How to Protect Your Money Under Trump’s Financial Regulation Changes

An executive memorandum signed by President Donald Trump on Feb. 3 is aimed at consumers’ retirement accounts and will impact a majority of Americans almost immediately. The memo might delay, potentially forever, the so-called “fiduciary rule” that would have legally bound financial advisers to give retirement savers the best advice possible.

Critics lashed out, claiming the memo was a gift to Wall Street, as it threatens to roll back rules designed to protect Americans’ retirement accounts instituted in the wake of the financial crisis, when some savers saw their account balances drop by 25% in a single year, according to an estimate from Hewitt Associates. But supporters say those rules were flawed, and that this cure for the financial crisis was worse than the disease.

Investors’ Best Interests Could Take a Back Seat

If you are looking for a bottom line, here it is: Financial advisers could be let off the hook from higher standards that were about to be placed on the advice they give investors. Those standards would have opened up advisers to lawsuits if they gave advice to clients that put their own commissions above their clients’ best interests.

But at least some of the intended effect of the rule may still happen. Because the rule was years in the making, and just weeks away from taking effect, many brokerages have said they’ve already implemented the changes it required. Some are even using the moment as a marketing opportunity.

In practical terms, the new rules discourage advisers from offering commission-based products to buyers, so some firms, like Merrill Lynch and JP Morgan Chase, were moving away from commission-based IRAs. That change will probably continue.

For now, the memo also means consumers must be vigilant and ask financial advisers, “Are you getting a commission?” when taking their advice.

Consumer advocates spent years working to get the federal government to enact a rule that targets these potential conflicts of interest. They finally made progress in 2010 when the Labor Department, which regulates some retirement accounts, initially proposed a fiduciary rule. After years of bickering with the financial industry, the Labor Department finally settled on the rule in April 2016. It was set to take effect this April.

Only retirement accounts were to be covered by the rule; normally taxed brokerage accounts were not. The rule would have covered certain financial advisers who use titles like wealth manager, investment consultant or broker; certified financial planners are already required to meet the fiduciary standard.

Many consumers don’t realize that current rules mean some advisers can legally steer clients into high-commission products when better, cheaper options exist. The Obama administration, which supported the Labor Department rule, issued a report last year claiming that less-than-best advice to savers costs Americans $17 billion annually in retirement funds.

Undermining Consumer Protections?

A second financial-related executive action signed by Trump last week may have even farther-reaching consequences, but they won’t happen right away. That order called for a review of financial reform legislation known as “Dodd-Frank,” which passed after the housing bubble burst. Its numerous protections included tighter monitoring of the stability of banks and creation of the Consumer Financial Protection Bureau. Trump’s order calls for the Treasury Secretary to review the law and recommend changes within 120 days.

Advocacy groups said that taken together, the two orders threaten to undermine a host of new rules put in place to protect consumers.

“President Trump’s comments and executive order today suggesting rollback of financial regulations would violate his campaign promises to hold Wall Street accountable and to help everyday American families,” said Christine Hines, Legislative Director of the National Association of Advocates, in a statement. “We must never forget that the reckless behavior of big banks and predatory lenders and the lack of safeguards to hold them responsible for their actions caused the Great Recession, leaving millions of Americans without jobs, wiping out their savings, and causing devastating loss of their homes.”

A draft of the fiduciary rule memo called for a 180-day delay of the rule and a review by the Labor Department. The order actually signed by Trump omitted the language calling for immediate delay, but that’s still a likely outcome. Acting U.S. Secretary of Labor Ed Hugler made that clear in a statement:

“The Department of Labor will now consider its legal options to delay the applicability date as we comply with the President’s memorandum,” it read.

The memo was cheered by some on Wall Street. Discouraging commission-based products hurts smaller investors who don’t like paying up-front fees, they argued.

“Americans are going to have better choices and Americans are going to have better products because we’re not going to burden the banks with literally hundreds of billions of dollars of regulatory costs every year,” said National Economic Council director Gary Cohn to the Wall Street Journal. “The banks are going to be able to price product more efficiently and more effectively to consumers.”

But consumer advocates were unanimous in their condemnation of the review, saying it could remove a critical tool for protecting unsophisticated retirement savers.

“If the Department of Labor follows through on this threat and delays and repeals the rule, brokers and insurance agents will be free to go back to putting their own financial interests ahead of the interests of their clients, recommending investments that are profitable for the firm but not the customer,” the Consumer Federation of America said in a statement. “And they will be permitted to do all this while claiming to act as trusted advisers.”

Sen. Elizabeth Warren (D-Mass.), said in a statement that the review “will make it easier for investment advisors to cheat you out of your retirement savings.”

“Donald Trump talked a big game about Wall Street during his campaign — but as President, we’re finding out whose side he’s really on,” she said.

Retirement savers should know that the immediate effect of the Trump memo means advisers can continue to give out bad advice that’s compromised by commission structure; the rule that remains in effect now requires only that the investment is “suitable.” That might sound like a small distinction, but John Bogle, the man who popularized low-cost index funds, put it in context in an interview with Business Insider at the end of December:

“Fiduciary means putting the client first, and as I have observed in the past, the only other rule we have is the client comes second,” Bogle said.

The Trump administration did not immediately respond to requests for comment on how the actions would affect consumers.

How You Can Protect Yourself

Before making any investment decision based on an adviser’s recommendation, always ask if he or she will earn a commission. When picking an adviser, ask if their firm accepts fiduciary responsibility. Even if it’s not legally required, advisers can voluntarily accept the fiduciary standard. But make sure you get that in writing.

It’s also wise to monitor your financial goals, like building and maintaining a good credit score, which you can do for free here on Credit.com.

Image: Squaredpixels

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Retirement Accounts: What You Need to Understand

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With mounting concerns over Social Security, and a languishing number pensions, it’s more important than ever to start investing for retirement. Tax advantaged retirement accounts offer investors the best opportunities to see their investments grow, but the accounts come with fine print. These are the things you need to know before you start investing.

What are employer sponsored retirement accounts?

Employee sponsored retirement accounts often allows you to invest pre-tax dollars in an account that grows tax-free until a person takes a distribution. In some cases, you may have access to a Roth retirement account which allows you to contribute post-tax dollars. Contributions to employer sponsored retirement accounts come directly from your paycheck.

The most common employee sponsored retirement accounts are defined contribution plans including a 401(k), 403(b), 457, and Government Thrift Savings Plan (TSP). Private sector companies operate 401(k)s, public schools and certain non-profit organizations offer 403(b)s, state and local governments offer 457 plans, and the Federal government offers a TSP. Despite the variety of names, these plans operate the same way.

According to the Bureau of Labor Statistics, 61% of people employed in the private sector had access to a retirement plan, but just 71% of eligible employees participated.

How much can I contribute? 

If you’re enrolled in a 401(k), 403(b), 457, or TSP, then you can invest up to $18,000 dollars to your employer sponsored retirement accounts per year in 2016. If you qualify for multiple employer sponsored plans, then you may invest a maximum of $18,000 across all your defined contribution plans. People over age 50 may contribute an additional $6,000 in “catch-up” contributions or $3,000 to a SIMPLE 401(k).

In addition to your contributions, some employers match contributions up to a certain percentage of an employee’s salary. Visit your human resources department to learn about your company’s plan details including whether or not they offer a match.

What are the benefits of investing in an employer sponsored retirement plan?

For employees that receive a matching contribution, investing enough to receive the full match offers unparalleled wealth building power, but even without a match, employer sponsored plans make it easy to build wealth through investing. The funds to invest come directly out of your paycheck, and the plan invests them right away.

However, there are fees associated with these accounts. Specific fees vary from plan to plan, so check your company’s fee structure to understand the details, especially if you aren’t receiving a match. If you don’t have an employer match, then it may make more sense to contribute to your own IRA in lieu of the employer-sponsored plan.

Investing in an employer sponsored means getting to defer taxes until you withdraw your investment. Selling investments in a retirement plan does not trigger a taxable event, nor does receiving dividends. These tax benefits provide an important boost for you to maximize your net worth.

In addition to tax deferred growth, low income investors qualify for a tax credit when they contribute to a retirement plan. Single filers who earn less than $41,625 or married couples who earn less than $61,500 qualify for a Saver’s Tax Credit worth 10-50% of elective contributions up to $2000 ($4000 for married filers).

What are the drawbacks to investing in an employer sponsored retirement plan?

Investing in an employer sponsored retirement plan reduces the accessibility of the invested money. The IRS punishes distributions before the age of 59 ½ with a 10% early withdrawal penalty. These penalties come on top of the income taxes that you must pay the year you take a distribution. In most cases, if you withdraw money early pay so much in penalties and increased income tax rates (during the year you take the distribution) that you would have been better off not investing in the first place.

Additionally, investing in an employee sponsored retirement plan reduces investment choices. You may not be able to find investment options that fit your investing style through their company’s plan.

Should I take a loan against my 401(k) balance?

Since money in 401(k) plans isn’t liquid, some companies allow you  to take a loan against your 401(k). These loans tend to be low interest and convenient to obtain, but the loans come with risks that traditional loans do not have. If your job is terminated, most plans offer just 60-90 days to pay off the loan balance, or the loan becomes a taxable distribution that is subject to the 10% early withdrawal penalty and income tax.

It is best to only consider a 401(k) loan for a short term liquidity need or to avoid them altogether.

What if I don’t qualify for an employer sponsored retirement plan?

If you’re an employee, and you don’t have access to an employer sponsored retirement plan you have to forgo the tax savings and other benefits associated with the accounts, but you may still qualify for an Individual Retirement Account (IRA).

However, if you pay self-employment taxes then you can create your own retirement plan. Self-employed people (including people who are both self-employed and traditionally employed) can start either a Solo 401(k) or a SEP-IRA.

A Solo 401(k) allows an elective contribution limit of 100% of self-employment income up to $18,000 (plus an additional $6000 in catch up contributions for people over age 50) plus if your self-employed, then you can contribute 20% of your operating income after deducting your elective contributions and half of your self-employment tax deductions (up to an additional $35,000).

If you qualify for both a Solo 401(k) and other employer sponsored retirement plan, then you cannot contribute more than $18,000 in elective contributions among your various plans.

A SEP-IRA allows you to contribute 25% of your self-employed operating income into a pre-tax account up to $53,000.

What are Individual Retirement Accounts?

Individual Retirement Accounts (IRAs) allow you to invest in tax advantaged accounts. Traditional IRAs allows you to deduct your investments from your income, and your investments grow tax free until they are withdrawn (at which point they are subject to income tax). You can contribute after-tax money to Roth IRAs, but investments grow tax free, and the investments are not subject to income tax when they are withdrawn in retirement. There are income restrictions on being eligible for deductions and these vary based on household income and if an employer-sponsored retirement plan is available to you (and/or your spouse).

What are the rules for contributing to an IRA?

In order to contribute to an individual retirement account, you must meet income thresholds in a given year, and you may not contribute more than you earn in a given year. The maximum contribution to an IRA is $5500 ($6500 for people over age 50).

A traditional IRA allows you to defer income taxes until you take a distribution. Single filers who earn less than $61,000 are eligible deduct one hundred percent of deductions, and single filers who earn between $61,000 and $71,00 may partially deduct the contributions. Couples who are married filing jointly may make contribute the maximum if they earn less than $98,000, and they may make partial contributions if they earn between $98,000 and $118,000.

Roth IRAs allow participants to invest after tax dollars that are not subject to taxes again. The tax free growth and distributions can be especially beneficial for those who expect to earn a high income (from investments, pensions or work) during retirement. Single filers who earn less than $117,000 can contribute the full $5,500, and those who earn between $117,000 and $132,000 can make partial contributions. Couples who are married filing jointly who earn less than $184,000 may contribute up to $5500 each to Roth IRAs, and couples who earn between $184,000 and $194,000 are eligible for partial contributions.

What are the benefits to investing in an IRA?

The primary benefits to investing in an IRA are tax related. Traditional IRAs allow you to avoid paying income taxes on your investments until you are retired. Most people fall into a lower income tax bracket in retirement than during their working years, so the tax savings can be significant.  Roth IRA contributions are subject to taxes the year they are contributed, but the IRS never taxes them again. Investments within an IRA grow tax free, and buying and selling investments within an IRA does not trigger a taxable event.

Additionally, low income investors also qualify for a tax credit when they contribute to a retirement plan. Single filers who earn less than $41,625 or married couples who earn less than $61,500 qualify for a Saver’s Tax Credit worth 10-50% of elective contributions up to $2000 ($4000 for married filers).

IRAs also allow individuals to choose any investments that fit their strategy.

What are the drawbacks to investing in an IRA? 

Investing in an IRA reduces the accessibility of money. Though it is possible to withdraw contribution money for some qualified expenses, many distributions are to be subject to a 10% early withdrawal tax penalty when a person takes a distribution before the age of 59 ½. In addition to the penalty, the IRS levies income tax on distributions the year that you take a distribution from a Traditional IRA.

Should I withdraw money from my IRA?

Taking a distribution from an IRA means less money growing for retirement, but many people use distributions from IRAs to meet medium term goals or to resolve short term financial crises. The IRS publishes a complete list of qualified exceptions to the early withdrawal penalty.

If you have to pay the penalty, withdrawing from an IRA is not likely to be the right choice. Once the money is withdrawn from an IRA it can’t be contributed again. For short term needs, taking out a loan usually comes out ahead.

What’s the smartest way to invest?

Investing between 15-20% of your gross income for 30 years often yields a reasonable retirement nest egg, but even if you can’t invest that much right now, it’s important to get started. The smartest place to invest for retirement is within a tax advantaged retirement account.

If you don’t have access to an employer sponsored plan the best place to start is by investing in an IRA. On the other hand, if you have access to both an employer sponsored plan and an IRA, the answer is not as clear. Anyone who has an employer with a matching policy should aim to invest enough to take full advantage of any matching plan that your company has in place.

After taking advantage of a match, the next best option depends on your personal situation.

Employer sponsored plans and Traditional IRAs offer immediate tax benefits that can be advantageous for high income earners. However, investing in a Roth IRA keeps money more liquid than either an employer sponsored plan or a traditional IRA.

Of course, the best possible scenario for your retirement is to maximize contributions to both an employer sponsored account and an individual retirement account, but you should carefully weigh how investing in these accounts affects your whole financial picture and not just your retirement goals.

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The Retirement Question Everyone Has to Answer: Roth or Traditional 401K

outlive our retirement savings

Many companies who provide 401K retirement plans are now starting to offer a Roth 401K option. How do you know which one to choose? Both savings vehicles allow you to make voluntary salary deferrals of the lesser of 100% of your pay or $18,000 (the limit in 2016) per year. And if you are 50 or older, you can typically contribute an additional $6,000. While the limits are the same, the deferrals and retirement distributions are taxed differently in the two plans.

A traditional 401K allows for pre-tax deferrals, meaning that they are deducted from the taxable income that is reported on your W-2 at the end of the year, reducing your taxable income and the income tax due in that year. As the investments grow, no tax is due on any gain until you withdraw money from the plan. At that time, you will pay ordinary income tax on all withdrawals (plus a 10% federal penalty if you are not at least 59½, or in the event of a few other less-common situations). You make pre-tax deferrals but receive taxable distributions.

A Roth 401K, named for the late Senator William Roth, requires that deferrals be made with after tax–dollars. This means that you will not save any income taxes at the time of the contribution. Similar to the traditional 401K option, the investments grow free of taxation. However, while traditional 401K withdrawals are taxable, all qualified distributions from a Roth 401K are income tax-free. Qualified distributions are those in which the account is at least five years old and the distribution is made due to disability, death or upon reaching age 59½. So your contributions are taxable but your distributions are generally income tax-free.

Which Option Is Better?

The answer is actually quite simple. If you are in a higher tax bracket when making contributions than the tax bracket you are in while taking distributions, you should choose the traditional version. If, however, you are in a lower tax bracket when making contributions than the one while taking distributions, you should choose the Roth version. If the tax rates are identical pre- and post-retirement, then it makes absolutely no difference.

When comparing the two options, it is necessary to adjust the contributions for taxation. Since the Roth contributions are after tax, for comparison purposes, the deferral must be reduced by the income taxes paid before the contribution is made. So an $18,000 contribution to a traditional 401K plan would be compared to a $15,300 contribution to a Roth 401K plan if the taxpayer is in the 15% tax bracket (15% X $18,000 = $2,700, and $18,000 – $2,700 = $15,300). Essentially, both contributions required $18,000 of gross pay. Upon retirement, the traditional 401K balance must be reduced by taxes due on distribution, while the Roth 401K balance is paid tax-free.

The chart below compares an $18,000/year-contribution for a traditional 401K to an after-tax contribution of $15,300/year to a Roth 401K, assuming a 15% pre-retirement income tax rate. It illustrates the after-tax retirement balances using 10%, 15% and 20% post-retirement tax rates. The investments are assumed to earn a hypothetical rate of return of 7% per year.

chart copy

These examples are hypothetical and for illustrative purposes only. The rates of return do not represent any actual investment and cannot be guaranteed. Any investment involves potential loss of principle.

Notice that when the pre-retirement tax rate of 15% is higher than the post-retirement rate of 10%, the traditional 401K plan has the advantage. When the pre-retirement rate of 15% is lower than the post-retirement tax rate of 20%, the Roth 401K is a better choice. However, when the pre- and post-retirement tax rates are equal at 15%, the net for the Roth and the Traditional 401K plans are identical.

So if you expect your income tax rate to decrease in retirement, choose the traditional 401K. If you expect taxes to increase during retirement, choose the Roth 401K. If you are not comfortable guessing what your tax rates will be at that time, then split your contributions evenly between the two options.

Remember, no matter what you’ve planned for retirement, it pays to know where your credit score stands and how everyday habits are affecting your credit. You can check your scores, updated monthly, for free on Credit.com.

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