Financial Advisors Have More Responsibility To Clients

Stockbrokers, financial planners, and insurance agents who provide advice regarding IRAs and other retirement accounts will have new responsibilities towards clients, and the way they bill their clients may change, under new rules announced by the U.S. Labor Department.

Under the rules, advisors must now act in their clients' best interests when they make recommendations. In the past, many advisors merely had to make recommendations that were "suitable" for a client, even if what they recommended wasn't the best possible option. 

In addition, advisors must now disclose if they have a conflict of interest (for instance, if the advisor is being paid by a third party to recommend a particular investment), and must adopt procedures to limit such conflicts.

Advisors who receive commissions must have a signed contract regarding them, and all commissions must be reasonable, under the new rules.

The Labor Department estimates that the changes will save investors some $4 billion a year, because they will get better advice and buy fewer inappropriate high-commission products.

As a result of the new rules, it's expected that many advisors will stop charging commissions altogether, and instead will manage money in return for a flat annual fee or a percentage of the amount invested. 

The Advantages of Making a List of Assets and Debts

Have you ever considered writing down a list of all your assets (with account number, passwords, and so on), as well as debts and recurring payments?

Making such a list and putting it in a secure place can be a godsend if something ever happens to you and you become incapacitated, because your family will have a much easier time looking after your affairs.

In a recent article in the Wall Street Journal, a middle-class couple described the extraordinary difficulties they faced when the wife's parents developed medical problems and could no longer handle their own finances. The couple had no idea what assets the parents owned, what insurance they had, where to find records, what bills needed to be paid, and so on. Handling the parents' affairs became a nearly full-time investigative job.

As a result of the experience, the couple resolved to maintain such a list for their own children.

The problem has only gotten worse in recent years, because of the proliferation of electronic reporting. In the past, bills and account statements would arrive regularly by mail, but now, many people access everything online. As a result, a family might never have the comfort of knowing they've located all of a person's assets.

If you make such a list, a good plan is to update it at least once a year, maybe when you do your taxes. The list has other advantages - for instance, you can always go to one spot if you forget an account number or a password. Also, reviewing and updating the list regularly can help you see what changes or improvements might be needed in your own estate planning.

Charitable Donations From Your IRA Could Save Taxes

Congress has revived a law that lets you make charitable donations directly from your IRA, which might provide you with some significant tax advantages.

The "IRA charitable rollover" was discontinued at the end of 2014. But Congress has now resurrected it, made it permanent, and also make it retroactive to the beginning of 2015. 

If  you're over the age of 70 1/2, you're required to take minimum distributions each year from your IRA, and you have to pay income tax on those distributions. But the "charitable rollover" law lets you transfer assets from  your IRA to a charity, and whatever amount you transfer reduces the amount you're required to withdraw. So if you're required to withdraw $20,000 in 2016, but you instead donate $20,000 to charity, you don't have to withdraw any funds for yourself, and you don't have to pay any income tax.

You won't get a charitable deduction for the amount you donate in this way. However, donating directly from an IRA may be better than taking a distribution and then making a donation, because it results in a lower adjusted gross income - which can help you avoid taxes on Social Security benefits, reduce your Medicare premiums, limit the 3.8% surtax on investment income, and qualify for other deductions and credits.

In addition, donating from an IRA is definitely to your advantage if you otherwise wouldn't be eligible for a charitable deduction, either because you don't itemize your deductions or because you're subject to the charitable deduction "phase-out" for higher-income taxpayers.

To qualify, you must contact the plan custodian and have the custodian transfer the assets directly to the charity. If the custodian sends you the funds and then you give them to the charity, you'll have to pay income tax on the distribution.

You can donate up to $100,000 to charity each year from an IRA. A married couple can donate up to $100,000 each, as long as each spouse contributes from his or her separate account. 

You can't contribute to a private foundation or a donor-advised fund, however, And the tax break applies only to IRAs, not to 401(k)s, 403(b)s, Keoughs, profit-sharing plans, Simple IRAs, SEPPs, etc.

While the tax break theoretically applies to Roth IRAs, there's much less of an advantage because Roth IRAs aren't subject to the minimum distribution rules. 

Many People Miss a Tax Deduction for Inherited IRA's

If you inherited a retirement account, and if the estate of the person you inherited it from owed an estate tax, you might be missing a big income tax deduction when you withdraw funds from the account. Many people forget to claim this deduction.

The deduction applies not only to inherited IRA's, but also to inherited 401(k) accounts, certain stock options and unpaid dividends, pretax gains in certain annuities, and some other assets.

The idea is that the IRA (or other asset) already triggered an estate tax for the person who died. So, taxing your withdrawals from the account amounts to taxing the same asset twice. The deduction exists to prevent this double taxation.

To calculate the deduction, you have to figure out how much of the estate tax was due to the fact that the IRA or other asset was part of the estate. Divide that amount by the value of the asset (as listed in the estate tax return), and multiply this result by the amount of your withdrawals in a given year. That's your deduction for that year.

If you haven't claimed this deduction on past withdrawals, you might be able to amend your tax returns for the past three years, and get a refund. And of course, you can claim it for any withdrawals going forward.

The deduction has to be claimed on your income tax return as a "miscellaneous itemized deduction." However, unlike most other miscellaneous itemized deductions, you can claim it in full, and you're not limited to amounts that exceed 2% of your adjusted gross income. Plus, you can claim it even if you're subject to the alternative minimum tax.

However, if your adjusted gross income is over a certain threshold (which was $258,250 for single filers in 2015, or $309,900 for couples), the deduction is reduced by 3% of the amount over that threshold.

You should also note that this deduction applies only where the estate of the person who died paid federal estate taxes. If the estate also paid state estate taxes, you don't get a break for that. 

Here's a thought: If you currently have a traditional IRA and you anticipate that state estate taxes will be owed when you pass away, this is a reason to convert to a Roth IRA. You'll have to pay income tax immediately on the conversion, but this reduces your taxable estate, and any future appreciation will be tax-free to your heirs, because they won't have to pay tax on their Roth withdrawals. 

Family Trust Could Prohibit Beneficiaries from Going to Court

People who set up trusts for children, grandchildren and other family members have a greater ability to limit the beneficiaries' right to challenge trustees' decisions in court, as a result of a new U.S. Tax Court decision.

Here's the background: You may know that you can give up to $14,000 a year to any person without incurring the federal gift tax. But that rule generally doesn't apply if you put the money in a trust for the person, because you're not giving them the money directly - in legal terms, the person doesn't have a present interest in the funds. So any such gift is potentially taxable.

So, how can you avoid this problem and put up to $14,000 a year into a trust without paying gift tax? A common solution is to put the money into a trust, but give the person 30 days in which he or she can withdraw the funds. Typically, beneficiaries won't actually withdraw the money, because they'll be afraid that if they do, no further contributions will be coming. But the 30-day window means the person has a present interest in the funds, and so you qualify to avoid the gift tax.

(A trust set up this way is often called a "Crummy Trust" after D. Clifford Crummey, a Methodist minister who pioneered the idea back in the 1960's.)

The new case involved Erna and Israel Mikel, a New York couple who over time transferred more than $3 million to a Crummey trust to benefit some 60 relatives. 

The trust documents said the beneficiaries could withdraw the money within 30 days (which no one did). The documents also gave detailed instructions for how and when the trustee could distribute funds to the beneficiaries over time, such as to help them pay for a wedding, buy a house, or get started in a profession.

Apparently the Mikels were concerned to prevent squabbles and lawsuits within the family, because they added a clause saying that if any beneficiary were to go to court to challenge a trustee's decision, that beneficiary would be cut off and could get nothing further from the trust.

That's when the IRS pounced. According to the IRS, this "don't-go-to-court" provision invalidated the whole plan, because it meant the beneficiaries didn't really have a present interest in the funds. If they demanded their money within 30 days and the trustees said no, the beneficiaries would be out of luck because they couldn't file a lawsuit, according to the IRS.

But the Tax Court sided with the Mikels. It said the "don't-go-to-court" provision didn't apply to a request to withdraw the money within 30 days; it applied only to future decisions by the trustees over whether to pay for a wedding, a house, tuition, etc. 

The ruling is good news if you want to create a trust for your family, but also make it less likely that your family members will later fight among themselves.

However, you still need to be careful. While the federal government lost this battle, some states also place their own restrictions on certain types of "don't-go-to-court" provisions.