More On Legal & Compliancefrom The Advisor's Professional Library
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- Client Commission Practices and Soft Dollars RIAs should always evaluate whether the products and services they receive from broker-dealers are appropriate. The SEC suggested that an RIAs failure to stay within the scope of the Section 28(e) safe harbor may violate the advisors fiduciary duty to clients, so RIAs must evaluate their soft dollar relationships on a regular basis to ensure they are disclosed properly and that they do not negatively impact the best execution of clients transactions.
When the Senate passed the Small Business Jobs and Credit Act of 2010, H.R. 5297, on Sept. 16, it contained provisions that might be a boon for some taxpayers and retirees--as well as the Treasury--at least in the short term.
The Senate's bill is different from the version the House passed earlier this year. The House is expected to vote on the Senate's version of the bill and send it to President Barack Obama for his signature, sometime "before the November elections," according to the "CCH Tax Briefing" newsletter on Sept 16.
While some provisions encourage retirement savings, these and some others will also raise revenue over the short term to offset the cost of the tax breaks in the bill. One of the provisions, the Roth 401(k), has been available since 2006 to employees of firms that added a Roth 401(k) choice to their retirement plans. The original Roth 401(k) provision was scheduled to sunset at the end of 2010, but has been permanently extended, according to CPA and attorney James Lange.
The Roth 401(k) enables businesses to offer employees both a regular 401(k) and a Roth 401(k). In a classic 401(k), contributions made by employees are pre-tax, grow tax-deferred and are taxed at ordinary income tax rates upon withdrawal during retirement. In a Roth 401(k), contributions are after-tax, and then grow tax free; withdrawals at retirement are not taxed. For those who bet that income-tax rates will be higher at retirement, and especially those with a long time horizon, allowing the money to grow, untaxed, for a longer period, the tax-free withdrawal can be a huge plus.
To Pay Tax Now or Later? That Is the Question
The Senate's version of the Small Business Aid Bill allows qualifying participants that have regular 401(k)s to convert some or all of the assets to Roth 401(k)s--for the first time. Prior to this provision, pre-tax 401(k) assets had to stay in the 401(k) until a person left a firm or retired, says Lange.
Now, if the firm offers the Roth 401(k) as well as the regular (pre-tax) 401(k), participants will be able to convert those assets, Lange added. He is the author of the book "Retire Secure!" (Wiley, 2009), and has an RIA firm, Lange Financial Group, in Pittsburgh, Pa. But there are some qualifications.
Reporting from DOL Speaks on Tuesday, AdvisorOne Washington Bureau Chief Melanie Waddell noted that Brian Graff, executive director and CEO of the American Society of Pension Professionals and Actuaries (ASPPA) in Arlington, Va., said that this rollover option is currently only available to workers aged 59 1/2 . "We'll have to see if [this age restriction] gets expanded," Graff said.
Many firms now offer a regular 401(k) but in order for employees to take advantage of after-tax Roth contributions or conversion, companies will have to add that to their plan. Individuals who are 50 or older could contribute up to $22,500 a year; contributions are limited to $16,500 for those shy of 50 years of age, Lange says.
When plan participants convert existing 401(k) money into a Roth 401(k), they pay the tax on the converted assets in the conversion year, and then those assets would grow tax free. When they are withdrawn during retirement, they would not have to pay tax on the withdrawals, according to Lange.
But that doesn't mean the conversion has to be done all at once. Taking money from the regular 401(k) and converting it to the Roth 401(k) means adding the amount to be converted to one's income and it is taxed at regular income-tax rates. But if a client is not in the top rate of 35%, it may be possible--and advantageous--to do a series of smaller conversions. If converting a smaller
amount of money from regular 401(k) to Roth will keep the income level at, say the 28% tax bracket instead of sending someone into a higher bracket, Lange says that a series of conversions over several years would be one way to structure the move to the Roth 401(k).
What about firms that don't offer the Roth 401(k)? Lange says "it's a benefit to a lot of employees--at virtually no cost" to the firm. "I don't see why all employers don't," offer both. It would, "help employees accumulate tax-free wealth, and that will help retain them and make them happy." He says it indicates the firm is "more progressive--at least in that area." He asserts: "When we did it, I don't think the fee the firm has to pay went up at all."
Offsetting the Tax Breaks With Revenue Now
In addition to encouraging individuals to contribute retirement accounts, the new Roth 401(k) provision is part of Congress's effort to "offset" tax breaks in the proposed law, with tax collections now. CCH's Tax Briefing lists tax breaks costing $9.4 billion over 10 years, which would, it says, be defrayed by tax payments from the retirement provisions, higher fees for late filing of "information returns" and other revenue "offset" provisions in the bill are estimated by Senate Finance Committee's projections to bring in $14.4 billion, according to the CCH Tax briefing.
Here's how the Senate's estimates break down, per the CCH Tax Briefing. (House estimates differ.) First, the tax breaks, over a 10-year period: Bonus Depreciation - $5.4 billion; Code Sec. 179 Expensing -$2.1 billion; Small Business Stock -$517 million; General Business Credit -$977 million; 6707A Penalty Relief -$176 million; and Start-Up Deduction -$230 million. And now, on the revenue side, again over 10 years: Retirement Savings +$6.5 billion; Information Reporting +$4.1 billion; and Other Revenue Raisers +$3.8 billion.
Do Your Clients Ever Get Caught in the AMT Squeeze?
The bill includes a break for "small businesses" that get caught in the alternative minimum tax (AMT): the "Senate bill removes the limitations on which general business credits may off set AMT liability for eligible small businesses," according to the CCH newsletter, which adds that, "the average annual gross receipts of the corporation, partnership, or sole proprietorship for the prior three tax year periods cannot exceed $50 million."
The Senate's version also gives small businesses a break by raising the capital gains exclusion in some circumstances when executives of small businesses sell "qualified small business stock," to 100%, the CCH Tax Briefing says, from the current 75% top exclusion.
Comments? Please send them to email@example.com. Kate McBride, AIF(R), is editor in chief of Wealth Managerand a member of The Committee for the Fiduciary Standard.