EagleStone Tax & Wealth Newsletter – December 2015

Six Common 401(k) Plan Misconceptions


Do you really know as much as you think you do about your 401(k) plan? Let’s find out.

1. If I leave my job, my entire 401(k) account is mine to keep.

This may or may not be true, depending on your plan’s “vesting schedule.” Your own contributions to the plan–that is, your pretax or Roth contributions–are always yours to keep. While some plans provide that employer contributions are also fully vested (i.e., owned by you) immediately, other plans may require that you have up to six years of service before you’re entitled to all of your employer contributions (or you’ve reached your plan’s normal retirement age). Your 401(k)’s summary plan description will have details about your plan’s vesting schedule.

2. Borrowing from my 401(k) plan is a bad idea because I pay income tax twice on the amount I borrow.

The argument is that you repay a 401(k) plan loan with dollars that have already been taxed, and you pay taxes on those dollars again when you receive a distribution from the plan. Though you might be repaying the loan with after-tax dollars, this would be true with any type of loan.

And while it’s also true that the amount you borrow will be taxed when distributed from the plan (special rules apply to loans from Roth accounts), those amounts would be taxed regardless of whether you borrowed money from the plan or not. So the bottom line is that, economically, you’re no worse off borrowing from your plan than you are borrowing from another source (plus, the interest you pay on a plan loan generally goes back into your account). But keep in mind that borrowing from your plan reduces your account balance, which may slow the growth of your retirement nest egg.

3. Because I make only Roth contributions to my 401(k) plan, my employer’s matching contributions are also Roth contributions.

Employer 401(k) matching contributions are always pretax–whether they match your pretax or Roth contributions. That is, those matching contributions, and any associated earnings, will always be subject to income tax when you receive them from the plan. You can, however, convert your employer’s matching contributions to Roth contributions if your plan allows. If you do, they’ll be subject to income tax in the year of the conversion, but future qualified distributions of those amounts (and any earnings) will be tax free.

4. I contribute to my 401(k) plan at work, so I can’t contribute to an IRA.

Your contributions to a 401(k) plan have no effect on your ability to contribute to a traditional or Roth IRA. However, your (or your spouse’s) participation in a 401(k) plan may adversely impact your ability to deduct contributions to a traditional IRA, depending on your joint income.

5. I have two jobs, both with 401(k)s. I can defer up to $18,000 to each plan.

Unfortunately, this is not the case. You can defer a maximum of $18,000 in 2015, plus catch-up contributions if you’re eligible, to all your employer plans (this includes 401(k)s, 403(b)s, SARSEPs, and SIMPLE plans). If you contribute to more than one plan, you’re generally responsible for making sure you don’t exceed these limits. Note that 457(b) plans are not included in this list. If you’re lucky enough to participate in a 401(k) plan and a 457(b) plan you may be able to defer up to $36,000 (a maximum of $18,000 to each plan) in 2015, plus catch-up contributions.

6. I’m moving to a state with no income tax. I’ve heard my former state can still tax my 401(k) benefits when I retire.

While this was true many years ago, it’s no longer the case. States are now prohibited from taxing 401(k) (and most other) retirement benefits paid to nonresidents. As a result, only the state in which you reside (or are domiciled) can tax those benefits. In general, your residence is the place where you actually live. Your domicile is your permanent legal residence; even if you don’t currently live there, you have an intent to return and remain there.

Give Your Retirement Plan an Annual Checkup


Financial professionals typically recommend that you review your employer-sponsored retirement savings plan annually and when major life changes occur. If you haven’t revisited your plan yet in 2015, the end of the year may be an ideal time to do so.

Reexamine your risk tolerance

This past year saw moments that would try even the most resilient investor’s resolve. When you hear media reports about stock market volatility, is your immediate reaction to consider selling some of the stock investments in your plan? If that’s the case, you might begin your annual review by reexamining your risk tolerance.

Risk tolerance refers to how well you can ride out fluctuations in the value of your investments while pursuing your long-term goals. An assessment of your risk tolerance considers, among other factors, your investment time horizon, your accumulation goal, and assets you may have outside of your plan account. Your retirement plan’s educational materials likely include tools to help you evaluate your risk tolerance, typically worksheets that ask a series of questions. After answering the questions, you will likely be assigned a risk tolerance ranking from conservative to aggressive. In addition, suggested asset allocations are often provided for consideration.

Have you experienced any life changes?

Since your last retirement plan review, did you get married or divorced, buy or sell a house, have a baby, or send a child to college? Perhaps you or your spouse changed jobs, received a promotion, or left the workforce entirely. Has someone in your family experienced a change in health? Or maybe you inherited a sum of money that has had a material impact on your net worth. Any of these situations can affect both your current and future financial situation.

In addition, if your marital situation has changed, you may want to review the beneficiary designations in your plan account to make sure they reflect your current wishes. With many employer-sponsored plans, your spouse is automatically your plan beneficiary unless he or she waives that right in writing.

Reassess your retirement income needs

After you evaluate your risk tolerance and consider any life changes, you may want to take another look at the future. Have your dreams for retirement changed at all? And if so, will those changes affect how much money you will need to live on? Maybe you’ve reconsidered plans to relocate or travel extensively, or now plan to start a business or work part-time during retirement.

All of these factors can affect your retirement income needs, which in turn affects how much you need to save and how you invest today.

Is your asset allocation still on track?

Once you have assessed your current situation related to your risk tolerance, life changes, and retirement income needs, a good next step is to revisit the asset allocation in your plan. Is your investment mix still appropriate? Should you aim for a higher or lower percentage of aggressive investments, such as stocks? Or maybe your original target is still on track but your portfolio calls for a little rebalancing.

There are two ways to rebalance your retirement plan portfolio. The quickest way is to sell investments in which you are overweighted and invest the proceeds in underweighted assets until you hit your target. For example, if your target allocation is 75% stocks, 20% bonds, and 5% cash but your current allocation is 80% stocks, 15% bonds, and 5% cash, then you’d likely sell some stock investments and invest the proceeds in bonds. Another way to rebalance is to direct new investments into the underweighted assets until the target is achieved. In the example above, you would direct new money into bond investments until you reach your 75/20/5 target allocation.

Revisit your plan rules and features

Finally, an annual review is also a good time to take a fresh look at your employer-sponsored plan documents and plan features. For example, if your plan offers a Roth account and you haven’t investigated its potential benefits, you might consider whether directing a portion of your contributions into it might be a good idea. Also consider how much you’re contributing in relation to plan maximums. Could you add a little more each pay period? If you’re 50 or older, you might also review the rules for catch-up contributions, which allow those approaching retirement to contribute more than younger employees.

Although it’s generally not a good idea to monitor your employer-sponsored retirement plan on a daily, or even monthly, basis, it’s important to take a look at least once a year. With a little annual maintenance, you can help your plan keep working for you.

Periodic Review of Your Estate Plan


An estate plan is a map that explains how you want your personal and financial affairs to be handled in the event of your incapacity or death. It allows you to control what happens to your property if you die or become incapacitated. An estate plan should be reviewed periodically.

When should you review your estate plan?

Although there’s no hard-and-fast rule about when you should review your estate plan, the following suggestions may be of some help:

  • You should review your estate plan immediately after a major life event
  • You’ll probably want to do a quick review each year because changes in the economy and in the tax code often occur on a yearly basis
  • You’ll want to do a more thorough review every five years

Reviewing your estate plan will alert you to any changes that need to be addressed.

There will be times when you’ll need to make changes to your plan to ensure that it still meets all of your goals. For example, an executor, trustee, or guardian may die or change his or her mind about serving in that capacity, and you’ll need to name someone else.

Events that should trigger a periodic review include:

  • There has been a change in your marital status (many states have laws that revoke part or all of your will if you marry or get divorced) or that of your children or grandchildren
  • There has been an addition to your family through birth, adoption, or marriage (stepchildren)
  • Your spouse or a family member has died, has become ill, or is incapacitated
  • Your spouse, your parents, or other family member has become dependent on you
  • There has been a substantial change in the value of your assets or in your plans for their use
  • You have received a sizable inheritance or gift
  • Your income level or requirements have changed
  • You are retiring
  • You have made (or are considering making) a change to any part of your estate plan

Some things to review

Here are some things to consider while doing a periodic review of your estate plan.

  • Who are your family members and friends? How do you feel about them?
  • Do you have a valid will? Does it reflect your current goals and objectives about who receives what after you die? Does your choice of an executor or a guardian for your minor children remain appropriate?
  • In the event you become incapacitated, do you have a living will, durable power of attorney for health care, or Do Not Resuscitate order to manage medical decisions?
  • In the event you become incapacitated, do you have a living trust, durable power of attorney, or joint ownership to manage your property?
  • What property do you own and how is it titled (e.g., outright or jointly with right of survivorship)? Property owned jointly with right of survivorship passes automatically to the surviving owner(s) at your death.
  • Have you reviewed your beneficiary designations for your retirement plans and life insurance policies? These types of property pass automatically to the designated beneficiary at your death.
  • Do you have any trusts, living or testamentary? Property held in trust passes to beneficiaries according to the terms of the trust.
  • Do you plan to make any lifetime gifts to family members or friends?
  • Do you have any plans for charitable gifts or bequests?
  • If you own or co-own a business, have provisions been made to transfer your business interest? Is there a buy-sell agreement with adequate funding? Would lifetime gifts be appropriate?
  • Do you own sufficient life insurance to meet your needs at death? Have those needs been evaluated?
  • Have you considered the impact of gift, estate, generation-skipping, and income taxes, both federal and state?

This is just a brief overview of some ideas for a periodic review of your estate plan. Each person’s situation is unique. An estate planning attorney may be able to assist you with this process.

What do I need to know about submitting the FAFSA?

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The FAFSA, which stands for Free Application for Federal Student Aid, is the federal government’s financial aid application. Though the thought of completing it may inspire a collective groan from parents each year, this form is the prerequisite for many different types of federal and college financial aid, including loans, grants, scholarships, and work-study. So filling it out should be one of the first things on your list if your son or daughter will need some type of financial aid to attend college.

Even if you don’t think your child will qualify for aid, you should still consider submitting the FAFSA in two instances. The first is when you want your child to have some “skin in the game” by taking on a small loan. In this case, filing the FAFSA will make your child eligible for an unsubsidized Stafford Loan each year–up to $5,500 for freshmen, $6,500 for sophomores, and $7,500 for juniors and seniors. Unsubsidized Stafford Loans aren’t based on financial need and are available to any student attending college at least half-time.

The second situation for which you might file the FAFSA is when you want your child to be considered for college financial aid. Colleges generally require the FAFSA, along with the CSS Profile form, before they’ll determine whether your child is eligible for any college need-based grants and scholarships.

The FAFSA is available online at fafsa.ed.gov. A new sign-in method (as of May 2015) requires creating an FSA ID, which consists of a username and password. The FSA ID replaces the prior PIN sign-in method and is meant to be more secure.

The FAFSA should be filed as soon as possible after January 1 for both new and returning students because some aid programs operate on a first-come, first-served basis. Practically speaking, many families wait to submit the FAFSA until after they have completed their tax returns, but you don’t have to wait. The FAFSA can be submitted with estimated tax numbers and then updated later with final tax numbers by simply adding the final numbers manually or using the government’s online IRS Retrieval Tool. Regarding the filing timeline, look for a change on the horizon. Starting with the 2017/2018 school year, families will be able to file the FAFSA as early as October 2016 using their 2015 tax information.

What happens after I file the FAFSA?

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After you submit the federal government’s FAFSA (Free Application for Federal Student Aid), you will receive a Student Aid Report (either electronically or by mail, depending on how you filed the FAFSA). This report summarizes key data from your FAFSA and provides you with the holy grail of numbers–your expected family contribution, or EFC, which is the amount of money the government expects your family to contribute toward college for the current year before being eligible for federal aid.

For example, EFC27000 means that your expected family contribution is $27,000. Keep in mind that this figure is what the government says you can afford to pay, not what you say you can afford. In fact, many families may find it difficult to pay their EFC, let alone any potential remaining costs.

Review your report carefully to make sure it contains your correct income and asset information. Any corrections should be made immediately and sent back for reprocessing. If you have questions, you can contact the Federal Student Aid Information Center at 1-800-433-3243. An asterisk (*) next to your EFC means that your application has been selected for verification, which means you’ll need to provide additional documentation as specified.

Your Student Aid Report is also sent to each college that your child listed on the FAFSA. The financial aid administrator at each school that has accepted your child will then use the report (along with the CSS Profile form, if applicable) to craft an aid package that attempts to meet your child’s financial need. Aid packages typically include various combinations of federal loans, grants, and work-study jobs along with college grants and scholarships. Colleges are not obligated to meet all of your family’s financial need. If they don’t, it’s called getting “gapped.” In this case, you’re on the hook for your EFC plus any gap.

Both new and returning students will be notified of a college’s aid package in the spring. Some colleges may send a letter, some may post the information on a password-protected online site, and some may do both. Make sure to look over the award carefully. If you have questions or your financial circumstances have changed since you filed the FAFSA, contact the college’s financial aid office.


IRS Circular 230 disclosure: To ensure compliance with requirements imposed by the IRS, we inform you that any tax advice contained in this communication (including any attachments) was not intended or written to be used, and cannot be used, for the purpose of (i) avoiding tax-related penalties under the Internal Revenue Code or (ii) promoting, marketing or recommending to another party any matter addressed herein.

Prepared by Broadridge Investor Communication Solutions, Inc. Copyright 2015


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