Retirement Strategies You Shouldn’t Overlook: Back-Door Roths & QCDs

irarotheggsWithin the last several days, President Obama released his 2017 budget proposal to the public. Included in the proposal were many provisions that targeted retirement income. Between this proposal targeting retirement income and the Bipartisan Budget signed last year that eliminated Social Security claiming strategies, it sure seems retirement strategies are being picked on quite a bit lately. But let’s remember, the President’s proposal shouldn’t be seen as anything more than a “wish-list”. While the “wish-list” provides a good indication of where the administration may be heading, it could take years before any of the provisions gain traction. In the meantime, it’s important to take advantage of the retirement strategies available to us.

One strategy that the President’s proposal would eliminate but is still available this year is known as a “backdoor” Roth. A Roth IRA is funded with after-tax dollars which allows the funds to grow tax-free. In addition, Roth IRAs do not require a minimum distribution to be taken. The limitation with Roth IRAs is that higher earners are not allowed to contribute to these accounts. In the spirit of the law, this would only give these individuals access to a traditional IRA. Traditional IRAs are funded with pre-tax dollars which are then taxed upon withdrawal. These accounts also require a person to take a minimum distribution starting at age 70 ½. By using a “backdoor” approach, these higher earners can have the benefit of contributing money to a Roth IRA. The sequence of action would be for the person to contribute to a nondeductible IRA, then convert to a Roth immediately afterwards. If the taxpayer does not have any pre-tax funds in their IRA, the conversion can be made without tax.

Late in 2015, Congress made permanent a few tax provisions that were set to expire at year-end. One in particular allows individuals to make charitable donations directly from their traditional IRA without treating the distribution as taxable income. As mentioned above, distributions from a traditional IRA are generally taxable and are required when a person reaches age 70 1/2. This transaction, known as a Qualified Charitable Distribution (QCD), will count towards the required minimum distribution but will not be treated as taxable income. To be considered a QCD, the individual must be age 70 ½ or older, the distribution must be paid to a public charity, the full payment must qualify as a charitable contribution and the distributions must be a direct transfer from the IRA trustee to the charity.

Being that the QCD is excluded from taxable income, the charitable donation itself cannot be deducted on an individual’s tax return. At first glance, this may seem to provide no real tax benefit. Why not just include the distribution as income and take the deduction? For many people, this may be the right strategy. For those individuals that are subject to itemized deduction phaseouts and the 3.8% Medicare tax on investment income, a QCD can help minimize or avoid these consequences. In addition, excluding IRA distributions from income will lower adjusted gross income (AGI) and may make it easier to deduct medical expenses and miscellaneous expenses subject to 2% of AGI, reduce the taxability of social security benefits and minimize the Medicare Part B insurance premiums.

It’s typically best practice to make your Roth or Traditional IRA contributions early in the year, so they can grow tax-free or tax deferred all year. Most of you will be meeting with your CPA or financial advisor within the next several weeks. This will be a good time to discuss these two strategies and see if they will work for you. Here at DWM, we are always happy and available to have these discussions with our clients, during tax season or not. Please let us know how we can help.

Fiduciary Standard Closing in on Reps and Brokers

willie sutton3Annuity salespeople may soon be facing a new, huge hurdle. The WSJ reported last week that the Department of Labor has proposed that advisers working with retirement savings be held to a “fiduciary” standard. We’re all for it. A fiduciary standard means that an adviser must work in the best interests of the client and avoid conflicts of interest, such as commissions and other sales-based compensation. Registered Investment Advisers, such as DWM, on the other hand, are required to always be fiduciaries for the clients. Sales representatives and brokers for banks, insurance companies and broker-dealers, are not. They are held to a “suitability” standard based upon a prospect’s financial objectives, current income level and age in suggesting various products for which they are paid commissions and fees.

Our regular readers know that annuities and fiduciary standards have been topics in past blogs. In our June 24, 2014 blog ( we discussed variable annuities. As a product, they do enjoy tax-free growth, which can be helpful. However, the problem is cost. According to Barron’s, the average contract cost is 1.5% per year. In addition, VAs generally use high-cost actively managed funds within, adding 1% or more. As a result, there can be a 2.5% or more drag on performance each year. These days, that may represent 50% or more of the gross return.

Insurance companies, which issue annuities, along with the brokerages and individual financial advisers who sell them, are not happy. Right now, many of these annuities pay an 8% upfront commission, most of which goes to the salesperson (who has been deciding for many prospects that these products are indeed quite suitable.) Variable annuity sales totaled $98 billion in the first nine months of 2015. Think of the upfront commissions- perhaps $7 billion to $8 billion per year. This is paid by the consumer through ongoing charges and surrender charges if the policyholder drops the contract within a certain time period, such as 7 years.

Furthermore, over 50% of the sales are made to retirement accounts. It’s amazing; retirement accounts grow tax-free, just as annuities do. So, there is no tax benefit to purchasing an annuity within a qualified account. However, as we know, there are trillions of dollars in retirement accounts which makes them perfect targets for annuity salespeople. It reminds us of Willie Sutton, the prolific American bank robber, who when asked why he robbed banks, he replied “Because that’s where the money is.”

The proposed DOL rule is expected to be finalized as soon as next month. This will likely lead to a change in upfront commissions and likely a big reduction in sales, at least in the beginning. Fiduciaries, like DWM, applaud this change. We want clients to do well, not the salespeople.

Regarding fiduciaries, perhaps some of our readers remember our blog from November 18, 2014 ( where “Money Hall” asked readers to pick from three financial advisers standing behind doors 1, 2 and 3. Adviser #1 was a broker, whose products likely included variable annuities as we discussed above. Behind Door #2 was an RIA who was a “fee-only” fiduciary. Adviser #3 was both an RIA “fee-only” fiduciary and a value-added wealth manager, with a quality management system to organize, formalize, implement and monitor all investment management and financial planning activity for clients.

It’s amazing what some advisers, such as those behind Door #1, will do to sell their products. They try to tell prospects they always put their clients’ interests first, though their industry fights tooth and nail to try to avoid being covered by a blanket fiduciary responsibility. They tell prospects they are “fee-based”, which we have come to understand as “fee-plus” meaning that they may take up-front fees, part of fund operating expenses as well as a fee based on assets. No surprise that they are not interested in becoming fiduciaries.   Their standard of living would likely take a big drop. If this keeps up, they may need to change their focus from selling “suitable products” to actually helping families increase their wealth by adding value. What a novel idea!


sb frazzleLet’s all go ahead and be emotional and let out a big scream. Arrrrrrrrrgh! These stock markets are really frustrating. After a lackluster 2015, equity markets are down around 10% in 2016. Of course, a balanced account might “only” be down 5% in 2016, but that still doesn’t feel good. Aren’t markets supposed to rise in Presidential Election Years?

Generally, that’s true. Since 1933, the S&P 500 has risen 8% per year in election years.

The simple fact is that politics is likely having a big impact on the markets. Certainly, investors are concerned about the price of oil, slowing world economic growth and China. But, a major part of the anxiety is very likely being caused by the presidential race. It’s similar to the impact that the Ebola scare had on the markets in mid-2014.

Think of it. In a normal election year, whether we are Republican, Democrat or Independent, we find a candidate that we think can make a change for the better in the U.S. and perhaps the world. We support that candidate with the hope and the optimism that things will be better after the election. In part, this typical election year optimism has helped produce historically good returns. Hence, there appears to be both a correlation between election year and good results and a likely causation.

So, what do we have now? Two political outsiders whose popularity has been largely anti-establishment. Donald Trump’s and Bernie Sanders’s victories in New Hampshire were seen as a vote of no confidence in the nation’s economy and the political status quo. Yet, while their supporters are happy to show their anger at the current situation and hope for change, neither candidate has any proven track record of being able to accomplish on a nationwide level what they propose.

Investors of all kinds are skeptical and concerned. The two “establishment” candidates, Jeb Bush and Hillary Clinton, are struggling.   There is a real question as to what would happen if Trump or Sanders was elected. This has likely helped spook investors, big and small.

Remember, too, that Mr. Trump is, according to the NYT, strongest among Republicans who are less affluent and less educated. Mr. Sanders appeals to a wide variety of people and has raised millions of dollars of support without the aid of a Super PAC. In Tuesday night’s victory speech, he thanked his more than one million supporters who contributed an average of $27 to his campaign. Their supporters are not your typical investor or Wall Street firms. Hence, this optimism generated by both candidates from their supporters doesn’t translate to typical election year investor optimism.

Then we have the omnipresent media. Every day we are besieged by the newspapers, TV and other sources filled with political content, much of which is pure useless trivia. Most candidates are all quite happy to drone on about the current problems and how they alone have simple solutions to fix everything. Educated people and institutions who represent the bulk of investors aren’t buying it. The result: a gradual, “grinding” downward slide that is worse than a fast panic-driven rout. It’s like everyone is bringing up the negative over and over and the “Group Think” pushes the equity markets down.

Brett was on a Goldman Sachs conference call yesterday discussing market volatility. They reiterated what Schwab, BlackRock and others have said. Yes, there continues to be concerns about China, credit/rates, oil, and expectations of monetary policy. They think there is a 15% chance of recession in the next 12 months. Which is good because any year on average is 24%. They summed it up this way, “There is a disconnect between fundamentals and what the market is saying. Take it easy, stay disciplined, stay diversified, and stay invested.”

We agree, the markets may continue to be choppy for 2016, particularly if a viable, experienced candidate, known and trusted by the investment community doesn’t move to the head of the pack. In the meantime, we suggest you let out a big scream and wait for the markets to swing back and catch up with the fundamentals. We know they will, we just don’t know when.

“Super Bowl Predictor”- Go Panthers!

peyton-manning-cam-newtonLots of investors are rooting for the Panthers in the Super Bowl Sunday.   Some don’t even know who Cam Newton is. They’re banking on a correlation between the conference of the winner and the performance of the stock market.

Historically, if a National Football Conference team (such as the Carolina Panthers or Chicago Bears) wins the Super Bowl, the Dow Jones Industrial average will rise that year. If the American Football Conference team (such as the Denver Broncos) wins, then the index will fall. It’s called the “Super Bowl Predictor.”  It’s an amazing correlation- working 82% of the time. In 2015, the American Conference New England Patriots won and the Dow fell 2% for the year.

Certainly, after enduring the poor stock market results the last few months, we’d all love to see the markets rise. However, there is a big difference between correlation and causation. Just because there has been a pattern of similar fluctuation (a correlation) between the conference winner and the Dow results, there is certainly no reason to believe that one resulted from the other. Correlation does not imply causation.

It’s human nature to want explanations. So, we and the media often like to jump from correlation to causation when we know one doesn’t imply the other. In fact, here are some farcical “spurious” correlations (courtesy of Tyler Vigen, Harvard JD student):

Divorce in Maine









Drowning in Pool








Spelling BeeThere are lots of these. Here are few more:

  • Math doctorates awarded to uranium stored at U.S. nuclear power plants
  • Per capita cheese consumption to number of people who died by becoming entangled in their bedsheets
  • People who drowned after falling out of a fishing boat to marriage rate in KY

Hopefully, I’ve made my point. Beware of spurious correlations. When two charts show a close relationship, we want to believe a relationship exist. However, in order to establish cause-and-effect, we need to go beyond the statistics and look for scientific evidence to support causation.

Back to the Super Bowl. I’ve always liked and admired Peyton Manning and the Broncos play a great brand of football. However, I’ll be pulling for the Panthers on Sunday. Cam Newton is a special athlete and the Panthers are a super team, with former Bear, Ron Rivera, as coach. In addition, they’re in the National Football Conference. And, while I know rationally that there is no cause-and-effect between the results on Sunday and what the stock markets will do this year, I don’t mind rooting for the correlation that has had an 82% success rate. It can’t hurt. Go Panthers!