LaToya’s Blog

1031 Exchange Roadmap

Advantages of a 1031 exchange include many things aside from the tax benefits. Investors can consolidate, diversify, move markets, or increase income potential on their current investment property.

Some people choose to do a 1031 exchange to acquire more income. For example, they can exchange vacant land for commercial or residential real estate. The investor is able to increase income potential by exchanging a property that is not generating any revenue, such as land, into real estate that has greater income potential like commercial and residential real estate.

Another advantage of doing a 1031 exchange is consolidation. Depending on the investor’s situation, they may not want to manage multiple properties. They can exchange their properties into one larger investment property that is easier to manage. Others are tired of managing properties and of being a landlord altogether. These investors can exchange from a residential or commercial property into a more manageable and less time consuming piece of land.

Some investors are looking to diversify. With a 1031 exchange they can exchange one property for multiple property types. For example, an investor can exchange their residential investment property into a commercial, residential, and vacant piece of land. This is one of the most attractive of the advantages of a 1031 exchange!

A 1031 exchange is great for investors who have multiple properties in other states or for investors who are moving markets. Instead of traveling from state to state to manage multiple properties, investors can exchange the out of state real estate into property that’s in one state. If the investor is moving markets, for example from one state to another, they can exchange their investment property in the current states for an investment property in another state.

Every situation is unique when considering the advantages of a 1031 exchange, and it is always advised that the taxpayer consult with his or her tax advisors before making any decisions!

For more information, visit www.DST.investments.

December 2018 Year End Planning

pexels-photo-775779.jpeg
Photo by IMAMA LAVI on Pexels.com

Tax reform and tax preparation


As a new year approaches, many of us will reflect on the year that has passed. Personal and professional accomplishments may take center stage. And we may take stock of any disappointments and recalibrate as 2019 approaches.

But in any case, I know it’s a busy time. Christmas shopping, holiday parties, tree trimming, family visits, and year-end cheer may already be on the calendar.

Yet it’s not too soon to start thinking about taxes. We’ve had discussions about 2017’s tax reform, but until we’ve filed for 2018, it may still feel confusing to many.

Before we jump in, let me stress that it is my job to assist and help you! I can’t overemphasize this, and I would be happy to review the options that are best suited to your situation. When it comes to tax matters, I also recommend you check with your tax advisor.

Let’s get started

Tax reform, officially known as the Tax Cuts and Jobs Act (TCJA) of 2017, was the biggest change in the tax code in over 30 years. The overhaul covered both individual and corporate income taxes. Most will see their tax bill decline when they file, but a few folks may see a sharper bite.

I’ll touch on some of the changes at a high level.

  1. Tax brackets and tax rates have changed. The lowest bracket holds at 10% but the top bracket has been lowered from 39.6% to 37%. There have also been modest adjustments to the rates and income levels for taxable income.

 

Single filers 2018   Single filers 2017
Taxable income Rate Taxable Income Rate
$0 – $9,525 10% $0 – $9,325 10%
$9,526 – $38,700 12% $9,326 – $37,950 15%
$38,701 – $82,500 22% $37,951 – $91,900 25%
$82,501 – $157,500 24% $91,901 – $191,650 28%
$157,501 – $200,000 32% $191,651 – $416,700 33%
$200,001 – $500,000 35% $416,701 – $418,400 35%
$500,001 or more 37% $418,401 or more 39.6%

 

Married filing jointly 2018*   Married filing jointly 2017
Taxable income Rate Taxable Income Rate
$0 – $19,050 10% $0 – $18,650 10%
$19,051 – $77,400 12% $18,651 – $75,900 15%
$77,401 – $165,000 22% $75,901 – $153,100 25%
$165,001 – $315,000 24% $153,101 – $233,350 28%
$315,001 – $400,000 32% $233,351 – $416,700 33%
$400,001 – $600,000 35% $416,701 – $470,700 35%
$600,001 or more 37% $470,701 or more 39.6%

*or Qualifying Widow(er)

Source: IRS US Tax Center 2017/18 Federal Tax Rates, Personal Exemptions, and Standard Deductions

  1. The personal exemption has been eliminated; child tax credit increased. The $4,050 personal exemption taken in 2017 has been eliminated. However, the child tax credit doubles to $2,000 per qualifying child, subject to income limitations.

 

  1. The increase in the standard deduction will simplify filing for some folks. The standard deduction will rise from $6,350 to $12,000 for single filers and $12,700 to $24,000 for joint filers.

The higher standard deduction and increased child tax credit will likely lower tax bills for many lower and middle-income filers. In addition, it simplifies filing every year.

  1. Some itemized deductions have been reduced or eliminated. State and local income taxes, property taxes, and real estate taxes are capped at $10,000. Anything above can no longer be written off against income.

All miscellaneous itemized deductions are eliminated, including deductions for unreimbursed employee expenses, tax preparation fees, the deduction for theft, and personal casualty losses, although certain casualty losses in federally declared disaster areas may still be claimed.

The new tax law enhanced the deduction for charitable contributions by raising it to 60% of adjusted gross income from 50%.

The law preserved the deduction for unreimbursed medical expenses, temporarily reducing the limitation from 10% to 7.5% of adjusted gross income for tax year 2018 and retroactively for 2017.

The floor returns to 10% in 2019.

  1. Changes to the AMT–the alternative minimum tax. The dreaded AMT is still with us but will snag far fewer taxpayers since the exemption and exemption phase-out have been substantially increased.

About 5 million taxpayers were expected to pay the AMT under the old law, but only 200,000 are expected to pay the AMT this year.

  1. There’s a new 20% deduction for business owners. The new law gives “pass-through” business owners, such as sole proprietorships, LLCs, partnerships, and S-corps, a 20% deduction on income earned by the business.

 It’s a substantial benefit to business owners who aren’t classified as C-corps and wouldn’t benefit from the reduction in the corporate tax rate to 21% from 35%.

REITs and MLPs are also eligible for the deduction.

The deduction is generally available to eligible taxpayers whose 2018 taxable incomes fall below $315,000 for joint returns and $157,500 for other taxpayers.

There are limitations to the new deduction and some aspects are complex. It is important to check with your tax advisor to see how you may qualify.

The points above are simply a summation of the major changes in 2018. You may see provisions that will benefit you. You may also see potential pitfalls. If you have any questions or concerns, let’s have a conversation.


8 smart year-end financial planning moves

1. Review your income or portfolio strategy

Are you reaching a milestone in your life such as retirement or a change in your circumstances? Has your tolerance for taking risk changed? If so, this may be just the right time to evaluate your approach.

However, let me caution you about making changes based simply on market performance.

One of my goals has always been to remove the emotional component from the investment plan. You know, the one that encourages investors to load up on stocks when the market is soaring or one that prods us to sell when volatility surfaces.

2. Take stock of changes in your life

Review insurance and beneficiaries. Let’s be sure you are adequately covered. At the same time, it’s a good idea to update beneficiaries if the need has arisen.

3. Mind the tax loss deadline

You have until Monday, December 31 to harvest any tax losses and/or offset any capital gains. But be careful. There are distinctions between short- and long-term capital gains, and you must be aware of wash-sale rules (IRS Publication 550) that could disallow a capital loss.

It may be advantageous to time sales in order to maximize tax benefits this year or next. We may also want to book gains and offset any losses.

4. Mutual funds and taxable distributions—be careful

This is best described using an example.

If you buy a mutual fund on December 18 and it pays a dividend and capital gain December 21, you will be responsible for paying taxes on the entire yearly distribution, even though you held the fund for just three days. It’s a tax sting that’s best avoided because the net asset value hasn’t changed.

It’s usually a good idea to wait until after the annual distribution to make the purchase.

5. Don’t miss the RMD deadline

Required minimum distributions (RMDs) are minimum amounts a retirement plan account owner must withdraw annually, generally starting with the year that he or she reaches 70½ years of age. Some plans may provide exceptions if you are still working.

The first payment can be delayed until April 1 of the year following the year in which you turn 70½. For all subsequent years, including the year in which you were paid the first RMD by April 1, you must take the RMD by December 31.

The RMD rules apply to traditional IRAs, SEP IRAs. Simple IRAs, 401(k), profit-sharing, 403(b), 457(b) or other defined contribution plans. They do not apply to ROTH IRAs.

Don’t miss the deadline or you could be subject to steep penalties.

6. Contribute to a Roth IRA or traditional IRA

A Roth gives you the potential to earn tax-free growth (not just deferred tax-free growth) and allows for federal-tax-free withdrawals if certain requirements are met.

You may also be eligible to contribute to a traditional IRA, and contributions may be fully or partially deductible, depending on your circumstances. Total contributions for both accounts cannot exceed the prescribed limit.

 There are income limits, but if you qualify, you may contribute $5,500, or $6,500 if you are 50 or older. In 2019, limits will rise to $6,000 and $7000, respectively.

You can make 2018 IRA contributions until April 15, 2018 (Note: state holidays can impact final date).

7. Consider college savings

A limited option, called the Coverdell Education Savings account, did not get axed by the new tax law.

Currently, total contributions for a beneficiary cannot exceed $2,000 in any year and must be made before the beneficiary turns 18.

Any individual (including the designated beneficiary) can contribute to a Coverdell ESA if the individual’s modified adjusted gross income for the year is less than $110,000. For individuals filing joint returns, the amount is $220,000.

A 529 plan allows for much higher contribution limits, and earnings are not subject to federal tax when used for the qualified education expenses of the designated beneficiary. Contributions to both accounts are not tax deductible.

8. Wrap up charitable giving

Whether it is cash, stocks or bonds, you can donate to your favorite charity by December 31, potentially offsetting any income.

Did you know that you may qualify for what’s called a “qualified charitable distribution (QCD)” if you are over 70½ years old? A QCD is an otherwise taxable distribution from an IRA or inherited IRA that is paid directly from the IRA to a qualified charity (“End-Of-Year Contribution and Distribution Planning for Tax-Favored Accounts”–Kitces.com).

This becomes even more valuable in light of tax reform as more taxpayers will no longer be able to itemize, and an RMD that is taken, then donated to a charity, may not provide tax benefits.

Given the increase in the standard deduction and limits on state income and property taxes, annual year-end gifts to your favorite charity may not exceed the higher thresholds. Therefore, you may consider giving an annual gift in early January. Coupled with an annual gift next December, you might reap the tax advantages from itemizing in 2019.

You might also consider a donor-advised fund. Once the donation is made, you can generally realize immediate tax benefits, but it is up to the donor when the distribution to a qualified charity may be made.


Uncertainty forces modest correction

The conclusion of the midterm elections failed to soothe concerns through much of November.

Anxieties include higher interest rates and a moderation in economic growth.

Eight 0.25 percentage-point rate hikes by the Fed have done little to discourage investors since late 2015, at least through September. While rates remain low by historical standards, concerns have cropped up that the Fed’s desire to gradually raise rates throughout 2019 might begin to crimp growth.

Maybe it’s temporary or just statistical noise. But we are seeing signs that U.S. growth is slowing in Q4. Global growth has moderated, which will likely create a headwind for U.S. exports. And trade tensions are creating uncertainty, which may be impacting business investment.

Housing sales have turned lower, and housing starts have slipped. In addition, first-time claims for unemployment insurance, a good leading indicator, have inched off September lows, according to the Department of Labor.

Given the heightened uncertainty, analysts have been trimming profit forecasts for 2019. Still, the sell-off has been modest since the late September peak.

As the month concluded, Fed Chief Jerome Powell appeared to take a slightly more dovish tone regarding rate hikes. Expect another 0.25 percentage point increase in December, but a gradual series of increases next year seem less uncertain.

If you are concerned and want to talk, I’m simply a phone call away. I’d love to hear from you.

Table 1: Key Index Returns

MTD % YTD % 3-year* %
Dow Jones Industrial Average 1.7 3.3 13.0
NASDAQ Composite 0.3 6.2 12.8
S&P 500 Index 1.8 3.2 9.9
Russell 2000 Index 1.4 -0.1 8.6
MSCI World ex-USA** -0.3 -11.7 1.5
MSCI Emerging Markets** 4.1 -14.1 6.9
Bloomberg Barclays US

Aggregate Bond TR

0.6 -1.8 1.3

Source: Wall Street Journal, MSCI.com, MarketWatch, Morningstar

MTD returns: Oct 31, 2018-Nov 30, 2018

YTD returns: Dec 29, 2017- Nov 30, 2018

*Annualized

**in US dollars

 

I hope you’ve found this review to be educational and helpful, but keep in mind that it is not all-encompassing. Once again, before making any decisions that may impact your taxes, please consult with your tax advisor.

Let me emphasize that it is my job to assist you! If you have any questions or would like to discuss any matters, please feel free to give me a call.

As always, I’m honored and humbled that you have given me the opportunity to serve as your financial advisor. If you have any concerns or questions, please feel free to reach out to me at latoya@latoyamaddox or call me at 678-821-2968 and we can talk. That’s what I’m here for.

 

 

 

Where is Your Financial Emergency Kit?

first aid case on wall
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Floods, hurricanes, wildfires, earthquakes, extreme winds, and tornadoes. They all have the potential to create treacherous conditions and cause devastation.

We prepare with insurance, but it is often inadequate. It covers many, but not all natural disasters. Flooding requires flood insurance. And a standard homeowners policy won’t cover damages caused if the ground shakes violently.

Disaster can strike with little or no warning. Early preparation is the key.

Today, I want to focus on the importance of building a financial emergency kit. The time to create an emergency kit is today, when the skies are blue and the winds are calm.

What do I need?

Consider purchasing a box or safe that is fireproof and waterproof. You can’t guarantee it won’t be damaged during a disaster, but it will go a long way in safeguarding important papers. A safety deposit box is also an option.

Store electronic copies of important documents on a USB drive. Even better, upload them to a password-protected, cloud-based system. And be sure to create a strong password that is unique. Include letters (some caps, some lower case), numbers, and special characters. If two-factor authentication is an option, enable it.

Cash and keys. Make a duplicate of house keys and auto keys. You may also need cash in the immediate aftermath of a disaster. ATM cards may not work and not everyone is prepared to take a credit card. Still, it wouldn’t hurt to include a duplicate credit card.

Contacts. Who are the important people in your life–family, friends, medical, and professional. Create a list with telephone numbers, emails, or other contact information.

You may store the information electronically, with the appropriate security precautions, but it’s recommended that you place a paper copy inside your kit.

Identification. If disaster strikes, you may be asked to confirm your identity to obtain disaster relief services, file insurance claims, or get access to your property and financial assets.

Your kit should contain essential documents, including extra originals or copies of a passport, driver’s license, birth certificate, marriage certificate, adoption records, Social Security card, green card, any military records, and pet ID tags.

These will allow you to establish your identity, the identify of immediate family members, and eliminate the need to replace important ID markers.

Important records. We have copies of your financials, but this doesn’t preclude you from safe harboring your records.

A short list of financial documents that can fit into your kit includes mortgages, property deeds, and legal documents such as a power of attorney, estate planning, wills, and insurance policies.

Also include recent bank and credit card statements, brokerage accounts records, and statements related to investments that might be held outside a brokerage firm (such as mutual funds or 529 college savings).

If you access accounts or documents online, include a list of password hints. Also, pack recent retirement account statements and your most recent tax return.

A password-protected flash drive or file might be safer than hard copies—as long as you have a way to access the files. If you receive electronic copies of bank and brokerage statements, it is advisable to place recent copies in your kit.

What are your valuables? Create an inventory of your personal belongings. Assemble a paper, photo or video inventory, and put it into your emergency kit.

Be sure to save receipts for major items, home upgrades, or any appraisals of valuable belongings. For your household items, record what’s in each room. For major items, write down serial numbers.

While you’re at it, record the cost. Take closeup pictures of valuables, including details such as serial number tags. You can also videotape your belongings with a narrative description of the relevant information.

If the project seems overwhelming, you may start by tackling one room at a time. If it’s ever needed, it will help you maximize benefits from your insurance policies and expedite the claims process.

(Sources: Ready.gov–Financial Preparedness, Finra.org–Lock down your Financial Emergency Kit, IRS: Prepare for Natural Disasters)

Your kids

A disaster will take an enormous mental toll on you. Having your financial house and records in order will remove one burden. But what about your children?

Your children’s wellbeing will largely be dependent on you. Kids look to Mom and Dad for their security.

Here is a checklist for your kids obtained from UNICEF USA;

  • Pack their essentials such as medicine and clothes.
  • Pack their toys, favorite books, music, electronics, and have fresh batteries.
  • Talk to your kids about what to expect at a shelter.
  • Develop a system with your children that will allow them to be identified if they are separated from you.
  • Learn basic first aid skills in case you are your child becomes sick and medical supplies are scarce.

Chat with your kids in ways they will understand. Be honest, reassure them, but don’t make promises that aren’t realistic. Just as important, let them know there are resources available that will assist your family.

While I sincerely hope you never experience the pain that comes with the loss of property or worse, we are here to assist. Taking proactive steps in advance can help eliminate one source of uncertainty in the event disaster strikes.

As always, I’m honored and humbled that you have given me the opportunity to serve as your financial advisor. If you have any concerns or questions, please feel free to reach out to me at latoya@latoyamaddox or call me at 678-821-2968 and we can talk. That’s what I’m here for.

 

Trends of the Wealthy

Let’s talk about some trends that are changing how private investors and especially the ultra-wealthy families worth $100 Million plus are allocating their capital.

While the mass affluent and billionaires are studied and talked about relentlessly in the media and by the general public, there are very few resources or facts available on those who are worth $100 million up to $2 billion.

These individuals are sometimes called Centimillionaires, a term rarely used.  This was similar to the use of the term “family office” used prior to 2000, and I think in the future the mass media, wealth managers, and dozens of other types such as industry service providers are going to sit up straight and realize that while there are only around 3,000 billionaires depending on what sources you trust, there are between 40,000 and 60,000 centimillionaires.

The families in the $100 million to $2 billion range need a lot of help, do not have as many gatekeepers as other 2 plus billionaires, and are less “famous” so they aren’t being pinged hundreds of times an hour with offers, pitches, requests and other inquiries.

Below are two trends we are seeing among Centimillionaires:

Transferring of Values (Not Capital): While the general public talks about baby boomers and the transfer of that wealth being central to their aging, Centimillionaire families seem to worry more about transferring values, responsibilities, family stories, and know-how being passed on to the next few generations.  Transferring of wealth in a tax efficient matter is important, but not much of that matters if the family tears themselves apart, wastes the money, embarrasses the family name, and squanders what past generations worked so hard to build as a family culture and legacy.  Many families are afraid that their family stories, governance structures, experience, etc. in creating the wealth is going to get lost between generations, and the true loss is either the family staying connected and/or the principles that lead to the wealth being created in the first place.  The wealth is truly transferred within the family values – not just a “warm fuzzy family emotions are more important than money” approach, but truly the only preservation and growth of the capital long-term is via the values/mission of the family.

Outsourcing: Most family offices are realizing that the only thing they should be doing in-house is what they did to create their wealth in the first place, the space where they believe there is great cross-over in a rising tide opportunity, using their experience and skills where they actively want to be 100% focused.  Trying to “recreate the wheel” just does not make sense.

Many single family offices, whether they hire a private bank or multi-family office or not, are leaning towards full outsourcing of their managers/stock/bonds/market exposure, a full in-house deployment of their investment back into the niches where they are playing offense, and then an in-between strategy of going through independent sponsors and some direct investments when it comes to real estate allocations.

This outsourcing trend with varying levels of accountability, control and transparency is likely to continue increasing with those with over $100 million in assets.

At NAMCOA we focus on adding real value, resources and peer connections to centimillionaires is one of those areas where those positioning now, building relationships now, and adding value now will do well long-term just as they will in the growing family office space.

 

The Legacy of Lehman

September 15th marked an ominous anniversary. Ten years prior, Lehman Brothers declared bankruptcy, sparking a financial crisis that engulfed the global economy.

Lehman’s failure could easily be described as a “systemic event.” That’s financial jargon for an event that triggers severe financial instability and sends shockwaves through the economy.

Economically, we’ve recovered from the downturn. Unemployment is low, and GDP is above pre-crisis levels. Major U.S. market indexes have topped pre-recession highs, but the crisis left an indelible mark on investors. For some, the scars remain.

While today’s bull market pushes higher, some investors fear a repeat. You see it every time the market experiences a correction, or a decline of at least 10%. One day, I believe the memory of the crisis will recede. It may take another downturn that doesn’t lead to severe losses, but I believe it will eventually fade.

Can it happen again?

We cannot unequivocally say “Never.”

Gone are the days when a borrower need only a pulse to obtain a mortgage. OK, that’s a bit of an exaggeration, but I think you understand what I’m trying to convey. Whether you blame it on the banks or blame it on borrowers, too many folks jumped into or were placed into loans they couldn’t afford or didn’t understand.

Today, banks are much better capitalized than in 2007. The major banks have a much bigger cushion to absorb loan losses. And underwriting standards for home loans are more realistic.

During the Fed’s quarterly press conference, Fed Chief Jerome Powell was asked about financial conditions.

Powell, said, “The single biggest thing I think that we learned was the importance of maintaining the stability of the financial system.” It’s something “that was missing” back then.

“We’ve put in place many, many initiatives to strengthen the financial system through higher capital, and better regulation, more transparency, central clearing, margins on unclear derivatives, all kinds of things like that, which are meant to strengthen the financial system,” Powell said.

These measures won’t prevent another recession, and systemic risks haven’t completely abated, but the financial system is in a much better position to withstand a shock than it was in 2008.

Table 1: Key Index Returns

MTD % YTD % 3-year* %
Dow Jones Industrial Average 1.9 7.0 18.2
NASDAQ Composite -0.8 16.6 21.0
S&P 500 Index 0.4 9.0 15.7
Russell 2000 Index -2.5 10.5 15.9
MSCI World ex-USA** 0.5 -3.8 6.4
MSCI Emerging Markets** -0.8 -9.4 9.8
Bloomberg Barclays US Aggregate Bond TR -0.6 -1.6 1.3

Source: Wall Street Journal, MSCI.com, MarketWatch, Morningstar

MTD returns: Aug 31, 2018—Sep 28, 2018

YTD returns: Dec 29, 2017— Sep 28, 2018

*Annualized

**in US dollars

Takeaways

It’s not about timing the market. It’s about time in the market, diversification, and the balance between riskier assets (such as stocks) that have long-term potential for appreciation, versus safer, less volatile assets that are less likely to appreciate.

Headlines can create short-term volatility. We saw that earlier this year, and we’ve seen it at various times in recent years. But patient investors who stuck with a disciplined approach were rewarded. Longer term, stocks historically have had an upward bias.

While heading to the safety of cash during volatility may bring short-term comfort, opting for the sidelines can have long-term costs.

Let me repeat a Fidelity study I recently quoted. “Investors who stayed in the markets (during 2008) saw their account balances—which reflected the impact of their investment choices and contributions—grow 147%” between Q4 2008 and the end of 2015.

“That’s twice the average 74% return for those who moved out of stocks and into cash during the fourth quarter of 2008 or first quarter of 2009.” Even worse, over 25% who sold out of stocks during that downturn never got back into the market.

Yes, the safety of cash during volatility may bring short-term comfort but opting for the sidelines can have long-term costs.

The opposite is also true. Don’t become overconfident when stocks are surging. Some folks feel an aura of invincibility and are tempted to take on too much risk.

That gets them into trouble, too.

I hope you’ve found this review to be educational and helpful. As always, I’m honored and humbled that you have given me the opportunity to serve as your financial advisor. If you have any concerns or questions, please feel free to reach out to me at latoya@latoyamaddox or call me at 678-821-2968 and we can talk. That’s what I’m here for.

 

What is a Privately Managed Account?

Also known as a SMA (“Separately Managed Account”), is a single investment account comprised of individual stocks, bonds, cash or other securities, tailored to achieve specific investment objectives.

Your portfolio manager oversees the investments according to your specific investment objectives and in an investment style with which you are comfortable.  Put simply, a SMA is for demanding investors who:
  • Seek the comfort of professional investment guidance and a heightened level of personal service
  • Still want to take an active role in their financial life
  • Desire the flexibility to invest in different strategies or styles, while seeking the liquidity and potential tax benefits that come from owning individual securities in separate accounts, versus mutual funds
  • May want a single fee to cover ALL account costs, including trading costs and performance reporting.
  • Low-cost, transparency and 24/7 online access

For those with more than $100,000 a SMA may be the smart way to manage portfolio assets, due to lower costs, greater tax efficiency and transparency.

Why the growth in Cash Balance Plans?

The Pension Protection Act of 2006 (PPA) is long and hard to read, but it played a crucial role in establishing cash balance plans as a viable and legally recognized retirement savings option. Before 2006, cash balance plans faced frequent legal challenges. Those bringing the suits argued that cash balance plans violated established rules for benefit accrual and discriminated against older workers. The rulings on these cases were inconsistent, and many business owners were reluctant to risk establishing a plan that just didn’t have firm legal footing.

The Pension Protection Act ended this uncertainty about the legality of cash balance plans. The legislation set specific requirements for cash balance plans, including:

  • A vesting requirement: Any employee who has worked for their company for at least three years must be 100% vested in their accrued benefits from employer contributions.
  • A change in the calculation of lump sum payments: Participants in a cash balance plan can usually choose to receive a lump sum upon retirement or upon the termination of employment instead of receiving their money as a lifetime annuity. Before 2006, some plans used one interest rate to calculate out the anticipated account balance upon retirement, but, when participants opted to receive an earlier lump sum, the plan called for using a different interest rate to discount the anticipated retirement balance back to the date of the lump sum payment. This could lead to discrepancies between the hypothetical balance of the account (as determined by employer contributions and accumulated interest credits) and the actual lump sum payout, an effect known as “whipsaw”. The PPA eliminated the whipsaw effect by allowing the lump sum payout to simply equal the hypothetical account balance.
  • Clarification on age discrimination claims: A cash balance plan does not violate age discrimination legislation if the account balance of an older employee is compared with that of a similarly situated younger employee (i.e. with the same length of employment, pay, job title, date of hire, and work history), and the older employee’s balance is equal to or greater than the younger employee’s.

There are, of course, many other points included in this lengthy piece of legislation, but the takeaway is this: the Pension Protection Act of 2006 removed the legal uncertainty surrounding cash balance plans and made them a much more appealing option for small business owners. The number of cash balance plans in America more than tripled after the implementation of the PPA. Additional regulations in 2010 and 2014 made these hybrid plans an even better option, and we anticipate that their popularity will continue to grow. There are thousands of high-earning business owners out there who can reap huge, tax-crushing benefits from implementing cash balance plan – they just have to know about them first.