It’s Too Complicated

Our CFO, Bill Sweet, likes to get down and dirty with the tax code. Last week, he uncovered a new type of tax deferred savings account in the 2017 tax reform bill called the Universal Savings Account (USA). These new accounts allow for annual contributions of $2,500, grow tax deferred, but unlike IRAs and ROTH IRAs, include no holding period or age restrictions for tax free distributions.

If USAs come to fruition, they are a great added benefit for savers. But this means that next year I will have an IRA, ROTH IRA, HSA, FSA (for daycare), 401k, 529, and now a new USA account. That’s seven different accounts, all with different rules for their proper use, that one should open to effectively save for retirement, healthcare, and college tuition.

It’s too complicated for the average, or even the above average person, to open and maintain all of these accounts. Let’s take a look at each account type, and how they work.

IRA: Individual Retirement Arrangements were introduced in 1974 as part of the Employee Retirement Income Security Act (ERISA). They allow taxpayers under the age of 70.5, with earned income, to contribute up to $5,500 ($6,500 if over age 50) with pre-tax dollars in to an account that grows tax deferred until retirement.

Contributions may or may not be deductible on the current tax return depending on the individual’s adjusted gross income (AGI), marital status, and eligibility for a qualified plan at work. Withdrawals before age 59.5 are assessed a 10% penalty, unless the withdrawal is for one of these exceptions. Withdrawals are fully taxed as ordinary income unless the account includes non-deductible contributions, in which case a portion of the withdrawal is taxed.

Required minimum distributions (RMDs) must begin in the year the owner turns age 70.5 and must be taken over the owner’s life expectancy (or the joint life expectancy of a married couple whose ages are more than 10 years apart). The penalty for failing to take an RMD is 50% of the required amount.

I’ve barely scratched the surface on IRAs. I didn’t cover the endless list of rollover rules or what happens when the IRA passes to the beneficiary.

Are you ready for the next six account types? I won’t do that to you.

Add on top of these rules and regulations the administrative burden of opening each account type at a bank or brokerage firm. You’ll have to keep track of online login information and passwords. Now you are swimming in paperwork, mailing notices, and statements.

There are tax forms to receive and to file. You won’t receive Form 5498, proof that you made an IRA contribution, until after April 15th, so don’t forget to tell your CPA. If you make non-deductible contributions, you must file Form 8606 and keep track of cumulative nondeductible amounts. Forget, and you might pay tax on those dollars twice when you take withdrawals from the IRA. When you transfer, or rollover, IRA funds from one brokerage firm to another, you’ll receive a Form 1099-R. If you don’t provide proof of the rollover to the IRS, you could be taxed on the full amount.

Taking withdrawals from FSAs, HSAs, or 529 plans? Make sure you keep your receipts to prove those withdrawals were for “qualified” expenses to avoid taxes and penalties. FSAs require you to spend the funds each calendar year.  The list of qualified healthcare expenses for HSAs was recently reduced to remove over the counter medicines. Qualified education expenses for 529 funds do not include transportation costs to and from college or the payment of student loans.

We know from Richard Thaler’s work on behavioral economics, that humans are more likely to participate when enrollment is automatic – and opt-out system rather than an opt-in. The barriers to utilizing these accounts discourage many from participating. Given the looming retirement crisis and the rising costs of healthcare and college tuition, wouldn’t it be wise to explore policies that ease the complexity of these programs?

For now, financial planners enjoy an inordinate amount of job security. There is a shortage of professionals available to work with young families whose assets don’t meet wealth management firm minimums. Roboadvisors are a first step, but so far they fall short of the comprehensive advice needed to navigate these complicated waters.


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