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New Plan Year Checklist

Each year, a great deal of attention is paid to the upcoming year end work: census gathering, compliance testing, 5500s, oh my! But the year-end also brings with it a host of items that may need attention before the year closes. Below are a few action items that may need to be considered.

  • Changes were made for the current plan year or upcoming plan year that required an amendment. Example: As of January 1, 2023, in-service distributions are available to participants at age 59 ½.
    • Do you have a signed copy of the amendment on file?
    • Have you revised your processes to ensure you are following the new terms of the plan?
  • If your plan includes automatic enrollment provisions, the following may help you keep on track.
    • Identify participants who will be eligible at the start of the plan year and be sure that deferrals are scheduled to begin on time for those that do not opt out.
    • For plans that include auto-escalation of contributions, create a list of participants whose deferrals need to be increased in accordance with the plan’s schedule.
  • With the significant increase in limits for 2023, it will be a great year for both participants and plan sponsors to take advantage of saving for retirement. It may make sense to review your current plan specifications to ensure that participants can take advantage of the higher limits. Some examples are raising your company match cap to a higher limit or letting employees enter the plan more quickly.
  • The 2023 COLAs significantly raised the annual compensation limit from $305,000 to $330,000. If you fund employer contributions during the year, be sure to adjust your calculations for the upcoming plan year based upon the new limit.
  • While some actions are needed ahead of the start of a plan year, the SECURE Act provided that a new plan can be added after the end of the year to which it applies. For example, if you maintain a 401(k) Plan and choose to add a Cash Balance Plan, the new plan can be implemented up to the due date of the company’s tax filing. This means that even if you choose to add a Cash Balance Plan for 2022, the plan document can be executed in 2023 if it’s adopted prior to filing the 2022 company tax return.

Cost of Living Adjustments for 2023

Save even more for retirement in 2023 due to record breaking increases in limits. On October 21, 2022, the IRS announced the Cost of Living Adjustments (COLAs) affecting the dollar limitations for retirement plans for 2023. Retirement plan limits increased well over the 2022 limits, the largest increase in over 45 years. COLA increases are intended to allow participant contributions and benefits to keep up with the “cost of living” from year to year. Here are the highlights from the new 2023 limits:

The calendar year elective deferral limit increased from $20,500 to $22,500.

The elective deferral catch-up contribution increased from $6,500 to $7,500. This contribution is available to all participants aged 50 or older in 2023.

The maximum available dollar amount that can be contributed to a participant’s retirement account in a defined contribution plan increased from $61,000 to $66,000. The limit includes both employee and employer contributions as well as any allocated forfeitures. For those over age 50, the annual addition limit increases by $7,500 to include catch-up contributions.

The maximum amount of compensation that can be considered in retirement plan compliance has been raised from $305,000 to $330,000.

Annual income subject to Social Security taxation has increased from $147,000 to $160,200.

See chart titled Annual Plan Limits:

Annual Plan Limits202320222021
Contribution and Benefit Limits
Elective Deferral Limit$22,500$20,500$19,000
Catch-Up Contributions$7,500$6,500$6,500
Annual Contribution Limit$66,000$61,000$58,000
Annual Contribution Limit including Catch-Up Contributions$73,500$67,500$64,500
Annual Benefit Limit$265,000$245,000$230,000
Compensation Limits
Maximum Plan Compensation$330,000$305,000$290,000
Income Subject to Social Security$160,200$147,000$142,800
Key EE Compensation Threshold$215,000$200,000$185,000
Highly Compensated EE Threshold$150,000$135,000$130,000
IRA Limits
SIMPLE Plan Elective Deferrals$15,500$14,000$13,500
SIMPLE Catch-Up Contributions$3,500$3,000$3,000
Individual Retirement Account (IRA)$6,500$6,000$6,000
IRA Catch-Up Contribution$1,000$1,000$1,000

Markets in Review

Global financial markets declined again in the third quarter as inflation persisted and remained at 40-year highs, geopolitical tensions escalated even further, and the Federal Reserve continued to aggressively raise interest rates. In late July, the Federal Reserve (the “Fed”) raised interest rates by another 75 bps but comments by the Fed Chair, Jerome Powell, indicated a potential deceleration of the pace of interest rate hikes which gave the equity markets a boost in July and early August. Things took a dramatic turn in mid-August when Powell remarked the Fed would do what is needed to tame inflation and warned the U.S. economy will likely feel some “pain” from the Fed’s action. Markets continued to sell-off in September as the August Consumer Price Index (CPI) report showed a slight increase in prices and the Federal Reserve raised interest rates again by 75 bps. 

All major market indices finished the quarter with negative returns. Equity markets, as measured by the S&P 500 Inde1, fell by 4.9% during the quarter and is down almost 24% on a year-to-date basis. 

With inflation persisting during the quarter, long term interest rates continued to surge. The 10-year U.S. Treasury started the quarter at 2.9%, hitting almost 4% during the quarter and subsequently finished the quarter at 3.8%. T-Bills posted a slightly positive return during the quarter, but all other fixed income indexes were negative with longer-dated government bonds posting the worst relative returns.

Unlike the first half of the year, growth outperformed value in the third quarter. Growth experienced a strong rebound early in the quarter with a bear market rally, however, much of those gains were erased by the end of quarter. On a sector level, only one sector of the S&P 500 finished the third quarter with a positive return. Consumer discretionary was slightly positive for the quarter due to strong consumer spending and low unemployment. The sector laggards for the quarter were communication services, real estate, and materials. Real estate declined as mortgage rates rose and home prices began to soften.

Foreign markets underperformed the U.S. markets during the third quarter as the US dollar continued to strengthen, energy prices surged in Europe and the U.K., and the European Central Bank and Bank of England raised interest rates to combat persistent inflation. Emerging markets fared worse than foreign developed markets with the surge in the U.S. dollar and rising fears of a global recession.

Real economic growth contracted during the first two quarters of the year, but the advance estimate of Q3 GDP showed a 2.6% annual growth rate for the economy. Despite lingering inflation and prolonged supply chain issues, the majority of Q2 earnings reports beat estimates indicating corporate America may be more resilient than previously believed by the markets.

The labor market tightened even more in the third quarter with 1.1 million jobs added to the U.S. economy. Jobs in leisure and hospitality and healthcare led the way. The overall U.S. unemployment rate remains at historic low levels at 3.5% with the total number of unemployed people standing at 5.8 million.

Inflation, as measured by the Consumer Price Index (CPI-U), grew at a pace of 8.2% for the past 12-month period ending September 30, 2022. The core inflation reading, which excludes food and energy, rose 6.6%. Rising prices for shelter, food and medical care were slightly offset by a decline in gasoline prices.

Monthly Market Update (October): 3 Things You Need to Know

Although this year has felt spooky, the U.S. stock market rallied in October after enduring several straight months of losses, leading to optimism that the end of the bear market may be in sight.

Here are 3 things you need to know:

  1. The S&P 500 ended the month up 8%. Ten of the 11 sectors of the S&P 500 rose during the month, with energy stocks leading the way higher.
  2. Gilts (a UK Government liability in sterling) led the way in fixed income thanks to the fiscal U-turn and a new Prime Minister after a disastrous decline under former PM Liz Truss. But they’re still down -35% year-to-date (in US Dollar terms).
  3. U.S. WTI Oil had a good month as the OPEC+ group cut production, and it’s far and away the best year-to-date performer (+15%).

Sources:

  1. Sources: J.P. Morgan Asset Management – Economic Update; Bureau of Economic Analysis (www.bea.gov); Bureau of Labor Statistics (www.bls.gov); Federal Open Market Committee (www.federalreserve.gov); Bloomberg; FactSet; Deutsche Bank.
  2. Indices:
    • The Bloomberg Barclays Aggregate Bond Index is a broad-based index used as a proxy for the U.S. bond market. Total return quoted.
    • The S&P 500 is designed to be a leading indicator of U.S. equities and is commonly used as a proxy for the U.S. stock market. Price return quoted.
    • The MSCI ACWI ex-US Index captures large and mid-cap representation across 22 of 23 developed market countries (excluding the U.S.) and 27 emerging market countries.  The index covers approximately 85% of the global equity opportunity set outside the U.S. Price return quoted.
    • The MSCI Emerging Markets Index captures large and mid-cap segments in 26 emerging markets. Price return quoted (USD).

Disclosure: BFSG does not make any representations or warranties as to the accuracy, timeliness, suitability, completeness, or relevance of any information prepared by any unaffiliated third party, whether linked to BFSG’s website or blog or incorporated herein and takes no responsibility for any such content. All such information is provided solely for convenience purposes only and all users thereof should be guided accordingly. Please remember that different types of investments involve varying degrees of risk, and there can be no assurance that the future performance of any specific investment or investment strategy (including those undertaken or recommended by Company), will be profitable or equal any historical performance level(s). Please see important disclosure information here.

Where can you get home loans below 5%? The First National Bank of Mom and Dad (Intra-Family Loans)

By:  Henry VanBuskirk, CFP®, Wealth Manager

With all of the recent headlines in the news about mortgage rates increasing and waning home affordability, it seems daunting for the first-time home buyer.  A 30-year fixed mortgage now exceeds 7%, a level that hasn’t been seen since 2008. That same 30-year fixed mortgage was around 3% just a year ago. 

The reality here is that you aren’t going to be getting a 30-year fixed mortgage at 3% from your local bank anytime soon.  With that being said, there is one bank that might be willing to loan to you at a rate lower than 7% – The First National Bank of Mom and Dad.  What I’m talking about is an intra-family loan, which is a strategy that can be beneficial to both the borrower (a parent, family member, or family friend) and the lender.

Intra-Family Loan Basics

An intra-family loan is a formal agreement between a borrower and a lender.  Interest on the borrowed amount must be equal to or greater than predetermined IRS rates that are referred to as ‘Applicable Federal Rates’ (AFRs) and these rates are reset monthly.  Here’s the AFR for November 2022:

Source: IRS

If we are using the mortgage example, we would want to assume a long-term AFR at a monthly rate (3.85% annually).  If we compare this to a mortgage rate of 7%, the AFR looks attractive to the borrower by comparison.  The key is that the lender must charge at least the AFR, because if they charge less than that, the IRS will impose their imputed interest rules.  Imputed interest is when the IRS believes that the loan is a gift and will instead report the difference between what the AFR is and what the lender charged and make the lender report that difference on the lender’s tax return.  As with anything involving the IRS, you want to make sure you are abiding by the rules they set forth and document that you are following those rules.

Consulting with a tax professional and legal professional is recommended before an intra-family loan arrangement is set up. The first step when drafting an intra-family loan is to make sure that you discuss the terms of the loan.  Then it is important to draft a promissory note, pledge collateral (i.e., the home), and send out monthly statements of the balance due.  We also recommend that an IRS Form 1098 be produced to the borrower for interest paid and an IRS Form 1099-INT be procured to the lender for interest received. 

Intra-Family Loan Example

For this example, assume that the borrowers are looking for a mortgage of $800,000 to help with their $1,000,000 home purchase and the bank quotes them a 30-year fixed rate mortgage at 6.5%.  Those same borrowers then look to mom and dad, and they are willing to set up an intra-family loan of $800,000 at a rate of 4.5% over 30 years.

Here is what an $800,000 30-year fixed-rate mortgage at 6.5% would amount to:

Now let’s look at the intra-family loan example for $800,000 over 30 years at 4.5% fixed:

The borrower would save $1,000 per month, every month, for 30 years and over $350,000 of interest over the life of the loan. 

Other Uses of Intra-Family Loans

Intra-family loans are not just a mortgage alternative.  An intra-family loan can also be set up to help the borrower start a small business.  It’s a similar argument for the mortgage example, the lender can loan to the borrower at a lower interest rate than the current prevailing interest rates. 

For reference, here are the current rates for small business loans from the Small Business Administration (SBA).

Source: SBA

For this example, assume that the borrower wants to start a business and needs to borrow $100,000 to do so.  The SBA is willing to loan the $100,000 at a 9% interest rate over 10 years.  The borrower’s family member is willing to loan the $100,0000 at a 7% interest rate over 10 years.  Here is what the SBA loan details would look like:

Here’s what that same loan would look like at a 5% interest rate:

The borrower would in this example save $200 per month and over $24,000 in interest over the life of the loan by doing an intra-family loan.

What’s in it for the Lender?

So far all of this sounds great for the borrower, but what about the lender?  Fortunately, there are benefits to the lender as well. If the lender chooses, they could set up the intra-family loan to be forgiven at the lender’s death. Doing this would decrease the taxable estate of the lender because the heirs would not be required to continue paying the loan to your taxable estate. This means that if your estate is valued above the estate tax exemption and your estate is taxable, then your heirs would not be liable for the tax due on the remaining amount of the loan repayments. 

Furthermore, the loan payments can also be made to the lender, where the lender sets up a Trust where the lender is the owner for tax purposes, but not for estate tax purposes. This is called an Intentionally Defective Grantor Trust (IDGT).  Assuming that the IDGT is set up correctly, the income taxes would be paid by the lender (not the Trust), which would allow the periodic payments that are being sent to the Trust to grow tax-free.  When the lender dies, the assets in the IDGT won’t be included in the grantor’s taxable estate. The intra-family loan would need to be carefully constructed to account for these types of measures and it is recommended that you consult a legal professional. 

Another advantage is that if the lender thinks of the intra-family loan interest rate as an income stream to them, they would be receiving an income stream that isn’t tied to the stock or bond market.  This could further diversify their investment portfolio. Further, if the borrower turns out to not want to pay you back for whatever reason, the loan is collateralized by the home, small business, or whatever asset the borrower pledged to the lender and you could always just seize the asset that was put up as collateral. 

Summary

There are many different ways that an intra-family loan can help both the borrower and the lender achieve their long-term financial goals. We discussed some of these ways, including helping a first-time home buyer purchase a home, supporting a business-owner in starting a business, and how a lender can decrease the size of their estate with careful planning.  We are happy to discuss your long-term financial goals with you and help determine if an intra-family loan would be appropriate for your unique situation.

Disclosure: BFSG does not make any representations or warranties as to the accuracy, timeliness, suitability, completeness, or relevance of any information prepared by any unaffiliated third party, whether linked to BFSG’s website or blog or incorporated herein and takes no responsibility for any such content. All such information is provided solely for convenience purposes only and all users thereof should be guided accordingly. Please remember that different types of investments involve varying degrees of risk, and there can be no assurance that the future performance of any specific investment or investment strategy (including those undertaken or recommended by Company), will be profitable or equal any historical performance level(s). Please see important disclosure information here.