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Fiduciaries

DEAR TRUST OFFICER:
 
I’ve heard something about a new “fiduciary rule” for retirement advisors.  What does that mean?  What does it mean for me?—FOLLOWING THE NEWS

 
DEAR FOLLOWING:
 
In general, the Securities and Exchange Commission provides the rules governing the conduct of investment advisors.  In May, the Department of Labor added a new rule, pursuant to ERISA, for advisors who provide advice to retirees, in particular those retirees who are rolling their retirement money from a 401(k) or similar plan to an IRA.  Such advisors will now need to put the interests of their customers ahead of their own, the essence of fiduciary obligation, which is more strict than the earlier rule that the advice must be suitable.  The purpose of the change to eliminate or at least disclose any conflicts of interest, including the compensation that the advisor may receive associated with the advice.

The change sounds small, but Morningstar projected that retirees may save $55 billion over the next ten years in fees as a result of the new rule [“The Final DOL Fiduciary Rule Has Arrived. Here’s What It Means for Investors,” April 26, 2024].  On the other hand, past attempts to impose fiduciary obligations on advisors have been successfully challenged in court, so it is not certain that the new rule will go into effect on schedule, on September 23 this year.

By the way, trust departments have always been fiduciaries, and have always adhered to an extensive list of fiduciary duties.  We’d be pleased to explain in detail, if you are interested.

 

Article ©2024 M.A. Co. All rights reserved. Used with permission. 

To be valid, a trust must have a purpose other than tax avoidance.

Lawrence Saccato was in the storage business.  Over the years, he created a variety of legal entities, and he managed them with his long-term girlfriend.  What he failed to do was file a tax return, a failure that recurred for 14 straight years.

When the IRS attempted to audit Mr. Saccato, he was not cooperative.  He claimed that he was neither the trustee nor the beneficiary of the various trusts he had set up in connection with his business.  The IRS therefore used his bank account records to reconstruct Saccato’s income.

Before the Tax Court, Saccato continued to maintain that he did not own the business property, that he was not the trustee of the trusts (although he had so described himself to a bank and the state authorities).  Saccato also made a number of assertions similar to those made by tax protesters, which the Tax Court characterized as “gibberish.”  

The Court held that “We find that these ‘trusts’ do not exist and that, if they did exist, they would be shams. The sole purpose of these fictitious entities was to obscure petitioner's true ownership of the assets they purportedly held.”  The IRS determinations recreating Saccato’s income from bank records were sustained.  What’s more, Saccato persisted in making nonsense arguments after he was warned to desist.  The Court added a $10,000 penalty to the overdue taxes for wasting its time.

 

Article ©2024 M.A. Co. All rights reserved. Used with permission. 

Retirement readiness

A recent survey from the Nationwide Retirement Institute suggests growing anxiety about retirement among those in the last decades of their careers.  Some 69% of those aged 55-65 agreed that retiring at age 65 “doesn’t apply to them.”  22% reported that in the last 12 months they’ve decided to retire later than planned.  More than 40% believe that they will have to keep working during retirement to make ends meet.

​Inflation is one culprit behind the pessimism.  42% said the rising cost of living has affected their spending habits, with 27% saving less for retirement as everyday spending consumes more of their income.  More than half of respondents expect that inflation will hurt their retirement portfolios.

​Over the years, many observers have worried about the transition away from employer-provided pensions, toward enabling employees to save for their retirement in 401(k) or 403(b) plans.  With a pension, the transition to retirement is somewhat seamless, as the regular payments take the place of the earlier salary in the household budget.  Not so with a lump sum accumulated in a tax-deferred plan.  How much in savings will be enough for retirement?  How much can be withdrawn each year?  How should it be invested?  The questions are daunting, there are no easy answers.  Will retirement turn into another kind of work?

​On optimistic side, writing for Morningstar, John Rekenthaler asserts that “There’s No Retirement Crisis” [April 29, 2024].  He reached that conclusion by examining the changes in relative incomes for each population cohort since 1994.  The data is from the U.S. Census Bureau.  Over the last 30 years, real, after-inflation income has grown by 42% for those age 65 -74, and by 33% for those 75 and older.  For comparison, the average income of those 45 - 54 has grown only 17% above the inflation rate.  What’s more, these figures do not include the 2023 8.7% increase in Social Security benefits.

​So there is no retirement crisis yet, according to Mr. Rekenthaler.  But he does conclude with a different caution about global demographics.  “The world is becoming older rather than younger. That shift will have profound implications, including with retirement funding.”

 

Article ©2024 M.A. Co. All rights reserved. Used with permission. 

Taxes on home sales

The tax blow for the sale of a principal residence may be softened, even eliminated, by the $250,000 exclusion from income ($500,000 for marrieds filing jointly) for the gain from the sale of a principal residence.  However, these boundaries were set in 1997 and never adjusted for inflation.  As the prices of houses has soared in the past few years, more and more taxpayers find themselves in taxable territory.  Had there been an inflation adjustment, the exclusion for couples would now be $981,558, according to the Bureau of Labor Statistics online calculator.

A recent Wall Street Journal article [“Capital-Gains Tax Hits More Home Sellers,” May 4, 2024] reported that roughly 8% of recent home sales have generated likely taxable gains.  However, there is considerable variation around the country. California is the leader, with an estimated 28.8% of home sales in the fourth quarter of 2023 resulting in taxation in. Hawaii, Washington, D.C., Massachusetts, and Washington state each were over 15% in the proportion of gains exceeding the exclusion amount. 

Long-term owners

To be eligible for the full exclusion for a home sale, one must have owned and used the property as a personal residence for at least two of the preceding five years.  Short absences (such as vacations) are not a problem, but a prolonged absence could be.

The doubled exclusion of $500,000 for married couples is available if: (1) either spouse meets the two-year ownership test; (2) both spouses meet the two-year use test and (3) neither spouse has claimed the exclusion within the prior two years.  If one spouse is ineligible, the other may still claim up to $250,000.

Relief for short-term owners

If the two-year test can’t be met, a partial exclusion may be salvaged if the home sale came about due to a change in the place of employment, a change in health or for “unforeseen circumstances.” IRS has provided examples that meet these vague requirements.  For example, the exclusion would be available for a sale due to:

  • multiple births from a single pregnancy;
  • a lost job;
  • a change in circumstances that leads to an inability to meet mortgage payments;
  • development of a disease, illness or injury (selling to improve one’s general health would not qualify).

For some taxpayers, a partial exclusion will be as good as full one if it covers the full amount of their gain.

Good records are essential

 These rules make good recordkeeping more important than ever.  Good records for current home owners will also be important when:

  • the owners intend to stay in the home for a long period of time;
  • they have invested heavily in renovations;
  • there is a possibility that the owners will claim a depreciation deduction for a home office or rental use of the residence.  Gain will have to be recognized to the extent of any depreciation deduction claimed.

The tax on the sale of a home applies to the net after the tax basis is subtracted from the sales proceeds.  Basis includes what the taxpayer paid for the house plus major remodeling, such as a kitchen upgrade or a new roof.  Routine repairs don't count.  Details on allowable expenses are provided in IRS Publication 523.

 

Article ©2024 M.A. Co. All rights reserved. Used with permission. 

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