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IRA bridge could maximize Social Security benefits

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First, the good tax news. 

Clients approaching retirement can delay their future required minimum distributions — and accompanying income taxes — until they’re 73 rather than starting them at 72, as was the rule prior to the Secure 2.0 Act. In 2033, the first RMDs will fall back to 75.

Those changes will help pre-retirees lock in more tax-advantaged investment gains in their individual retirement accounts and build more wealth apart from Social Security.

The bad news is that they face the potential for much higher taxes in the future if they wait that long to begin taking the distributions into their taxable income.

More financial advisors and tax professionals with clients who are eligible for penalty-free IRA withdrawals as young as 59½ years old are considering how the distributions can be a bridge to claiming Social Security benefits later and avoiding so-called stealth expenses, according to four experts who spoke with Financial Planning. The approaching end of the year and the current federal tax brackets mean that it’s an especially timely topic of discussion.

The later the clients claim Social Security, the higher their monthly payments will be in retirement. At the same time, those benefits draw taxes for higher-income households that are also subject to higher Medicare costs. If the clients have built up healthy nest eggs in their traditional IRAs, those assets pose a complex planning opportunity with some built-in risks that can make a major impact on their retirement.

Sarah Brenner, the director of retirement education with Ed Slott and Company
Sarah Brenner is the director of retirement education with Ed Slott and Company.

Ed Slott and Company

“For a lot of people, their IRA is one of their biggest assets, if not their biggest asset,” Sarah Brenner, the director of retirement education with retirement consulting firm Ed Slott and Company, said in an interview. “It makes sense to use this taxable money earlier. It makes sense to use this money as a bridge.”

She and the other experts stressed that the bridge depends on any number of factors that are part of the retirement mix. The strategy also represents a departure from “the old regime,” which held that advisors and their clients should “defer, delay” and “wait until the bitter end” when they were obligated to receive the IRA distributions, according to Heather Schreiber, the founder of advanced planning consulting firm HLS Retirement Consulting.

“Now we’ve had to change our logic about that,” she said. “We have to think about shifting the mindset of people to say, ‘How do we take our assets in a way that’s the most tax-efficient?”

READ MORE: 30 tax questions to answer by the end of the year

The essentials

Advisors and their clients will be looking especially closely at four categories of numbers to figure out whether to use the bridge, with their cash flow needs being the first basic question. 

They’ll need to know the size of their possible RMD — the quotient of their IRA balance divided by life expectancies issued by the IRS. Then they’ll weigh that amount against their Social Security benefit, which is based on their average earnings over as many as 35 years in the workforce and their timing for taking benefits as early as 62, at the full retirement age between 66 and 67, or as late as 70. That’s when there will no longer be an advantage to waiting to claim the benefits.

If those considerations weren’t enough, they’ll need to remember that roughly 40% of Social Security beneficiaries pay federal taxes on the payments they receive and those in some areas must pay state duties on them as well. At the federal level, as much as 85% of the benefits are taxable for individuals with more than $34,000 in “combined income” or joint filers with $44,000. Medicare adds another layer of questions, since any possible Income Related Monthly Adjustment Amounts (IRMAA) with their monthly premiums are tied to income as well.

Each of the permutations could look different through, say, converting the IRA to a Roth to avoid the question of RMDs entirely for the rest of the client’s life while also paying the taxes for the switch. A qualified charitable distribution from an IRA could provide another way around the additional income from the mandatory withdrawal.

Erin Wood, a senior vice president for financial planning and advanced solutions with Omaha, Nebraska-based registered investment advisory firm Carson Group
Erin Wood is a senior vice president for financial planning and advanced solutions with Omaha, Nebraska-based registered investment advisory firm Carson Group.

Carson Group

The stealthiness of the tax and expenses comes from their interaction across income brackets, healthcare costs, RMDs and other areas, according to Erin Wood, a senior vice president for financial planning and advanced solutions with Omaha, Nebraska-based registered investment advisory firm Carson Group.

“All of these things end up being connected together,” she said. “It does surprise people if they’re in a different position than they thought they would be in.”

For some clients, unexpected health problems could put them in that type of bind in which they may need to tap the Social Security benefits right away, according to Valerie Escobar, a senior wealth advisor with Kansas City, Missouri-based advisory practice BMG Advisors. For others, they may wish to keep earning tax-free yield in their IRAs and claim benefits sooner as well, she noted. A third group could opt to use earlier withdrawals as a bridge to wait until 70 for Social Security to get the maximum benefits possible.

Valerie Escobar, a senior wealth advisor with Kansas City, Missouri-based advisory practice BMG Advisors
Valerie Escobar is a senior wealth advisor with Kansas City, Missouri-based advisory practice BMG Advisors.

Valerie Escobar

“I know that if I can wait as long as possible, then 8% growth is going to be credited to me,” Escobar said. “It is a way to offset the risk. You’re putting it on the government and not having to make it on your own investment dollars.”

READ MORE: The post-‘stretch’ home stretch for Roth IRA conversions

Timely questions

In general, the last quarter marks a good time for completing any RMDs or other withdrawals or planning them for next year. The new rules under Secure 2.0 lent another reason for a fresh look at a clients’ options and mandates, according to Brenner.

“Roths are more important than ever,” she said. “They can access that completely tax-free during their retirement.”

The expiration date of many provisions of the Tax Cuts and Jobs Act of 2017 at the end of 2025 tacked on more incentive to convert to a Roth or take distributions under brackets that may revert to their previous, higher rates in 2026, Shreiber noted.

“Do you wait or do you take advantage?” she said. “These years — especially this year and next — are really pivotal opportunity years to consider doing that.”

The current lower rates may act as a “big, big savings opportunity to take advantage of now,” Wood agreed, noting that another shift in IRA guidelines from Secure 2.0 in 2025 and beyond will give clients between the ages of 60 and 63 a chance to make larger so-called catchup contributions to their accounts. Those “can be gold mines for getting extra money saved as well,” but advisors and their clients must find the right balance with their future taxes, she said.

“How much income you have in every given year is the difference between being in a higher tax bracket and a lower tax bracket and what level your Social Security is going to be taxed at as well,” Wood said.

READ MORE: Planning for 2025’s tax brackets and retirement rules

Avoid these mistakes by planning

All of the experts pointed out that clients could get a double whammy from higher taxes and lower benefits by claiming Social Security while still working full- or part-time. The significant hit to benefits offers another rationale for using the bridge strategy to claim later or simply to think through the RMDs far in advance.

“It gives you much more flexibility,” Escobar said. “It allows your model to be able to have more options when you’re planning it all out for your clients.”

Advisors should guide clients through the decision about when to take IRA distributions and claim Social Security by assisting them in avoiding two of the most common mistakes, according to Shreiber. 

The first comes from underestimating how long they’ll live in general and in retirement. The second revolves around the possible negative impact of a “widow’s penalty” in the form of “substantially lower income” for a surviving spouse when there is a significant disparity between their earnings and ages and the older one took Social Security benefits early, she said.

Heather Schreiber, the founder of advanced planning consulting firm HLS Retirement Consulting
Heather Schreiber is the founder of HLS Retirement Consulting.

HLS Retirement Consulting

Talking to clients early and often about the bridge strategy and other tools that may be at their disposal in their retirement can set them up for financial security down the line.

“I tell advisors all over the country that consumers need them — they need them as their advocates on this. They go to Social Security and oftentimes come out more confused than they went,” Shreiber said. “They need help. They really need advocates, and they’re searching for them. So this is an opportunity for advisors to really help their clients by getting more educated about Social Security.”

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Accounting

Tax Fraud Blotter: Partners in crime

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Captive audience; some disagreement; game of 21; and other highlights of recent tax cases.

Barrington, Illinois: Tax preparer Gary Sandiego has been sentenced to 16 months in prison for preparing and filing false returns for clients. 

He owned and operated the tax prep business G. Sandiego and Associates and for 2014 through 2017 prepared and filed false income tax returns for clients. Instead of relying on information provided by the clients, Sandiego either inflated or entirely fabricated expenses to falsely claim residential energy credits and employment-related expense deductions.

Sandiego, who previously pleaded guilty, caused a tax loss to the IRS of some $4,586,154. 

He was also ordered to serve a year of supervised release and pay $2,910,442 in restitution to the IRS.

Ft. Worth, Texas: A federal district court has entered permanent injunctions against CPA Charles Dombek and The Optimal Financial Group LLC, barring them from promoting any tax plan that involves creating or using sham management companies, deducting personal non-deductible expenses as business expenses or assisting in the creation of “captive” insurance companies.

The injunctions also prohibit Dombek from preparing any federal returns for anyone other than himself and Optimal from preparing certain federal returns reflecting such tax plans. Dombek and Optimal consented to entry of the injunctions.

According to the complaint, Dombek is a licensed CPA and served as Optimal’s manager and president. Allegedly, Dombek and Optimal promoted a scheme throughout the U.S. to illegally reduce clients’ income tax liabilities by using sham management companies to improperly shift income to be taxed at lower tax rates, improperly defer taxable income or improperly claim personal expenses as business deductions. As alleged by the government, Dombek also promoted himself as the “premier dental CPA” in America.

The complaint further alleges that in promoting the schemes, Dombek and Optimal made false statements about the tax benefits of the scheme that they knew or had reason to know were false, then prepared and signed clients’ returns reflecting the sham transactions, expenses and deductions.

The government contended that the total harm to the Treasury could be $10 million or more.

Kansas City, Missouri: Former IRS employee Sandra D. Mondaine, of Grandview, Missouri, has pleaded guilty to preparing returns that illegally claimed more than $200,000 in refunds for clients.

Mondaine previously worked for the IRS as a contact representative before retiring. She admitted that she prepared federal income tax returns for clients that contained false and fraudulent claims; the indictment charged her with helping at least 11 individuals file at least 39 false and fraudulent income tax returns for 2019 through 2021. Mondaine was able to manufacture substantial refunds for her clients that they would not have been entitled to if the returns had been accurately prepared. She charged clients either a fixed dollar amount or a percentage of the refund or both.

The tax loss associated with those false returns is some $237,329, though the parties disagree on the total.

Mondaine must pay restitution to the IRS and consents to a permanent injunction in a separate civil action, under which she will be permanently enjoined from preparing, assisting in, directing or supervising the preparation or filing of federal returns for any person or entity other than herself. She is also subject to up to three years in prison.

jail2-fotolia.jpg

Los Angeles: Long-time lawyer Milton C. Grimes has pleaded guilty to evading more than $4 million in federal taxes over 21 years.

Grimes pleaded guilty to one count of tax evasion relating to his 2014 taxes, admitting that he failed to pay $1,690,922 to the IRS. He did not pay federal income taxes for 23 years — 2002 through 2005, 2007, 2009 through 2011, and 2014 through 2023 — a total of $4,071,215 owed to the IRS. Grimes also admitted he did not file a 2013 federal return.

From at least September 2011, the IRS issued more than 30 levies on his personal bank accounts. From at least May 2014 to April 2020, Grimes evaded payment of the outstanding income tax by not depositing income he earned from his clients into those accounts. Instead, he bought some 238 cashier’s checks totaling $16 million to keep the money out of the reach of the IRS, withdrawing cash from his client trust account, his interest on lawyers’ trust accounts and his law firm’s bank account.

Sentencing is Feb. 11. Grimes faces up to five years in federal prison, though prosecutors have agreed to seek no more than 22 months.

Sacramento, California: Residents Dominic Davis and Sharitia Wright have pleaded guilty to conspiracy to file false claims with the IRS.

Between March 2019 and April 2022, they caused at least nine fraudulent income tax returns to be filed with the IRS claiming more than $2 million in refunds. The returns were filed in the names of Davis, Wright and family members and listed wages that the taxpayers had not earned and often listed the taxpayers’ employer as one of the various LLCs created by Davis, Wright and their family members. Many of the returns also falsely claimed charitable contributions.

Davis prepared and filed the false returns; Wright provided him information and contacted the IRS to check on the status of the refunds claimed.

Davis and Wright agreed to pay restitution. Sentencing is Feb. 3, when each faces up to 10 years in prison and a $250,000 fine.

St. Louis: Tax attorneys Michael Elliott Kohn and Catherine Elizabeth Chollet and insurance agent David Shane Simmons have been sentenced to prison for conspiring to defraud the U.S. and helping clients file false returns based on their promotion and operation of a fraudulent tax shelter.

Kohn was sentenced to seven years in prison and Chollet to four years. Simmons was sentenced to five years in prison.

From 2011 to November 2022, Kohn and Chollet, both of St. Louis, and Simmons, who is based out of Jefferson, North Carolina, promoted, marketed and sold to clients the Gain Elimination Plan, a fraudulent tax scheme. They designed the plan to conceal clients’ income from the IRS by inflating business expenses through fictitious royalties and management fees. These fictitious fees were paid, on paper, to a limited partnership largely owned by a charity. Kohn and Chollet fabricated the fees.

Kohn and Chollet advised clients that the plan’s limited partnership was required to obtain insurance on the life of the clients to cover the income allocated to the charitable organization. The death benefit was directly tied to the anticipated profitability of the clients’ businesses and how much of the clients’ taxable income was intended to be sheltered.

Simmons earned more than $2.3 million in commissions for selling the insurance policies, splitting the commissions with Kohn and Chollet. Kohn and Chollet received more than $1 million from Simmons.

Simmons also filed false personal returns that underreported his business income and inflated his business expenses, resulting in a tax loss of more than $480,000.

In total, the defendants caused a tax loss to the IRS of more than $22 million.

Each was also ordered to serve three years’ supervised release and to pay $22,515,615 in restitution to the United States.

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On the move: KSM hired director of IT operations

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Hannis T. Bourgeois celebrates 100 years with charitable initiative; KPMG and Moss Adams release surveys; and more news from across the profession.

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AICPA wary of new PCAOB firm metrics standard

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The American Institute of CPAs is still concerned about the Public Company Accounting Oversight Board’s new firm and engagement metrics standard, despite some modifications from the original proposal. 

During a board meeting Thursday, the PCAOB approved two new standards, on firm and engagement metrics, and firm reporting. Both would have significant implications for firms. 

Under the new rules, PCAOB-registered public accounting firms that audit one or more issuers that qualify as an accelerated filer or large accelerated filer will be required to publicly report specified metrics relating to such audits and their audit practices. The metrics cover the following eight areas:

  • Partner and manager involvement;
  • Workload;
  • Training hours for audit personnel;
  • Experience of audit personnel;
  • Industry experience;
  • Retention of audit personnel (firm-level only);
  • Allocation of audit hours; and,
  • Restatement history (firm-level only).

The AICPA reacted cautiously to the announcement. “We’re still studying the components of the final firm metrics requirements but, as we stated in our comment letter to the PCAOB this past summer, these rules will place a significant burden on small and midsized audit firms and could lead some to exit public company auditing altogether,” said the AICPA in a statement emailed Friday to Accounting Today. “This is not just conjecture: a majority of respondents (51%) to a recent survey we did of Top 500 firms with audit practices said they would rethink engaging in public company audits if the requirements were approved.”

AICPA building in Durham, N.C.

The PCAOB it made some modifications to the original proposal in  response to the comments had received since April:

  • Reduced the metric areas to eight (from 11);
  • Refined the metrics to simplify and clarify the calculations;
  • Increased the ability to provide optional narrative disclosure (from 500 to 1,000 characters); and,
  • Updated the effective date. (If approved by the SEC, the earliest effective date of the firm-level metrics will be Oct. 1, 2027, with the first reporting as of September 30, 2028, and engagement-level metrics for the audits of companies with fiscal years beginning on or after Oct. 1, 2027.)

The AICPA welcomed those changes but doesn’t think they go far enough. “We’re glad the PCAOB took some comments to heart by extending implementation dates, particularly for smaller firms, and lowering the number of required metrics,” said the AICPA. “But the potential consequences of the remaining requirements — reduced competition and market diversity in the public audit space — are a significant risk. We hope the SEC will give these unintended outcomes the weight they deserve before giving final approval to the requirements.”

The Securities and Exchange Commission would still need to give final approval to the standard, as well as the new firm reporting standard. Last week, the PCAOB decided to pause work on its controversial NOCLAR standard, on noncompliance with laws and regulations, until next year. On Thursday, SEC chairman Gary Gensler announced he would be stepping down in January, which may affect the timing of its approval or disapproval by the SEC. With the incoming Trump administration, the SEC is expected to take a far less aggressive stance on enforcement and regulation. On Friday, the SEC announced that it filed 583 total enforcement actions in fiscal year 2024 while obtaining orders for $8.2 billion in financial remedies, the highest amount in SEC history.

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