Category Archives: IRA Issues

The Emerging Benefit Trend of Student Loan Assistance

Employers are by now familiar with the scary statistics on mounting student loan indebtedness, including that approximately 71% of 2015 college seniors graduated with a student loan, and almost 80% of millennials believe that student loan debt will make it harder for them to meet their financial goals.  Per Mark Kantrowitz of Cappex.com, the average student loan balance increased by almost 50% between 2005 and 2015, and now hovers around $35,000 per graduate.

Large student loan debt impacts current employees and prospective new hires in many ways: it may cause rejection of a desired position or promotion due to income needs, it may postpone retirement plan participation due to cash flow needs, and it may delay or even rule out home ownership or starting families, leading to a less stable and community-involved workforce.

Employers want to be able to help mitigate some of the downside of high student loan debt among their employees, but their efforts are hindered by the fact that employer loan payments on behalf of an employee are currently taxable to the employee.

Several pieces of new legislation proposed for the 2017-2018 Congressional term encourage or facilitate employer assistance with student loan repayments through tax incentives. A survey of some of these measures follows:

The Higher Education Loan Payments (HELP) for Students and Parents Act (H.R. 1656)

  • This measure would permit employers to make up to $5,250 per year in tax-free student loan repayments on behalf of employees, and provide an employer tax credit based on 50% of contributions made within that dollar limit.
  • It would also permit employers to make up to $5,250 per year in the form of “qualified dependent 529 contributions” direct to employees’ tax-exempt tuition savings accounts set up on behalf of their children (up to age 19; students up to age 24), and would provide a corresponding 50% employer tax credit.
  • If passed it would thereby double the current $5,250 limit on employer education assistance under Internal Revenue Code (“Code) § 127.
  • Significant for smaller employers, the HELP for Students and Parents Act would treat sole proprietors and partners as employees for purposes of the excludible contributions.

The Student Loan Repayment Act (H.R. 615)

  • This bill would offer employers a 3-year business tax credit equal to 50% of startup costs for a student loan program (up to $500 per participating employee) under which the employer matches employees’ student loan repayments, up to $2,000 per year.
  • The startup costs are program creation costs, not amounts used for employer matching contributions.
  • The bill would also allow employers who hire “qualified student loan repayers” to claim the Work Opportunity Tax Credit, which encourages hiring of select populations such as veterans and recipients of certain types of public assistance. A “qualified student loan repayer” must have at least an associate’s degree, and outstanding education loans of at least $10,000.

The Student Loan Repayment Assistance Act (H.R. 108)

  • This bill would amend the Code to allow businesses a tax credit for employer-paid student loan repayments made direct to the lender, equal to 10% of the amounts that the employer pays on behalf of any employee, not to exceed $500 per employee per month.
  • The credit would be refundable for small businesses and non-profits who cannot use the credit against taxes.
  • The bill would require a written plan document, notice to employees, annual reporting to IRS and must be made “widely available” to employees (not discriminate in favor of “highly compensated employees”).

The Retirement Improvement and Savings Enhancement (RISE) Act of 2016

  • This measure took the form of a discussion draft in the 2014-2016 Congress but likely will be re-introduced in the current 115th Congress.
  • It would permit employers to make matching contributions to an employee’s 401(k) or SIMPLE IRA account based on his or her student loan repayments, essentially treating employee student loan repayment as equivalent of a 401(k) salary deferral.
  • Its retirement provisions would also curtail currently permissible IRA strategies including “mega Roth IRAs” and stretch IRAs, and would permit IRA contributions after reaching age 70 1/2.

As legislative efforts progress, vendors are already stepping in to the breach. Tuition.io provides a software interface that permits employer money to go direct to repay student loans, without going through employee pay.  The average employer contribution per paycheck is $50 – $200.   Other vendors include Student Loan Genius, PeopleJoy, Peanut Butter, and Gradifi.

One compliance question that these programs raise is whether student loan repayment programs would comprise ERISA plans, subject to trust and reporting requirements, or simply be viewed as “payroll practices” exempt from Title I of ERISA.  They do not provide retirement income or defer compensation to retirement age, thus would not likely be an ERISA pension plan, and do not provide benefits within the definition of ERISA “health and welfare” plans, so probably would not fall within ERISA’s scope.  This should help encourage formation of these programs by employers, as ERISA compliance burdens can be complicated and costly. Employers may still need to meet certain requirements in order to ensure tax-qualified status, however, as in the case of the Student Loan Repayment Assistance Act, which imposes documentation, notice and reporting duties.

Employers that want to address their employees’ student loan debt through workplace financial assistance can take the following steps to help select the program or policy that best suits their needs:

  • Talk to your recruiters and use other methods to estimate the student loan burden faced by your staff and new hire candidates.
  • Carefully evaluate various student loan aid vendors and identify those with the best fit for your organization.
  • Invest time in plan design and scheduling a roll out.
  • Remember that communication and ease of use are both key success factors.
  • Continue to monitor legislation for new assistance options.

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IRS Announces New Benefit Limits for 2017

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On October 28, 2017 the IRS announced 2017 cost-of-living adjustments for annual contribution and other dollar limits affecting 401(k) and other retirement plans.   Salary deferral limits to 401(k) and 403(b) plans remained unchanged for the second year in a row, but other dollar limit adjustments were made. Citations below are to the Internal Revenue Code.

Limits That Remain the Same for 2017 Are As Follows:

–The annual Salary Deferral Limit for 401(k), 403(b), and most 457 plans, currently $18,000, stays the same.

–The age 50 and up catch-up deferral limit, currently $6,000, also remains the same. For 2017 as in this year, the maximum salary deferral an individual age 50 or older may make is $24,000.

–The compensation threshold for determining a “highly compensated employee” remains unchanged at $120,000.

–Traditional and Roth IRA contributions and catch-up amounts remain unchanged at $5,500 and $1,000, respectively.

–The compensation threshold for SEP participation remained the same at $600.

–The SIMPLE 401(k) and IRA contribution limit remained the same at $12,500.

Limits That Changed for 2017 Are As Follows:

–The maximum total annual contribution to a 401(k) or other “defined contribution” plan under 415(c) increased from $53,000 ($59,000 for employees aged 50 and older) to $54,000 ($60,000 for employees aged 50 and olded).

–The maximum annual benefit under a defined benefit plan increased from $210,000 to $215,000.

–The maximum amount of compensation on which contributions may be based under 401(a)(17) increased from $265,000 to $270,000.

-The compensation dollar limit used to determine key employees in a top-heavy plan increased from $170,000 to $175,000.

In a separate announcement, the Social Security Taxable Wage Base for 2017 increased from $118,500 to $127,200.  

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A Conversation About the DOL Fiduciary Rule (Audio File)

The Department of Labor recently published a final regulation defining a “fiduciary” for purposes of investment advice rendered for a fee with regard to “retirement accounts.” The final regulation marks the first change in the regulatory definition of this type of fiduciary since the regulation originally was published in 1975. Retirement accounts under the new rule include those held under qualified plans (e.g., 401(k), pension plans), which have always been subject to ERISA, and now for the first time with regard to IRAs, which formerly were subject only to Internal Revenue Code rules governing self-dealing and other forms of prohibited transactions that the Internal Revenue Service enforced through audits.  The new rule – together with new and amended prohibited transaction exemptions related to the rule – becomes applicable on April 10, 2017, with full implementation required on and after January 1, 2018.

Recently I was interviewed about the new definition of an investment advice fiduciary for an episode of Money Talk that KZSB (1290 AM) will broadcast a 2:00 p.m. PDT on June 20, 2016.  The interview provides a broad overview of the rule and how it will likely impact IRA investors, employers, and the investment industry.  Joining me were program hosts Dianne Duva, Partner at Arlington Financial Advisors, and Neil Kriesel, who worked in finance for many years, has taught at SBCC as an adjunct faculty member and serves on the SBCC Foundation Board and various other non-profit organizations.  Click below to listen.

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Few Changes Are Made to 2016 Benefit Plan Limits

On October 21, 2015 the IRS announced 2016 cost-of-living adjustments for annual contribution and other dollar limits affecting 401(k) and other retirement plans.   There are few changes to be noted, as the increase in the cost-of-living index stayed below many thresholds necessary to trigger adjustments. Citations below are to the Internal Revenue Code.

Limits That Remain the Same for 2016 Are As Follows:

–The annual Salary Deferral Limit for 401(k), 403(b), and most 457 plans, currently $18,000, stays the same.

–The age 50 and up catch-up limit, currently $6,000, also remains the same. For 2016 as in this year, the maximum plan deferral an individual age 50 or older may make is $24,000.

–Maximum total annual contributions to a 401(k) or other “defined contribution” plans under 415(c) remains at $53,000 ($59,000 for employees aged 50 and older).

–The maximum annual benefit under a defined benefit plan remained at $210,000.

–Maximum amount of compensation on which contributions may be based under 401(a)(17) remains at $265,000.

–The compensation threshold for determining a “highly compensated employee” remains unchanged at $120,000.

–The compensation dollar limit used to determine key employees in a top-heavy plan remains unchanged at $170,000.

–The compensation threshold for SEP participation remained the same at $600.

–The SIMPLE 401(k) and IRA contribution limit remained the same at $12,500.

–Traditional and Roth IRA contributions and catch-up amounts remain unchanged at $5,500 and $1,000, respectively.

–The Social Security Taxable Wage Base for 2016 remains at this year’s level, $118,500.

Limits That Changed for 2016 Are As Follows:

  • The deductibility of IRA contributions made by someone who is not covered by an employer’s retirement plan but is married to someone who is, phases out if their joint income is between $184,000 and $194,000, up from $183,000 and $193,000.
  • The deductibility of contributions to a Roth IRA phases out over the following adjusted gross income ranges:
    • $184,000 to $194,000 for married couples filing jointly, also up from $183,000 and $193,000;
    • $117,000 to $132,000 for singles and heads of households, up from $116,000 to $131,000.
  • The retirement savings contribution tax credit (saver’s credit) for low and moderate-income workers is limited to those whose adjusted gross income does not exceed:
    • $61,500 for married couples filing jointly, up from $61,000;
    • $46,125 for heads of households, up from $45,750; and
    • $30,750 for married filing separately and for singles, up from $30,500.

 

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IRS Announces Increased 2015 Retirement Plan Contribution Limits

On October 23, 2014 the IRS announced 2015 cost-of-living adjustments for annual contribution and other dollar limits affecting 401(k) and other retirement plans.   A 1.7% rise in the September CPI-U over 2013 triggered $500 increases to the annual maximum salary deferral limit for 401(k) plans, and the catch-up limit for individuals age 50 or older. Citations below are to the Internal Revenue Code.

Limits That Increase for 2015 Are As Follows:

–The annual Salary Deferral Limit for 401(k), 403(b), and most 457 plans, currently $17,500, increases $500 to $18,000.

–The age 50 and up catch-up limit also increases $500, to $6,000 total. This means that the maximum plan deferral an individual age 50 or older in 2015 may make is $24,000.

–Maximum total annual contributions to a 401(k) or other “defined contribution” plans under 415(c) increased from $52,000 to $53,000 ($59,000 for employees aged 50 and older).

–Maximum amount of compensation on which contributions may be based under 401(a)(17) increased from $260,000 to $265,000.

–The compensation threshold for determining a “highly compensated employee” increased from $115,000 to $120,000.

–The compensation threshold for SEP participation increased from $550 to $600.

–The SIMPLE 401(k) and IRA contribution limit increased $500 to $12,500.

–The Social Security Taxable Wage Base for 2015 increased from $117,000 to $118,500.

Limits That Stayed The Same for 2015 Are As Follows:

–Traditional and Roth IRA contributions and catch-up amounts remain unchanged at $5,500 and $1,000, respectively.

–The compensation dollar limit used to determine key employees in a top-heavy plan remains unchanged at $170,000.

–The maximum annual benefit under a defined benefit plan remained at $210,000.

 

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IRS Announces 2014 Benefit Limits

On October 31, 2013 the IRS announced 2014 cost-of-living adjustments for annual contribution and other dollar limits affecting 401(k) and other retirement plans.  The announcement had been delayed until the September 2013 Consumer Price Index for Urban Consumers (CPI-U) was available, which in turn was delayed by the government shutdown over the budget and debt ceiling debate.   A modest 1.2% rise in the September CPI-U over 2013 left a number of the dollar limits unchanged for 2014, although a few limits have increased (citations are to the Internal Revenue Code).
Some limits that did not change for 2014 are as follows:
–Salary Deferral Limit for 401(k), 403(b), and 457 plans remains unchanged at $17,500. The age 50 and up catch-up limit also remains unchanged at $5,500 for a total contribution limit of $23,000.
–The compensation threshold for “highly compensated employee” remained at $115,000 for a second year in a row.
–Traditional and Roth IRA contributions and catch-up amounts remain unchanged at $5,500 and $1,000, respectively.
–SIMPLE 401(k) and IRA contribution limits remain at $12,000.
Limits that did increase are as follows:
–Maximum total contribution to a 401(k) or other “defined contribution” plans under 415(c) increased from $51,000 to $52,000 ($57,500 for employees aged 50 and older).
–Maximum amount of compensation on which contributions may be based under 401(1)(17) increased from $255,000 to $260,000.
–Maximum annual benefit under a defined benefit plan increased from $205,000 to $210,000.
–Social Security Taxable Wage Base increased from $113,700 to $117,000.
–The dollar limit defining “key employee” in a top-heavy plan increased from $165,000 to $170,000.

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Reality Check on IRA Investments in Real Estate

Multiple times each year I am asked by prospective clients whether, and how, they can invest traditional IRA assets in real estate.  In this time of distressed real estate and very low interest rates, many investors have maxed out on their after-tax investments in real estate, and their IRA account balances beckon as a new source of investment capital.  If these folks look online, they will find many sources of purported “advice” on how to get rich through IRA investments in real estate.  Unfortunately, the information available online usually obscures or overlooks altogether some significant practical and tax hurdles to making IRA investments in real estate work from both the technical/legal and “return on investment” perspectives.

Below I summarize those obstacles.  They are not barriers, per se, but prospective investors should assess them carefully, preferably in consultation with their attorneys, CPAs, or other tax advisors, before committing IRA assets to an investment in real property.    Failure to steer clear of them could result in immediate taxation of the entire IRA account – including conventional investments.

  1. Understand How the IRS Views Your IRA

A very important concept that much of the online marketing around IRAs overlooks is that, from the perspective of the IRS:

  • the IRA is solely meant to provide a source of retirement income and is not a ready source of capital for an investment opportunity; and
  • You are a fiduciary with regard to your IRA account.

The IRS applies a term – prohibited transaction or “PT” – to any use of IRA assets for personal gain other than preservation of a retirement income stream.  The prohibited transaction rules disallow a number of specific transactions, such as selling real estate to or buying it from your IRA, or personal or immediate family member use of real estate owned by an IRA, but they also generally prohibit “self-dealing” which is defined to include any act of a fiduciary (i.e., you) by which IRA income or assets are used for the fiduciary’s own interest.   Examples of self-dealing could include purchase of real estate built on speculation by a son in law, purchase of real estate adjoining your own property or that of a family member in order to control how the property is used and who lives there, or , outside the real estate context, use of IRA assets alongside personal assets in order to meet a minimum investment account threshold.

If your IRA investment in real estate constitutes a prohibited transaction of any stripe, the total account balance of the IRA will be treated as if it were distributed to you on the first of the year in which the investment is made, and thus included in your taxable income for that year.  If you are under age 59 ½, you also may have to pay an early distribution penalty equal to 10% of the prohibited investment.

Even if the purchase transaction satisfies PT rules, management of the IRA-owned real estate can also trigger violations, as is discussed in section 4, below.

  1. Analyze the Tax Consequences:  Income Tax Rates, versus Capital Gains (plus deductions)

Investing IRA assets in real estate means that gains on your investment  –  when realized through sale of the real estate and distributed from the IRA – will be taxed at regular income tax rates, rather than the lower capital gains rates that apply to after-tax real estate investments.  Also, during the time that your IRA holds the real estate, depreciation and the many deductions for property expenses claimed on Schedules C or E will not apply as they would to after-tax real property investments.

  1. Pay Cash – Avoid Unrelated Debt Financed Income

Your IRA must pay cash for the real estate, otherwise tax will be owed on “unrelated debt financed income” under Internal Revenue Code Section 514 if the leveraged property generates income (such as rents) or if it is sold for a profit while the mortgage is still outstanding (or within 12 months of paying it off).   The IRA trustee or custodian must pay the tax.

In determining how much your IRA can afford to pay for a parcel of real estate, you must arrange ahead of time, preferably with the help of a CPA or other tax advisor, to maintain liquid investments in the IRA to pay off certain recurrent costs and expenses, and for other reasons outlined in 5 – 7, below.

  1. Follow Correct Procedures (the Natalie Choate 4-Step Test)

As mentioned, the IRS views you as a fiduciary with regard to your own IRA.  Because the PT rules prohibit an IRA fiduciary from engaging in business transactions with the IRA itself, you will need to use third parties both to purchase the real estate, and to manage the real estate.  Natalie Choate, a nationally recognized authority on the estate planning aspects of IRAs and qualified retirement plans, specifically recommends the following four steps:

  • Find a specialized IRA  custodian.  Not all IRA custodians are well versed in the intricacies of the prohibited transaction rules, and how real estate investments may trigger violations.  You will want to find a bank custodian who has experience in this area.  Work through trusted contacts such as your CPA or other tax advisor until you have found the right match.
  • Custodian engages in purchase transaction, not you.  The PT rules require that the IRA custodian, not you as IRA fiduciary, uses your IRA assets to purchase the real estate.  You cannot buy the real estate and transfer it to your IRA, or sell it to your IRA.  The latter transaction would be a PT; the transfer would not work because generally only cash may be contributed to an IRA.
  • The Custodian engages a third party property manager. This step is recommended if your real estate has residential tenants or commercial tenants in anything other than a “triple net” lease requiring that they assume costs the landlord otherwise would pay.  The property manager, not you, should run the property (e.g., make repairs, collect rent, pay expenses and property taxes, etc.) and send the IRA custodian a check each month that is net of all such costs.  This arrangement makes it unlikely that you will intermingle your personal assets with the IRA assets, for instance by directly hiring a painter or gardener, or by paying a bill associated with the IRA owned property.
  •  No family use or sweat equity.  For the same reasons that a third party property manager is recommended, you must avoid any personal use of the IRA-owned real estate, or use by direct family members.  Even use by extended family members or family friends could comprise a “self-dealing” type of PT as described above.  You must also resist the urge to work on the property yourself, show apartments, or have family members fill any of these roles.  Ideally, your property manager will anticipate and take care of such needs on an arms-length basis, without involving you.
  1. Set Aside Liquid IRA Investments for Required Minimum Distributions

When you reach age 70 ½, the IRS requires that you begin taking annual minimum required distributions from your traditional (i.e., non-Roth) IRA.  If you have multiple traditional IRAs, you can choose one from which to take distributions, but you must pool all IRA account balances together to determine the minimum required amount you must withdraw each year.  Failure to timely take out a sufficient amount could result in a 50% tax, based on what you should have withdrawn.  Needless to say, minimum required distributions are most easily made from liquid IRA investments – stock that can be sold, money market accounts, etc.  Before investing IRA assets in real estate, make sure that you preserve sufficient liquid IRA investments from which to take required minimum distributions.  You CPA or other tax advisor can help you do some advance planning in this regard, to determine the principal amount you should set aside for this purpose, and income you can expect it to generate.

Failure to preserve liquid investments for this purpose will make it very hard to take minimum required distributions.  You might have to distribute fractional interests in the IRA-owned real estate, which would be an expensive process (both in determining the value of the fractional interests, and in documenting the interest transfer).

  1. Set Aside Liquid IRA Investments for Annual Valuations of the RE Investment

Most reputable IRA custodians will require annual valuations of real estate investments or other non-traditional investments (privately held stock, etc.)  The valuation may cost several thousand dollars, possibly more.  The IRA must pay for this expense; you cannot use personal funds.  Before committing IRA assets to the real estate purchase, you need to determine how much in liquid IRA investments you need to aside in order to pay this recurrent expense from either the liquid investments themselves and/or anticipated investment income they generate.

  1. Set Aside Liquid IRA Investments for Property Taxes, Expenses, Insurance Improvements, Management Fees

As mentioned, your third party property manager will be using IRA funds to pay property taxes, maintenance and other expenses, insurance, improvements, and will also draw on the IRA to pay its own management fees.  Before committing IRA assets to the real estate purchase, you will need to determine how much in liquid IRA investments you need to set aside in order to pay these expenses from the investments themselves and/or anticipated investment income they generate.  Some amounts will be predictable and recurring; others, such as large repairs (roof replacement, etc.) are not predictable and you will have to use good judgment in estimating a set-aside.

Bottom line, IRA investments in real estate can be done, but there are many rules that must be followed to avoid disqualification of the IRA and immediate taxation of the entire IRA account. The availability of required minimum distribution amounts, the loss of capital gains treatment, and the self-dealing restrictions, generally make an IRA investment in real property unsuitable and problematical at best.  For investors who are still “game,” some advance financial and tax planning strongly is advised both before the transaction occurs, during the life of the real estate investment, and well in advance of any minimum required distribution start date.

Finally, you will note that this post does not discuss strategies using business entities within an IRA, such as IRA-owned single member limited liability companies (“LLCs”).   Often marketed as “checkbook control” IRAs, these arrangements raise a host of compliance issues over and above the ones discussed below.  The Groom Law Group has an excellent article debunking this and a number of other questionable IRA strategies that you can read here.

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