should be treated as such.

 

As Vice President and Wealth Manager at Willis Johnson & Associates, his goal is to really get to know his clients, all the while providing a proactive approach to comprehensive wealth management.

 


Willis Johnson & Associates is a registered investment advisor. Information presented is for educational purposes only. It should not be considered specific investment advice, does not take into consideration your specific situation, and does not intend to make an offer or solicitation for the sale or purchase of any securities or investment strategies. Investments involve risk and are not guaranteed. Be sure to consult with a qualified financial advisor and/or tax professional before implementing any strategy discussed herein. Insurance products and services are offered or sold through individually licensed and appointed agents in various jurisdictions. 

What Nick’s Reading | How Restricted Stock Works & What You Should Consider for Your Financial Plan

Published: April 10, 2018

Does your employer offer restricted stock as a form of employee compensation? If so, do you know how restricted stock works?

What restrictions and tax implications accompany the restricted stock shares long-term? What happens to your restricted stock if you’re laid off? What if you decide to retire?

These are all questions you should ask, and be able to answer, when incorporating your company’s restricted stock offering into your financial plan.

 

Employers offer restricted stock compensation as a means to retain and incentivize key employees, but many employees do not fully understand how restricted stock works. The fine print associated with these grants can be complex and can vary depending on the grant. Therefore, it may be effective to consult with your financial advisor, or initiate a relationship with a financial planning professional, before you accept a restricted stock grant from your employer.

 

How Restricted Stock Works: A (Very) Basic Overview

Restricted stock awards are shares of company stock granted to an employee by the employer, which the employee does not have the ability to control for a specified period of time. Think of restricted stock as a conditional promise from the employer to the employee. Once the employee meets the pre-determined conditions, the promise is fulfilled. In some ways, restricted stock is a deferred bonus which pays out at an increased or decreased value depending on the price of your employer’s stock.

 

A majority of employers require an employee to meet a specific quota(s), often a designated term of employment with the company and/or individual performance metrics, in order to achieve full ownership of the stock.  If the employee meets the quota(s), the funds will ‘vest,’ meaning the employee is no longer restricted from selling, converting, or receiving dividends on the shares. 

 

Employers utilize restricted stock to align the employee’s interests with those of the firm. Ideally, the employee wants to increase the value of their restricted stock, thus increasing their compensation. Similarly, the employer wants to enhance productivity among invested employees, thus increasing the company’s stock value as a whole. The idea is that both parties are motivated to improve the long-term stock value of the company because both parties are thinking and acting like stakeholders.  

 

How Restricted Stock Works and WHEN: A General Timeline

 

A majority of employers implement a restricted stock compensation timeline similar to the one below.

 

 

1) Grant Date: Restricted Stock is Granted to the Employee by the Employer

 

a. Restricted stock is granted to the employee by the employer, starting the clock for the employee to fulfill the specified vesting conditions, also known as the vesting schedule.
b. The employee does not pay taxes on the shares when they are granted, unless they choose to complete an 83(b) Election (see section on 83(b) Elections below).

 

2) Pre-Vesting Purgatory: Post-Grant Date, Pre-Vest Date, and the Policies In-between

 

a. The length and restrictions associated with the pre-vesting period, or vesting schedule, are unique to the company granting the stock.
b. The employee does not have ownership rights to the restricted stock, meaning they cannot sell the shares, or convert the shares to cash.
c. At this time, the restricted stock is still considered to have a Substantial Risk of Forfeiture and is not subject to taxes. 
d. There are two main types of vesting schedules:

i. Graded Schedule: The employer will determine a set percentage of the shares to vest each year for a set number of years.
ii. Cliff Schedule: 100% of the restricted stock shares granted to the employee are vested after the specified employment conditions are met by grant recipient.

 

3) Vest Date: Value…and Taxes

 

a. Once the employee has fulfilled the criteria set by their employer, the shares are vested. This means the employee now has full ownership rights to the company shares and the stock is no longer ‘restricted.’
b. Upon vesting, the shares are no longer a ‘Substantial Risk of Forfeiture’ and are subject to taxation. The vested shares are subject to earned income tax rates, unless the employee completes an 83(b) Election (see section on 83(b) Elections below).
c. The cost basis for the stock is the value of the stock on the date it vests. As such, there is often little to no additional tax due if the employee sells the stock soon after it vests.

 

How Restricted Stock Works with 83(b) Elections: The Exception to the Tax Rule

A majority of employees are subject to paying earned income taxes on restricted stock once the shares have vested and the employee officially owns the stock. However, some employees choose to make an 83(b) Election in an attempt to decrease the amount of taxes paid on the growth. Instead of paying taxes on the value of the stock when it is vested, the employee will pay taxes on the value of the stock when it is granted.

 

Thus, if the stock basis increases from the time the restricted stock is granted to the time it vests, the employee may be able to reduce the taxes paid on the shares, as any growth that occurs after the grant date is taxed at capital gains rates instead of earned income rates. However, this strategy requires the employee to pay taxes on stock that has not yet vested, and if they ultimately do not receive the stock, the taxes paid on the shares are non-refundable.

 

Restricted Stock Awards vs. Stock Options: Similar, But Not the Same

Restricted stock and stock options are two terms often confused by employees working to understand their employer compensation offerings. Stock options were a popular choice in the past, but restricted stock awards have become the preferred compensation method for employers over the last decade. 

 

Restricted Stock:

• A conditional award of stock to an employee once they reach the vesting date and fulfill the pre-determined conditions specified by their employer.
• The shares are taxed on their stock basis upon vesting, meaning the employee does not pay taxes on the grant date.
• The value of the promised stock is subject to market fluctuations. In other words, when the stock goes up, the award is worth more, but when it goes down, the award is worth less.
• Restricted stock is almost always worth something. Even if the stock value drops dramatically, the shares will most always retain some value and will rarely be worthless to the employee.

 

Stock Options:

• The option for an employee to purchase a specific number of shares in company stock at a specific price for a certain amount of time.
• If the market price of the stock exceeds its exercise price, the employee can decide to buy the stock, thus paying a lower price for the shares than their actual market price.
• If the stock price is below the exercise price at expiration, the options have no intrinsic value to the employee and may end up being worthless.

 

Common Curveballs: Pre-vesting Pitfalls, Overconcentration in Company Stock

Like all financial planning, it is important to prepare for what could go wrong. Restricted stock offerings can be a valuable opportunity for employees to receive direct compensation for their contribution to the company. However, without the right information and careful consideration, an employee may unintentionally jeopardize the value of their restricted stock.

 

Pre-Vesting Pitfalls to Avoid

 

The most important thing to remember about restricted stock awards is that the stock shares are not guaranteed until the shares have vested. Just because an employee is granted restricted stock, does not mean they will receive the shares on the vest date.

 

Retirement/Resignation:
For many employers, the retirement or resignation of an employee will trigger the automatic forfeiture of the individual’s unvested shares. However, this may not be the case for every employer, so be sure to thoroughly read and re-read your employer’s restricted stock grant documents to determine what policies may affect your financial plan.

 

Employee Termination:
What if you are laid off? In such a position, you have less control over the situation than you would if you decided to retire or resign. Many employers offer a severance package that allows the terminated employee’s restricted stock to continue vesting. Refer to your employer’s severance agreement to clarify how unvested shares are treated in this context.

 

Performance Shares Classification:
Another variable to consider is an employer’s potential treatment of restricted stock shares as performance shares. This means the employer will adjust the amount of shares the employee receives based on a specified set of metrics. So, if an employee is granted 100 shares, they may receive more shares if the company performs well, and less if the company performs poorly between the grant date and vest date.

 

Overconcentration in Company Stock

 

Once the restricted stock shares are vested, what do you do next?  Should you keep all of your shares? Sell everything? Sell part? If you only sell part, how much should you sell and when?

 

 

Planning for the post-vesting period is just as important as planning for pre-vesting. You should have a clear understanding of how you will manage your vested shares to compliment your financial plan.

 

For example, as we begin working with new clients, we often find they are over concentrated in their employer’s stock. They have been working for the same company for a long period of time while accumulating company stock year after year without diversifying their holdings. Suddenly, they may realize that 10%, 20%, or 30% of their net worth is invested in their employer.

 

This is already a high concentration before these clients account for the unvested restricted stock, the fact they will continue to be employed, and additional employer-related incentive compensation that make up their portfolios. All of these components are tied to the company they work for, which can be a major risk if an unexpected event like the BP Horizon Spill, or worse, an Enron bankruptcy were to occur. Such unforeseen incidents can destroy an employee’s retirement plan if their portfolio is heavily weighted in employer-associated assets, which is why a diversification strategy should be in play from the start.

 

We work with our clients to set up a diversification strategy that takes into account their net worth, tax situation, and expected future vesting of restricted stock. A diversification strategy may include staged selling, covered calls, and/or laddered limit orders to ensure you are reducing specific company-specific risk in a tax efficient manner. Talk to your advisor or reach out to a member of the WJA team to learn more about what strategy is best for you.

 


nickNick Johnson, CFA®, CFP®

CONNECT WITH ME ON LINKEDIN

 

Nick Johnson believes that financial planning is more than numbers on a balance sheet and a standardized process. People are unique and should be treated as such.

 

As Vice President and Wealth Manager at Willis Johnson & Associates, his goal is to really get to know his clients, all the while providing a proactive approach to comprehensive wealth management.

 


 

Willis Johnson & Associates is a registered investment advisor. Information presented is for educational purposes only. It should not be considered specific investment advice, does not take into consideration your specific situation, and does not intend to make an offer or solicitation for the sale or purchase of any securities or investment strategies. Investments involve risk and are not guaranteed. Be sure to consult with a qualified financial advisor and/or tax professional before implementing any strategy discussed herein. Insurance products and services are offered or sold through individually licensed and appointed agents in various jurisdictions. 

 

What Nick’s Reading | The Power of a Backdoor Roth IRA Contribution

Published: January 12, 2016 

Edited: March 12, 2018

We like to make sure you have the most up-to-date information, which is why we wanted to refresh this helpful article regarding the power of a Backdoor Roth IRA Contribution. 

 

Our clients typically turn to their 401(k) account as the vehicle to maximize tax-advantage savings and ask the following questions:

 

1) How much money did I contribute last year?

2) Was my contribution made through a pre-tax account, or a Roth 401(k)?

3) Did I make an after-tax contribution?

4) Is it in my budget to contribute more this year?

5) Did my employer make any changes to my plan?

6) Have the employee contribution caps increased since the 2017 tax year? 

 

(Note: Maximum 401(k) contributions of $18,500 for pre-tax or Roth with a $6,000 catch-up contribution limit.)

 

What is a Backdoor Roth IRA Contribution?

We agree that the 401(k) is a very important part of retirement savings, however, many clients forget about Traditional IRAs and Roth IRAs. Many think that the maximum income threshold for married couples filing jointly to contribute to a Roth IRA (during the 2017 tax year) is $196,000 and that the tax deductibility phase out limit for a Traditional IRA ranges from $99,000 – $119,000, if covered by a plan at work.

 

While these limits are prominent in IRS tables, we want to steer your attention to the lesser-known Backdoor Roth IRA contribution strategy. As a broad overview, there are no income limits with this strategy.  Additionally, the Backdoor Roth IRA contribution strategy marries a contribution to a non-deductible IRA with a conversion to a Roth IRA.

 

This strategy allows you to save up to $6,500 annually per person (including spouses), over and above what you are already contributing to your employer’s 401(k). Many investors can still contribute $6,500 for the 2017 tax year (as long as the contribution is made before filing the 2017 tax return) in addition to contributing for the 2018 tax year.  If you are married, that means $13,000 in additional retirement plan savings for 2017 and an additional $13,000 for 2018, for a total of $26,000 in additional retirement savings.

 

What Should You Consider Before Making a Backdoor Roth IRA Contribution?

Before a saver can begin utilizing the Backdoor Roth IRA strategy, it is important to ensure that they do not have any pre-tax money in IRAs. Upon completing a Roth Conversion, an individual moves the money from an IRA to a Roth, and will pay taxes on any pre-tax money that was converted. If you only have non-deductible money in your IRA, this is not an issue.

 

The dilemma: If you have pre-tax money in any of your Roths, it’s important to understand the pro-rata rule and its stipulation that all IRAs are treated as one IRA. So, how can the pro-rata rule affect the outcome of using a Backdoor Roth IRA strategy? Let’s walk through an example of the consequences one may face upon completing a Backdoor Roth IRA contribution without proper planning:

 

Max has an IRA at Vanguard that contains $93,500 of pre-tax funds. He decides he wants to do a Backdoor Roth IRA contribution, so he opens an IRA at Fidelity. Max contributes $6,500 of non-deductible money and immediately proceeds to convert the money to his Roth IRA at Fidelity. Max thinks that he will not owe any taxes on the conversion because he converted money from his Fidelity IRA to his Fidelity Roth IRA. However, he did not understand the pro-rata rule before making this financial decision.  
The pro-rata rule says that all IRAs are treated as one IRA for the purposes of Roth Conversions. So, in reality, Max has $6,500 of non-deductible money across his IRAs and $93,500 of pre-tax money. In other words, 6.5% of the funds in Max’s IRAs are non-deductible, and the other 93.5% of the funds are pre-tax. So, of the $6,500 Roth conversion 6.5% is tax-free; the other 93.5% is taxable at ordinary income rates!

 

You may be saying to yourself, “I have pre-tax money in IRAs, does this mean that I cannot utilize the Backdoor Roth IR contribution strategy without incurring negative consequences?” For the majority of our clients, the answer is probably not. However, these individuals generally require some consolidation of accounts before applying the Backdoor Roth IRA Contribution strategy to their own financial plan.

 

Our clients are primarily corporate executives and professionals, many of whom are still working in corporate America and have a 401(k) plan with their employer. Employer plans are not considered part of the pro-rata rule. So, if Max were our client, we may decide to consolidate his pre-tax IRAs to his company’s 401(k) plan. After we consolidated the $93,500 of pretax money into Max’s company’s 401(k), then we could assist him in making a Backdoor Roth IRA Contribution because he no longer has any pre-tax IRA money.

 

We want to emphasize this strategy as one to discuss with a financial professional in early 2018, as its use may help you achieve your financial goals.

 

Willis Johnson & Associates is a registered investment advisor. Information presented is for educational purposes only. It should not be considered specific investment advice, does not take into consideration your specific situation, and does not intend to make an offer or solicitation for the sale or purchase of any securities or investment strategies. Investments involve risk and are not guaranteed. Be sure to consult with a qualified financial advisor and/or tax professional before implementing any strategy discussed herein. Insurance products and services are offered or sold through individually licensed and appointed agents in various jurisdictions. 

 


nick

Nick Johnson, CFA®, CFP®

CONNECT WITH ME ON LINKEDIN

 

Nick Johnson believes that financial planning is more than numbers on a balance sheet and a standardized process. People are unique and should be treated as such.

 

As Vice President and Wealth Manager at Willis Johnson & Associates, his goal is to really get to know his clients, all the while providing a proactive approach to comprehensive wealth management.

 


 

 

What Nick’s Reading | How the Lower Marginal Tax Rates Make Partial Roth Conversions More Attractive

Published on: February 13, 2018

The recent tax reform changes resulted in a number of adjustments to the laws and associated strategies taxpayers are accustomed to.

One element I want to talk about today is how the Tax Cuts and Jobs Act has made Partial Roth Conversions even more attractive.

But first, the basics…

 

To understand why Partial Roth Conversions are even more attractive, you need to have a firm understanding of how the marginal tax rates have changed under the recent tax reform.

 

 In case you don’t know, the marginal tax rate is the percentage of taxes an individual pays on an additional dollar of income. In other words, for each additional dollar, you earn (via a pay raise, job change, consulting, etc.), your income increases, thus shifting your marginal tax bracket or the tax rate of your last dollar of income.

 

For example, consider that Tom and Sue have $276,000 of taxable income after taking the $24,000 standard deduction available to married couples filing jointly in 2018 (or $300,000 in total household income).

 

The chart below shows that $276,000 of taxable income is in the marginal bracket of 24%. Thus, Tom and Sue will owe $54,819 in taxes for the 2018 year.

 

2018 Marginal Tax Rates

2018 marginal rates-2

 

However, if Tom and Sue had $300,000 of total household income in 2017 (before tax reform) and took the 2017 standard deduction of $12,700, they would have $287,300 in taxable income and be subject to a marginal rate of 33% as highlighted in the chart below. Tom and Sue would owe $70,026 in taxes for the 2017 tax year.

 

2017 Marginal Tax Rates

2017 marginal rates-2

 

 

Thus, Tom and Sue fare better under the 2018 marginal tax brackets than they had under the 2017 marginal tax brackets, as they save $15,207.

 

G3

 

In some cases, it may be possible for an individual to not owe ANY federal taxes, even though there is not a 0% tax bracket.

 

How does this occur?

 

If the difference between an individual’s income and deductions is zero or less, they may be exempt from paying federal taxes. Considering the increase of standard deductions for single and married individuals, such a situation is most likely to occur among corporate executives and professionals in the first few years after retirement (specifically those that took pensions as a lump sum and are living off after-tax income first).

 

Although recent changes to the tax code have lowered personal tax rates for a majority of individuals, these reductions are expected to go back up in the future, unless Congress makes the lower rates permanent as it did with some of the Bush administration’s tax cuts in 2012. Therefore, it may be best practice to modify your financial plan so that you take advantage of this tax break while it’s still in effect.

 

Roth IRAs Allow for After-Tax Contributions and Tax-Free Growth

I’ve talked about the marginal rate, but let’s do a quick refresher on Roth IRA. They are a particularly tax-advantaged way to save for your retirement years. A few of the main advantages of this retirement account are as follows:

 

-After-tax contributions

-Growth on the Roth investment is tax-free

-Roth IRA distributions during retirement do not count towards your personal taxable income

-This also means the money will not be considered as personal income for purposes of determining whether your Social Security income will be taxed or if you will have to pay a Medicare surcharge

-Unlike an IRA or a 401(k), you’re not required to take a required minimum distribution (RMD) at age 70 ½, which is particularly beneficial for estate planning purposes as it allows the investment to continue to grow.

 

Roth Conversions in Low Tax Years are Even More Attractive with Future Expectations of Higher Income and Higher Tax Rates

 

Why am I talking about Roths and the Tax Cuts & Jobs Act? Because of how powerful partial Roth Conversions can be, given the lower marginal rates that are expected to go up in the future!

 

A partial Roth Conversion may make the most sense in low-income years (often in retirement before RMDs & Social Security begin). In case you don’t know, a partial Roth Conversion is where an individual moves a portion (but not all) of their IRA money to a Roth IRA and pays federal ordinary income taxes on the amount converted.

 

For example, an opportune time to do a Roth Conversion is during a year when you have a lower income than you expect to have in the future. Typically, this would be someone who just retired, was laid off, or has made large charitable gifts.

 

A common mistake we’ve observed among the newly retired professionals we serve is their tendency to become overly excited when they experience the transition of paying little to no taxes in the first few years after retirement. We often see this from our clients at Shell, Chevron, Exxon, and others (especially when they decide to take a lump sum pension as opposed to annuitization).  

 

However, this elation will be short-lived if they do nothing to take advantage of these low tax years, as their marginal tax brackets will likely be increasing significantly as Required Minimum Distributions (RMDs) and Social Security will shift them to a much higher tax bracket in the future.

 

It’s important to remember that if you do not take advantage of low tax brackets during these low-income years, you will be forced to take out the money when you’re in a higher tax bracket, thus increasing the amount of taxes you pay during that time.

 

For example, consider that you’re a sixty-year-old, married household who files a joint tax return and has a significantly large IRA. The IRA will begin automatically kicking out RMDs at age 70, and the Social Security payouts must begin by age 70 as well. If the above household has $100K of income from a pension today, they will pay a marginal tax rate of 22%.

 

 

However, by the time this household turns 75, the pre-tax IRAs will have had a lot of time to grow. It would be expected for this household to have significant required minimum distributions (RMDs) and Social Security income on top of their $100k pension. Let’s say their RMD’s at age 75 are about $200,000 and the household Social Security is $60,000. All of a sudden, this household which only had $100,000 of income at age 60 now has $360,000 of income, increasing their marginal rate by 11% to a total of 33%.

 

Website Infographic FEB 2018 WNR- WITHOUT RC (1)

 

Remember, the lower marginal rates from the Tax Cuts & Jobs Act only lasts for 10 years before reverting!

 

However, if this household were to employ a partial Roth Conversion, it would allow them to pull future income forward taking it out at a 22% rate (instead of a 33% marginal rate!) This household could take an additional $65,000 of income each year for the next 10 years, by converting $65,000 of IRA money to Roth IRA money. Yes, they will be required to pay taxes upon making the Roth Conversion, but these strategic conversions will increase the Roth IRA assets and decrease the size of the IRAs. This lowers the future RMDs thus decreasing their total future income and shifting their future marginal tax bracket to a lower rate of 28%.

 

 

Website Infographic FEB 2018 WNR- WITH RC (2)

 

What makes partial Roth Conversions even more exciting in the context of today’s tax laws is that the current lower rates will Sunset (Remember the tax cuts expire in ten years and almost all the rates get worse!). Even if the household happens to have the same taxable income in the future as they do today, they are most likely in a lower tax rate today.

 

Other Considerations for Tax Payers

 

No More Roth Recharictarizations 

A major change implemented by the recent tax reform law is the elimination of Roth Recharacterizations. Therefore, if you convert money to a Roth, you are unable to move the money back to a pre-tax IRA account. Because of this, we generally recommend that our clients convert their money at year-end once they know the total income they have earned. It’s common for households to underestimate their total income for the year as investments, pensions, restricted stock payouts, consulting income, and various additional items are often overlooked when looking ahead for the year.

 

A Decrease in Tax Rates May Decrease the Value of Roth Conversions

If tax rates decrease for American taxpayers as a whole or an individual household, Roth Conversions may not be a smart financial decision. This is because you are converting money at potentially higher tax rates today and you might be paying in the future. Of course, we do not think it is likely for rates to go down in the future.

 

Roth Conversions and the 5-Year Rule   

As we move forward under the new tax code, it’s important to remember a few of the time limitations associated with Roth Conversions. You are not able to immediately withdraw money from a Roth IRA because of the five-year clock rule.

 

This rule stipulates that five years must have passed since the tax year the Roth Conversion was made before you can withdraw the converted portion of the earnings on the account without being subject to penalties or taxes.

 

It’s also important to remember that Roth IRA distributions are taken from contributions, conversions, and earnings, in that order.

 

In addition, the five-year clock always starts on January 1st of the year the conversion was made.  For example, if a Roth conversion is completed in December 2018, the five-year countdown starts on January 1, 2018.

 

Roth conversions are not the only option available to help fill up low-income years. There are other opportunities available and it’s worth understanding the pros and cons before making a decision. Additional options include:

 

-Variable Annuity withdrawal

-IRA/Pre-tax 401(k) withdrawal

-Realizing capital gains to receive a step up in basis

-Trust Distributions

 

If you would like to learn more about the recent tax code changes and how they may affect your financial strategy, contact a trusted advisor or a WJA representative for more information. You can also register for one of our upcoming webinars, here.

 

Want to check out my first blog post breaking down the changes given the Tax Cuts & Jobs Act? Read it here.

 


nickNick Johnson, CFA®, CFP®

CONNECT WITH ME ON LINKEDIN

Nick Johnson believes that financial planning is more than numbers on a balance sheet and a standardized process. People are unique and should be treated as such.

 

As Vice President and Wealth Manager at Willis Johnson & Associates, his goal is to really get to know his clients, all the while providing a proactive approach to comprehensive wealth management.

 


Willis Johnson & Associates is a registered investment advisor. Information presented is for educational purposes only. It should not be considered specific investment advice, does not take into consideration your specific situation, and does not intend to make an offer or solicitation for the sale or purchase of any securities or investment strategies. Investments involve risk and are not guaranteed. Be sure to consult with a qualified financial advisor and/or tax professional before implementing any strategy discussed herein.

 

What Nick’s Reading | Tax Cuts & Jobs Act: The Basics

 Published: January 9, 2018

After much negotiation, and many compromises, the GOP has passed the final tax reform plan, which looks quite a bit different than the simplified version Trump and Ryan were pushing for in early 2017.

In the end, the GOP did succeed in lowering both corporate and personal rates, but it did not simplify tax rules for Americans.

 

 

Instead, the revised tax code will complicate financial planning for individuals going forward. Financial advisors will require a thorough understanding of the changes implemented in order to help individuals create or alter their long-term financial plans.

2018 Tax Reform: Personal Tax Rates

Yes, personal tax rate reductions were put in place and most households should see a tax decrease, however there are some exceptions. It’s also important to note that personal tax rate reductions are not permanent and will be subject to Sunset Provisions.

 

The Sunset Provision only allows Senate legislation to be passed with a simple majority if it does not result in net tax cuts beyond a 10-year period (otherwise, it requires 60 votes to prevent a legislation-stopping filibuster). Republicans had to allow Sunset Provisions into law since they did not have enough votes to prevent a filibuster in the Senate. However, many Republicans anticipate that they will eventually be able to make the rules permanent, because when the 10 years are up, the “fiscal cliff” it creates may compel Congress to act to prevent a tax increase. (This is similar to how the sunset provisions of President Bush’s tax cuts were ultimately made permanent).

 

Want to get an idea of how it will affect you? CNN put out a fairly robust tax calculator that does a reasonable job estimating your change in after-tax income.

 

2018 Tax Reform: Corporate Tax Rates

Unlike personal tax changes, corporate tax rate reductions are permanent. In addition, the rules for corporate tax rates (especially pass-through entities) are quite complex and we are expecting many to focus in on loopholes to game the system going forward. Though, not a focus of this article, if you own a small business, are a consultant, or receive pass-through income, we highly recommend you speak with a tax advisor to discuss strategies going forward.

 

Tax Brackets

Individuals will still face seven tax brackets, on top of the Alternative Minimum Tax (AMT), which the GOP was unable to do away with despite it being one of their goals going into reform. The final tax brackets under the GOP Tax Plan, though, followed the original Senate proposal, which retained our existing seven tax brackets, and simply trimmed (most of) the tax brackets by a few points. In the end, the Tax Cuts & Job Acts (TCJA) official tax brackets will be 10%, 12%, 22%, 24%, 32%, 35%, and a top rate of 37%, and will remain in place until the end of 2025, when they will sunset.

 

While tax reform is estimated to create savings for most households, wealthier households are expected to receive a larger percentage of positive change in their after-tax income. Likewise, in an attempt to reduce the impact of the marriage penalty, married couples generally receive more of the benefit compared to individuals (unless they earn over $600,000). This can best be seen in the comparison of marginal rates between the old law and the new. See the chart below from Kitces.com.

 

tax bracket graph-kitces

 

There are only a small number of married households that will have a higher marginal rate; specifically a few households with income slightly above $400,000, whereas the majority of individual filers with incomes between $200,000 and the low $400,000s have a higher marginal rate.

 

It’s important to note, that just because a marginal rate at a certain income level is higher under tax reform, does not mean taxes paid are actually higher. Remember it’s the effective tax rate that matters and even if you are paying a higher marginal rate of 35% (vs 33%) at $250,000 of income, you had lower rates of 12%, 22%, and 24% (vs 15%, 25%, and 28%) at lower income brackets.

 

An important consideration going forward will be to optimize tax brackets given current and projected taxable income. For retirees, this will include when one should begin Social Security, receive distributions from insurance products (like variable annuities), and withdraw from pre-tax retirement accounts. Pre-retirees should consider whether additional deferrals should be placed in pre-tax or post-tax (Roth) retirement accounts given current and projected tax rates. For some households, low current tax rates may mean Roth deferrals are more attractive in an environment where rates are expected to go up in the future.

 

Standard Deductions

Standard deductions have almost doubled and the personal exemption has been removed with the new tax reform. Households will still be able to claim most deductions, but many are now limited. For example:

 

· A single filer’s deduction increases from $6,350 to $12,000.

· The deduction for Married and Joint Filers increases from $12,700 to $24,000.

 

The deduction increase is predicted to cause fewer people to itemize deductions, but they may miss out on the benefits bundled deductions can offer. Estimates are that 94 percent of taxpayers will take the standard deduction, which provides even more opportunity to bundle deductions in the future. And with a higher standard deduction, far fewer will itemize at all. As such, bundling deductions may become more and more important going forward. Overall, the strategy for bundling deductions will change and you will need to consult your tax advisor to determine the best strategy for bundling in the future.  

 

Many people will not be able to itemize every year. If charitably inclined, you may choose to bundle deductions using a Donor-Advised Fund, or DAF. Consider bundling deductions one year and taking the standard deduction the next. A DAF may allow you to maintain your effective charitable contributions, while still bundling your deductions.

 

Capital Gains

Before tax reform, the threshold for long-term capital gains (and qualified dividend) rates correlated with tax brackets. For instance, if you were in the 15%, 35%, or 39.6% marginal bracket or below, you paid a 0%, 15%, or 20% long term capital gains rate. In the new tax plan, the GOP moved the income levels for the tax brackets, but did not move the income levels for capital gains and qualified dividends. As a result, preferential capital gains and qualified dividend rates will no longer line up cleanly with the ordinary income tax brackets. See the chart from kitces.com below.

 

capital gains graph-kitces

 

As such, it will be even more important going forward to complete tax planning for higher net worth households. Such individuals will need to choose (when possible) between filling up low tax bracket retirement years by receiving additional income from realized capital gains instead of implementing ordinary income from strategies like low-bracket Roth conversions, which will have more complex trade-offs going forward.

 

If you have any questions regarding the recent tax reform plan and how it may affect your financial future, consult your tax advisor or reach out to a member of the WJA team.

 

Willis Johnson & Associates is a registered investment advisor. Although this information has been gathered from sources believed to be reliable, it cannot be guaranteed. Federal tax laws are complex and subject to change. Willis Johnson & Associates does not offer tax or legal advice. As with all matters of a tax or legal nature, you should consult with your own tax or legal counsel for advice.

 


nickNick Johnson, CFA®, CFP®

CONNECT WITH ME ON LINKEDIN

 

Nick Johnson believes that financial planning is more than numbers on a balance sheet and a standardized process. People are unique and should be treated as such.

 

As Vice President and Wealth Manager at Willis Johnson & Associates, his goal is to really get to know his clients, all the while providing a proactive approach to comprehensive wealth management.

 

 


 

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