Greetings!

Happy Easter!  And for me, happy tax season.  I'll be brief today as I've got more than a couple 1040's sitting on my desk with my name on them.

My first article was inspired by a true story.  It made me realize that a lot of investors ignore (at their own peril) liquidity risk.  Check out the article to learn more.

Many of you have or had the ability to contribute after tax dollars to a non-Roth 401(k). The IRS has clarified rules on how and when you can roll those funds over to a Roth IRA.  The second article covers this topic.

My Quick Comment updates the comment from last month concerning IRS Form 3115.

The last two articles cover estate planning myths and tax issues for business owners.  We all have estate planning issues so make sure you check out that article and if you're thinking about opening a business you'll definitely want to check out the tax article...which is a start.

I hope you have a great Holiday weekend and that your Spring starts out great. 

See you in May!  

Curt

Curtis L. Sheldon, CFP®, EA, AIF®
C.L. Sheldon & Company, LLC
(703)542-4000 or (800) 928-1820

 
Featured Article
Liquidity Risk...Do You Consider It When Making Investment Decision?
 
I read an email the other day from an acquaintance.  He had some stock in a closely held corporation and was trying to sell it to "pursue other opportunities".  A month or so later, I received another email from him about the stock.  It was now "on sale" with greater discounts for buying larger lots.  Made me think...this individual didn't think about liquidity risk when he purchased the stock.

Just what is liquidity risk?  My CFP® textbook defines liquidity risk as follows:

The degree of uncertainty associated with the time it takes to sell an investment with a minimum of capital loss from the current market price.

In other words, "Will you be able to sell your investment quickly and at full price?"

Many times individuals will neglect this risk when making purchases or deploying cash.  Here are some examples.

Your House/Mortgage.  The great American Dream is to pay off (and then burn) the mortgage.  When you do this, you are in effect deploying your cash into a very illiquid asset.  We all know that it normally takes months to sell a house and you're going to pay a lot of commissions and expenses to sell it.  Beyond that, your house is an all or nothing sale.  You can't sell a part of the house when you have an unexpected expense.  Before you pay off your mortgage make sure you have the liquid assets you need to cover planned and unplanned expenses

Annuities.  Virtually all annuities have some sort of surrender charge if closed in the first few years.  This in effect ties up your money for 7 -10 years.  For those years, your investment is pretty illiquid

Non-Traded REITS.  There are two types of REITS.  Those traded publically and those that are not.  Non-traded REITS can only be sold during certain times and the price is notoriously hard to value.

Limited Partnerships.  These types of investments are common in oil and gas drilling and real estate.  To sell your shares you need to find a willing buyer...basically on your own.

Closely Held Corporations.  That start-up company may sound great.  If you buy stock in it, be prepared to hold it for a long time.  Stock of closely held corporations is so hard to sell the IRS even allows a reduction in the value of these stocks when valuing an estate for estate tax purposes. 

Retirement Accounts (401(k), TSP, IRA, etc.). Think about it.  You can't get these funds until age 59 1/2 without paying a penalty (with some exceptions).  I've seen it happen.  An individual had the goal of opening a franchise after retiring from the military.  The only investment he had was TSP.  If he wanted to access these funds he would have to pay penalties (there are other options, but that is for a different discussion).  Pretty illiquid until you're in retirement.

I'm not saying that you should never own these assets/investments.  That should be pretty obvious when Retirement Accounts are on the list.  But...make sure you do a thorough review of all risks, including liquidity risk before you deploy your cash into any asset.  Or, we'll be happy to do that for you.
Second Thoughts
The IRS Clarifies Rules on Rollovers of Retirement Plan Monies
 

After years of ambiguity around what is and is not allowed regarding the disbursement of after-tax contributions to an employer-sponsored retirement plan, the IRS ruled in September of 2014 that plan participants can roll those dollars into a Roth IRA tax free.

 

IRS Notice 2014-54, Guidance on Allocation of After-Tax Amounts to Rollovers, "provides rules for allocating pretax and after-tax amounts among disbursements that are made to multiple destinations from a qualified plan." (1) Importantly, the Notice states that all disbursements from a retirement plan made at the same time will be treated as a single distribution even if they are sent to multiple new accounts. Prior to this ruling, the IRS treated distributions from a retirement plan that were rolled over to multiple new accounts as separate distributions, each requiring that a proportional share of pretax and after-tax monies be disbursed.(2)

 

A Simplified Process

 

Now individuals holding both pretax and after-tax amounts in their plan can transfer -- through direct, trustee-to-trustee rollovers -- the pretax portion of the distribution (including earnings on after-tax amounts) to a traditional IRA and the after-tax portion of the distribution to a Roth IRA. In the past, this could only be accomplished through indirect 60-day rollovers, not through simplified direct rollovers.2

 
 
More Clarification, Please

 

As with many IRS rulings, Notice 2014-54 raised many questions with taxpayers. In response, the IRS recently issued some answers to those commonly asked.

 

Q: If I have both pretax and after-tax monies in my retirement account, can I roll over just the after-tax monies to a Roth IRA, leaving all of the pretax monies intact?

 

A: No, the new rule does not change the requirement that each distribution from a plan -- including partial distributions -- must include a "proportional share" of the pretax and after-tax amounts. 

 

Example: If your account balance is $100,000 and consists of $80,000 in pretax amounts and $20,000 in after-tax amounts, and you request a distribution of $50,000, your distribution would consist of $40,000 of pretax amounts and $10,000 of after-tax amounts.2

 

In order to roll over all of your after-tax contributions to a Roth IRA, you could take a full distribution (all pretax and after-tax amounts), roll over all the pretax amounts directly to a traditional IRA or another eligible retirement plan, and roll over all the after-tax amounts directly to a Roth IRA.  

 

Q: Can I roll over my after-tax contributions to a Roth IRA and the earnings on my after-tax contributions to a traditional IRA?

 

A: Yes, since earnings on after-tax contributions are considered pretax monies, after-tax contributions can be rolled over to a Roth IRA while the earnings on those contributions can be directed to a separate traditional IRA and avoid being taxed until they are distributed.

 
Plan Sponsors: A New Opportunity

 

The new guidelines present an opportunity for plan sponsors to reach out to participants to determine which individuals have after-tax money in their plans and explain the new rules -- and the new opportunity -- to them. Further, for those participants who are not currently making after-tax contributions, advisors may want to encourage them to do so, if their employer plan allows.

With the current annual pretax contribution limit of $18,000 -- or $24,000 for individuals age 50 or older -- high-earning employees who are not making after-tax contributions are missing out on the chance to sock away significantly more (the annual total contribution cap on defined contribution plans is $53,000 in 2015) while benefitting from tax-deferred investment growth.

 

Source/Disclaimer:

1 The Internal Revenue Service, Notice 2014-54, Guidance on Allocation of After-Tax Amounts to Rollovers, September 18, 2014.

2 The Internal Revenue Service, Employee Plans News, December 23, 2014.



Required Attribution
 
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Around the Horn
Curt's Quick Comment
Last month I talked about the possible requirement for all businesses (including rental property owners) to file a Form 3115.  The IRS has established a Safe Harbor for small businesses.  Many readers of this newsletter will qualify for the Safe Harbor.  Consult with your tax advisor. 
6 Common Estate Planning Myths: Here's The Reality

 

Some people avoid estate planning at all costs. But putting aside the inevitable emotions involved in looking ahead to your own demise, it's crucial to understand the process. A good place to start is by debunking these six common but potentially damaging myths: Read More Here 

 

 

Self-Employed? Map Out Tax Details  
 

Have you joined the ranks of the self-employed? You're not alone. According to the Bureau of Labor Statistics, more than 14.4 million Americans were counted as being self-employed in 2014. Some estimates place the total even higher. More Here

 

 

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