Rollover Rules You Need to Know

By: Lori Eason, CFP(R)

In my line of work, I am often asked about IRA rollovers.  Most commonly, clients have a 401k with a previous employer and are wondering what steps they need to take to remove their funds from the plan.  Starting in 2015, the IRS now follows a stricter interpretation of the 60-day IRA rollover rule.  I wanted to shed some light on this rule and what the changes mean for investors.

First off, there are two ways to move IRA money from one IRA to another IRA: indirectly and directly.  With indirect transfers, also known as 60-day rollovers, clients receive a check from their IRA made out to them.  They then have 60 days to redeposit the funds to another IRA and you can only have one of these per 12-month period.  The second way is a direct transfer, also known as a trustee to trustee transfer.  This is when funds move from one IRA to another without the client touching the money.  For example, if a check is the method of payment, the check is written by one custodian out to another custodian, i.e. Fidelity writes a check to Charles Schwab and Co.  This is always our recommended method of rollover and this method is not subject to the once-per-year rule.

 

Ever since IRAs have existed, there has been an IRS rule in place that allows IRA distributions to be rolled over within 60 days to avoid taxation.  Under the original rule, there could be one indirect IRA rollover per year, and the IRS interpreted this once-per-year rule to apply on an IRA-by-IRA basis.  Beginning in 2015, you can only make one indirect rollover form an IRA to another IRA in any 12-month period, regardless of the number of IRAs you own.

You may be wondering why the IRS decided to limit indirect rollovers to one per year.  I’m sure you won’t be surprised to find they did so because people figured out a way to abuse the system.  It is possible to use the rollover funds as a personal short-term loan, as long as the rollover contribution is made within 60 days.  Under the previous interpretation, an individual with several IRAs could potentially take a series of rollovers, allowing for an extended period of personal loans much longer than the 60 day period. 

This issue surfaced as a result of the recent ruling in Bobrow v. Commissioner.  Alvan Bobrow, a tax attorney, engaged in a series of sequential rollovers from separate IRAs to form an extended loan strategy.  His strategy involved two of his own IRAs and one of his wife’s.  He actually made a mistake and his final rollover took place after 61 days and was $25k short.  He claimed he had made a timely request and that he had requested the full $65k amount, but couldn’t produce any evidence for either.  Since the last rollover was not complete, it was reported as being partially taxable, but Bobrow disputed it.  I’m not sure which was the dumber move, the original “mistake” or disputing it which is what ultimately drew the IRS’ attention.  He could have just paid his tax bill and moved on.  As a tax attorney, he chose to represent himself in Tax Court.  The Tax Court ended up not only supporting the IRS’ decision, but also declared that since IRAs are aggregated together for income tax purposes, that aggregation should also apply for the once-per-year rollover rule as well. 

There are hefty penalties associated with violating the once-per-year rollover rule.  A second rollover made within a year could cause a taxable distribution plus a 10% penalty if the individual is under the age of 59 ½.  Also, this rollover will be considered an excess contribution subject to a 6% penalty for every year the ineligible rollover funds remain in the account.  It’s important to note that the year is a 12-month rolling period starting with the date of the distribution, not the calendar year.

Although 60-day rollovers are now riskier than in the past, these types of rollovers are easy to avoid by just sticking with direct, trustee to trustee rollovers, which is what we have always recommended.  There is no limit on the number of direct rollovers you can make in a year.  Keep in mind that it’s rarely a good idea to leave funds in a previous employer’s 401k.  While 401ks are a great benefit while you are employed as you can take advantage of salary deferrals and employer matching, they come with a very limited list of investment choices and generally high administrative expenses that are hidden within the funds.  When you’re no longer receiving the employee benefits, it’s time to roll the account over to an IRA.  Feel free to contact me if you’d like guidance on handling a 401k left behind with a former employer.

Second Quarter 2015 Commentary

Breaking News From 2010

Some things just never seem to change.  The recent weeks of volatility that have given us triple digit moves in the Dow Industrial Average have been exclusively driven by worries over Greek debt and the cohesion of the European monetary union.  That last sentence could have lead off our market commentary in 2009, 2010, 2011 or 2014.  Not only has Greece not dealt with their systemic deficit problems, but the EU can’t seem to come to terms with the fact that Greece won’t get its fiscal house in order. 

The recent stock market downturn in the U.S has been in response/sympathy to the broad market declines in Europe.  Euro zone markets have experienced sharp declines as the European Central Bank and IMF have been unsuccessful at negotiating repayment terms for the outstanding Greek debt.  Greece was due to make a substantial loan payment ($1.73b) to the IMF at the end of June, but of course didn’t have the funds necessary to fulfill that obligation.   In addition, Greece is running out of cash to meet its current payables.  Without further outside financial support, Greece will have no choice but to leave the European Union so it can reintroduce its own currency.  The Drachma may not be worth much, but at least they could print as much as they’d like.

In our opinion, a Greek exit is inevitable.  There surely has to be a point where the Germans will tire of bankrolling the Greeks.  It seems that most market participants are now coming to terms with that conclusion as well.  The larger question is the same as it has been for years - what will that mean for other weak European Union members?  This larger question is what’s really driving the current market fears. 

While that question is legitimate, we feel the current market reaction is entirely overblown.  There are significant differences today than there were five years ago.  Most notably, the European banking sector is in much better shape than it was in 2009.  Back then, Greek and other questionable sovereign debt was held throughout European banks and posed a real threat to their capital levels.  Years later, that debt, and Greek debt in particular, is held with the ECB.  The risk to the EU banking system doesn’t exist like it did in the past. 

For this reason, we believe this latest downturn will pass in the coming months.  If that were to be the case, we should see stock prices stabilize at their April levels.  Even then, that would only put the S&P 500 up 2.5-3% (before dividends) for the year.  As modest as those returns are, it would be in keeping with our expectations at the beginning of the year.  At that time, we felt that 2015 would finish with upper single digit returns with much of those gains occurring in the last quarter.

The U.S. stock market has strung together several consecutive years of gains (albeit from very depressed levels) and was in need of a pullback due to the valuations.  This year was likely to be the year earnings would need to catch up to stock prices.  The greatest impediment to that scenario was the strengthening dollar relative to the Euro.  Europe is our second largest export market so a stronger dollar makes our goods more expensive in their currency.  This then negatively translates into many U.S. companies’ earnings.

Depending on the day you’re reading this, to date the U.S. stock markets are largely flat.  Unlike last year, the mid and small cap sector of the stock market has performed better than the S&P 500.  The NASDAQ index has also out-performed large cap stocks.  Still these gains are modest at best. 

One other unknown hanging over the stock market is when will the Fed begin to raise rates?  They have stated that their preference is to start the process sooner than later.  At this point, the consensus is, barring any European contagion, it will be this fall.  Generally rate hikes are bad for the stock market, but this expectation has been built into the market for a while.  Higher rates will also be a needed relief for investors seeking income.  There’s a long way to go before we see anything that looks like normal interest rates, but we need to begin that move very soon.

In conclusion, while the Greek news had a big impact on the past quarter’s performance, ultimately we don’t think it will have led to anything by the end of the year.  Once there is a better understanding of the stronger dollar’s impact on GDP, we’ll probably see the Fed enact their first rate hike since the financial crisis began years ago. 

Will it be Debit or Credit?

By Charles Webb

Not all plastic is created equal.  When you reach into your wallet and pullout a card to make a purchase, you probably don’t give much thought as to what the card is beyond VISA or American Express, but you should, and here’s why.  The real distinction among the various cards offered today is if it’s a credit card or debit card. 

There are two primary differences between credit cards and debit cards.  Firstly, credit card charges accumulate in an account with the card issuer and can go no further than that.  Because you owe the balance to the card issuer, you are in an inherently stronger position when it comes to dispute resolutions.  You can wait to make the payment after the dispute is resolved to your satisfaction.  A debit card, on the other hand, places you in the position of having the card issuer refund your money once the dispute is resolved to their satisfaction because the money is withdrawn from your checking account when the charge is made. 

The second difference between the two card types is the consumer protection laws.  The Consumer Financial Protection Bureau says that if your credit card number (not your physical credit card) is stolen, you are not responsible for unauthorized charges under federal law.  If the actual credit card is stolen, you are liable for no more than $50 in unauthorized charges as long as you report it to the card issuer.

With debit cards, the CFPB says that if an unauthorized transaction appears on your statement (but your card or PIN has not been lost or stolen), under federal law you will not be liable for the debit if you report it within 60 days after your account statement is sent to you.  The rules are different if the card or PIN has been lost or stolen: Report the problem within two business days and liability is limited to $50 of unauthorized charges. Past two days and the maximum liability rises to $500.  If any unauthorized charges go unreported for more than 60 days, the CFPB says your money and future charges by the same person could be lost.  Most card issuers have a zero liability policy because they want you using their cards, but ultimately they are not required to by law. 

Most stolen card information has come from retailer data breaches.  This means that you likely won’t even know that fraudulent charges are being made until well after the fact.  If this occurs with a credit card, then there is no harm while the situation gets fixed.  However, if the fraud occurs on a debit card, your checking account can get emptied before you’re notified, potentially affecting all of your other checking activity (i.e. bounced checks, unable to get cash from an ATM, etc.).  Even though your bank will refund the fraudulent charges, you still have to deal with the NSF charges from the companies you wrote checks to.  There’s no guarantee they’ll refund those or that it won’t lead to dings on your credit report.

Hands down, a credit card is the safer form of payment.  As a bonus, many credit card companies also offer free reward points just for using your card.  Banks promote the use of debit cards because it’s a better deal for them.  You should do all of your shopping on a credit card and pay it off every month.

First Quarter 2015 Commentary

April Already?

So far this year, the action in the stock and bond markets has been pretty uneventful.  Most of the major averages sit near where they were at the beginning of the year.  Stocks showed some life in February, advancing roughly 3%, only to see those gains evaporate the next month.  As of March 31st, the S&P 500 was only up 0.5% on the year.  The small and mid-cap sectors of the market performed better, but only slightly.

Our expectation for this year remains unchanged.  In our last commentary, we expressed our belief that 2015 will look a lot like 2014.  While this year, thus far, hasn’t had the same level of volatility as last year, there are several significant economic factors that are building behind the scenes which we believe will be the main drivers of stock performance in 2015. 

The most notable of these factors are global interest rates and their effect on the dollar’s value.  As everyone is aware, interest rates in the U.S. have remained at historic lows since the 2008 financial crisis.  This has been true for all maturities and can be seen by the yield on the 10-year Treasury bond which has declined steadily for almost two and a half years. The yield now sits below 2%.  As paltry as two percent seems, this is actually high by comparison to other developed sovereign debt such as the Eurobond and Japanese debt. 

In Europe, interest rates have been falling sharply, in some cases into negative territory, since the European Central Bank last year introduced measures meant to spur the economy in the Eurozone, including cutting its own deposit rate. The ECB in March also launched a bond-buying program similar to what the Federal Reserve had undertaken, driving down yields on Eurozone debt in hopes of fostering lending.

Another major player in the global bond market is the Bank of Japan.  In fact, last month the BOJ over took China as the largest holder of U.S. Debt.  Japan has also been undergoing their own monetary easing program.  The impact has been just what we’ve seen everywhere else – ultra low interest rates.  Their 10 year bond only yields 0.34%.
So it’s basically the same story around the world.  High credit sovereign debt is extremely expensive and thus their yields are miniscule. The result is U.S. treasuries, by comparison, are the best game in town and international investors are buying them in droves.  The side effect of this demand for U.S. debt is that it has greatly increased the demand for the dollar. The stronger dollar has become a major headwind for U.S. firm’s exports.

This has become the biggest concern for stocks this year.  In particular, it has been a bigger concern for large-cap stocks, as they tend to have a larger proportion of their sales overseas.  So far, there has only be a slight downturn in exports.  Last year, U.S. firms exported a little over 2.3 billion dollars of goods and services.  That number is trending down to be more like 2.2 billion dollars.  It’s still too early to predict what the annual export number is going to look like this year, other than it will be lower.

We view this as the real headwind to stocks this year.  On the flipside, lower energy prices should provide a significant boost to earnings and consumer spending.  Our belief is that this economic benefit will outweigh the negative impact of exports and thus our positive expectation for stocks this year. 

Stock prices are much more influenced by future expectations than actual results.  Because of this, our guess is that there will need to be more clarity in the relationship between the dollar and oil before stocks are able to sustain a rally.  That likely won’t occur until the second half of the year.  Until then, stocks are likely to trade in a narrow range similar to what we’ve seen so far.

The good news is that the major stock indexes’ performance has finally broadened.  Over the last three quarters, the gains have been concentrated in the large cap sector of the market.  This has caused our most diversified equity positions to underperform the Russell 1000 benchmark.  This will happen from time to time, but usually only for one quarter.  This quarter’s results are finally reversing that trend with most of our client equity positions out pacing the Russell 1000 by half to one and a half percent.

By Lori Eason, CFP(R)

As many of you are aware, new cost basis reporting rules were phased in over the past few years. In an attempt to find missing tax revenue, new rules require brokerage firms to include cost basis information on 1099-B's for certain securities. These rules drastically change the way cost basis is reported to the IRS and affect brokers, financial advisors and investors in a major way. We never expected this transition to happen smoothly, and it hasn't so far.

Two very important terms to understand are covered verses uncovered securities. Covered securities are those that brokerage firms are required to track and report cost basis on and uncovered are those they are not. Equities purchased on or after 1/1/11 (Phase 1), mutual funds or ETFs purchased on or after 1/1/12 (Phase 2) and "less complex" bonds and options purchased on or after 1/1/14 (Phase 3 ½?) are considered covered securities. Debt instruments and options were supposed to be considered covered if they were purchased on or after 1/1/13, but in May of 2012, the IRS announced that it would postpone the effective date for these categories until 2014 as the financial services industry was still trying to understand and figure out a way to comply with the new rules from phases I and II.

In 2014, cost basis reporting rules were introduced for "less complex" bonds and most options purchased starting on 1/1/14. These bonds include corporate, treasury and municipal bonds with a fixed interest rate, payment schedule and maturity. We purchase asset backed bonds as well as adjustable rate bonds in many of our client portfolios which without a doubt fall in the "more complex" category. As of now, "more complex" bonds are scheduled to become covered in January of 2016, but we're not sure the cost basis on these will ever be accurately tracked by brokerage firms.

For our clients, part of my job is maintaining our portfolio management software, which among other things, accurately tracks cost basis for every security we purchase, regardless of whether it is considered covered or uncovered by the IRS. For this reason, the Gain/Loss report we provide our clients with at the beginning of each year will always be the most complete and accurate source for calculating your cost basis.

Where's My Social Security Statement?

By Lori Eason, CFP(R)

Have you noticed that you haven’t been receiving Social Security benefits annually? Back in 2011, the Social Security Administration began phasing out mailed annual benefit statements to save money. While people can at any time access the same information by setting up "my Social Security" accounts online, very few people have actually done so (about 6%). In light of this, the administration recently decided that they will begin mailing statements again, but with some stip...ulations. Workers who have created an online account will not receive mailed statements. Workers age 25 and older who aren’t registered online or receiving benefits will receive mailed statements every 5 years and those over 60 will receive annual statements. Here's a link to create an online account to view your benefits if you're interested:  http://www.ssa.gov/myaccount/

April 15th - Just Another Day of the Year?

By:  Lori Eason, CFP(R)

If it seems like every year preparing and filing your taxes has become  more and more difficult, it's because it has. There is probably no better proof of the need for tax reform than what most Americans have to go through now to simply file form 1040. In the past, this was mostly a problem for the ultra-wealthy that had various business interests, tax shelters and an army of accountants to keep up with it all. Not so today. Anyone with even a basic level of financial complexity in his or her life faces a myriad of changing tax rules and strategies to understand and stay current on from one year to the next.

If you're a business, the challenges of complying with the tax code are even worse. This is especially true of financial institutions. Whether they are banks, brokerage firms, or investment companies, any firm that is required to report investors' activity to the IRS is being buried by those obligations. Taxpayers simply have to take a look at the length of their 1099s they receive every year to get a sense of what we're talking about.

Ten years ago, the typical client's 1099 form was roughly 6 pages long. That same client will have seen the number of pages grow to over 50 today. The amount of information that the IRS wants from these financial institutions on you and I has simply exploded. This is clearly an effort by the government to capture any lost tax dollars it thinks may be going unreported. In reality, though, it has created a complex chain in which a series of financial institutions have to file reports to one another so that finally your bank or brokerage firm can provide you with what you need to file your taxes.

Here's a typical scenario: You own a mutual fund in your brokerage account. That fund invests in a variety of securities that include ETF's, partnerships, futures or maybe option contracts. Each of those underlying investments inside the ETF, for example, has to send their financial information to their transfer agent who then passes that along to the shareholder (the ETF manager). The ETF manager then compiles that with all of their other holdings and forwards that to their shareholders (the mutual fund company). The fund company, in turn, compiles that data with all of their other holdings and sends that to your brokerage firm, who then collects similar information for all the activity in your account and prints your 1099.

In the past, the amount of information collected and sent along was pretty much limited to interest, dividend and sales proceeds. There is now far more data that has to be collected and with each new data point comes the likelihood that something will be wrong or missing. Any correction then has to get forwarded up the food chain. This ultimately shows up as a corrected 1099.

The Affordable Care Act created the biggest reporting burden by requiring financial institutions to keep up with the cost basis of most securities held in taxable accounts for the purpose of calculating your trading gains or losses. This is no easy task as the cost basis is subject to tax rules themselves. Factors affecting the cost basis are, just to name a few, the amortization of premiums and discounts, wash sale rules or accounting for multiple tax lots.

Securities subject to these requirements were fully phased in over four years ending last year. Our experience is that we've seen more and later corrected 1099's (some as late as June). Understandably, clients have become increasingly frustrated when this happens. I can't count the number of calls I have received during the past couple of tax seasons with the question "Is this the last 1099?" As badly as I want to answer this, unfortunately, there is no way for neither me nor the brokerage firm, in our clients' case, Charles Schwab & Co., to know.

Through the normal course of business, we often speak to our clients' accountants and what we've heard from them is that filing tax returns by April 15th is becoming a thing of the past. There just isn't enough time by then to accurately compile all of the information the government requires and disseminate it to the end user - tax payers. Literally, every accountant we spoke to last year told us that they are advising their clients to plan on filing an extension from here on out.

Based on what we've experienced, we agree with this advice. If you have been receiving late corrected 1099s, it's probably a good idea to file a tax extension. This will relieve a great deal of stress for both you and your accountant. Filing an extension with the IRS gives you an additional 6 months to file your taxes pushing back the deadline from April 15th to October 15th. It's important to note that this extension of time does not provide additional time to pay and payments made after April 15th are subject to penalties and interest. If you are due a tax refund, this will delay receipt, but filing an extension does not mean you have to wait until October, you can file in late June only delaying your refund slightly. On a side note, if you're receiving a substantial refund each year, you should revisit your tax situation and adjust your tax payments instead of giving the government an interest free loan every year.

Filing an extension is easy and done so by filing Form 4868, which is a very simple and short form. The only somewhat tricky part is that you have to estimate your total tax liability for the year. To do so, you'll need to prepare a mock form 1040. While state tax extension guidelines vary, many states do not require you to file a state extension if you already filed a federal one. Georgia, for example, applies the automatic six-month extension if a federal extension has been accepted and a copy of the federal extension is attached the return when filed. Alabama automatically grants a six-month extension and does not require taxpayers to file an Alabama extension form.

The bottom line is that if you expect to receive late corrected 1099s, filing an extension can make life easier for both you and your accountant. Please let us know if you have any questions about filing an extension or contact your CPA.