Data & Research March 7, 2018

Negative Tax Consequences Often Result from Poor Rollover Knowledge

Unforeseen negative tax consequences often hit job changers when they decide to move money from their previous employers’ retirement plans without sufficient know-how; in an extensive new report, the GAO recommends employers and regulators provide far more support for plan participants.

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Defined contribution (DC) retirement plan participants in the United States face significant challenges after they change jobs, including not receiving effective rollover communications from either their new or old plan sponsors, according to a report from the Government Accountability Office (GAO).

This leaves job seekers vulnerable to unforeseen tax consequences that can result in a loss of retirement savings, according to GAO researchers.

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“When participants leave savings in a plan after separating from a job, the onus is on them to update former employers with their new address and to respond to their former employer’s communications,” GAO explains. “We found that although an employer may incur costs searching for separated participants, there are no standard practices for the frequency or method of conducting searches.”

GAO reports that from 2004 through 2013, over 25 million participants in workplace plans separated from an employer and left at least one retirement account behind, despite efforts of sponsors and regulators to help participants manage their accounts.

“Department of Labor [DOL] officials told GAO that some sponsors do not search for participants when disclosures are returned as undeliverable,” the report notes. “DOL has issued guidance on searching for missing participants for some plans that are terminating, but guidance does not exist on what actions DOL expects ongoing plan sponsors to take to keep track of separated participants. A key element of DOL’s mission is to protect the benefits of workers and families. However, without guidance on how to search for separated participants who leave behind retirement accounts, sponsors may choose to do little more than remove unclaimed accounts from the plan when possible, and workers may never recover these savings.”

The GAO recommended that the Internal Revenue Service (IRS) Commissioner should consider revising the letter forwarding program in a cost-effective manner to again provide information on behalf of plan sponsors on unclaimed retirement accounts to participants. The IRS stopped its letter-forwarding program in 2012, and the Social Security Administration stopped forwarding letters in 2014.

Related to these challenges at home, the GAO report zeros in on a unique issue facing the sizable number of “U.S. individuals who participate in foreign workplace retirement plans.” This group faces unique challenges in reporting their retirement savings for tax purposes because of complex federal requirements governing the taxation of foreign retirement accounts and a lack of clear guidance on how to report these savings.

As the report lays out, stakeholders told GAO it is not always clear to U.S individuals or their tax preparers how foreign workplace retirement plans should be reported to the Internal Revenue Service (IRS).

“The process for determining this can be complex, time-consuming, and costly,” GAO warns. “In the absence of clear guidance on how to correctly report these savings, U.S. individuals who participate in these plans may continue to run the risk of filing incorrect returns. Further, U.S. individuals in foreign retirement plans also face problems transferring retirement savings when they switch jobs.”

As GAO explains, in the United States, transfers of retirement savings from one qualified plan to another are generally exempt from taxation. However, foreign plans are generally not tax-qualified under the Internal Revenue Code, according to IRS officials, and such transfers could have tax consequences for U.S. individuals participating in foreign retirement plans.

“Officials from the Department of the Treasury told GAO that a change to the U.S. tax code could improve the tax treatment of transfers between foreign retirement plans that Treasury has already examined,” the report says. “Without action to address this issue, U.S. individuals may not consolidate their foreign retirement accounts or may have to pay higher U.S. taxes on transfers than taxpayers participating in qualified plans in the United States, threatening the ability of U.S. individuals to save for retirement abroad.”

Considering these issues together, GAO recommends Congress “consider addressing taxation issues affecting the transfer of retirement assets between plans within the same foreign country.” GAO is making seven recommendations, laid out in full in the report, including that DOL issue guidance to help ongoing plan sponsors search for separated participants, and that IRS issue guidance to clarify how U.S. individuals should report foreign retirement savings to the IRS.

According to GAO, the agencies generally agreed with its recommendations, with some minor disagreements. However, it remains unclear whether any correction action may be forthcoming. The full report is available for download here.

In Practice March 7, 2018

CFP Board Sees Expanding Role for Digital Advisers

Looking to 2018 and beyond, traditional advisers, brokerage firms and banks are widely (and aggressively) seeking to integrate digital advice into their service offerings; the CFP Board Center for Financial Planning offers a digital advice road map to help make sense of it all.

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The CFP Board Center for Financial Planning, in partnership with Heidrick & Struggles, established a Digital Advice Working Group in 2016 to explore the key issues and uncertainties affecting the future of the financial advisory industry; the group’s second report offers an updated review on the digital advice landscape.

As the reporting shows, many traditional providers of in-person financial services are seeking out ways to better integrate digital advice offerings. Overall, as a result, the digital advice market space continues to grow strongly, yet there is also evidence that increased competition, regulatory shifts and cybersecurity concerns could reshape the landscape in unpredictable ways over the next several years.

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After an analysis of the working group’s initial 2016 predictions, it was found that five of the nine issues the group considered to be the industry’s greatest uncertainties in 2016, in fact had much greater clarity one year later. Collectively, the group believes that by 2021, consumer comfort with a digital financial advisory experiences will be much higher than it is today.

Beyond this, the group feels it is now pretty definitive that profit margins in investment management will continue to decrease. Although the extent of margin erosion is unclear, this will put pressure on providers to find more efficient ways to do business—a natural advantage for digital advice pathways looking forward. Tied to this, the group now feels, greater transparency in the investing industry at large will lead to a modest increase in consumer awareness and drive demand for greater value at lower costs, again potentially favoring robo-advice.

Important to note, the group now says it fully expects a stricter fiduciary standard “will be applied equally to both human-led and digital advisory platforms” in the near-term future. This will obviously have a strong impact on the exact ways traditional providers choose to structure and deliver digital offerings.

The final area of increased certainty over 2016, according to the working group’s report, is that the market for financial advice will expand in the “mass market segment.” This is a client group that can be especially well-served by digitally supplemented advice offerings, the group feels.

Uncertainties remain

According to the updated analysis, four key issues remain uncertain. First, members of the working group remain split almost evenly as to whether consumer demand will press for more holistic, integrated advice or allow for a fragmented approach across multiple financial disciplines. Second, while the working group did not feel a significant transfer of wealth would occur from Boomers to Generation X and Millennials in the coming four years, participants were split as to the degree of wealth (and thus influence as consumers of financial advice) that these younger generations will eventually amass.

Beyond these factors, the working group did not believe digital advice platforms would continue to remain focused solely on investment management by 2021, and they were nearly evenly split on the degree of growth to expect. The main question outstanding among working group members is whether digital platforms will see explosive growth in capabilities across financial disciplines, perhaps by expanding into tax optimization, estate planning, insurance or risk management. Some believe the growth will be great, while others feel that expansion of such capabilities be more tempered.

Finally, on the question of cybersecurity, there remains significant disagreement. Working group participants were confident that cyber security attacks would continue to occur in the financial sector between now and 2021, but remained uncertain of the likely consumer response. Members debated in particular whether cyber security attacks and data breaches will stoke consumer fears and decrease their willingness to use digital advice platforms, or whether consumers might grow numb to the ever-increasing number of cyber incidents and generally remain unfazed.

Digital advice roadmap

According to the working group, many firms are beginning to deploy a more disciplined process for monitoring uncertainty and staying ahead of their competitive environment, vis a vis, digital advice.

“Often this entails an ongoing, concerted effort from an interdisciplinary team; individuals that come together to discuss market changes, piece together data and dynamically adjust and communicate the firm’s viewpoint and strategy for the future based on real-time learning,” the group explains. “These individuals track market signals (e.g. from customer feedback, regulatory changes, competitive actions) observed in the course of their daily work and periodically convene to interpret those signals and discern what they mean for the future of the industry.”

Environmental monitoring, as the working group calls it, is “an excellent way to track market developments with speed and agility, and enable your organization to see the future sooner than your competitors.”

To kick-off their own monitoring efforts, traditional providers may consider chartering a “monitoring team.” For those uncertainties that are quantifiable, this group can create a baseline or index for where the firm is today, and where it could move in the years ahead. 

“As you monitor those metrics, interpret future increases or decreases in light of what it means for the most-likely future scenario for digital advice,” the group recommends. “Set aside additional time to monitor non-traditional data sources that are not typically a part of your day-to-day work (e.g. social media, blog posts) but that might reveal useful data that could inform strategic decisions. Think creatively about potential black swans (low likelihood events that would be highly impactful) in your marketplace and identify the potential weak signals that may precede those events.”

Beyond this, the working group recommends that industry practitioners “share their learning, data sources and relevant takeaways with team members via email as high-impact signals are uncovered.” Firms might even create a semi-annual monitoring report of their own to regularly communicate important signals in the environment and distill the strategic implications for leadership.

The full report from the CFP Board and Heidrick & Struggles is available for download here.

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