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Loan Consequences

If your company offers a 401(k) plan loan, it can be among your most cost-effective options for short-term needs (five or fewer years). However, these loans come with potential drawbacks. Before you take money from your 401(k), understand all the consequences.

THE BASICS

Not every 401(k) plan will allow loans, but the majority that do will have limits — typically no more than 50% of an account balance. Loans are potentially better for your bottom line than withdrawals, because doing the latter could trigger early withdrawal penalties.

Still, a 401(k) loan could be better than the alternatives, with potentially lower interest rates and automatic deduction of loan payments from your paycheck. Additionally, it won’t require a credit check.

However, a 401(k) loan can cause some unintended consequences outlined below.

DRAWBACKS

One drawback is two-pronged: The amount of your loan will miss out on potential growth, while your paycheck will be lighter by the amount of your repayment until the loan is paid in full. The second drawback is more problematic. Whether you lose your job or leave it voluntarily, you will still have to repay the loan.

Many plans will require payment in full before you separate from employment. If you don’t have the money to pay the entire loan, your plan administrator will deduct the amount from your account balance. This will create tax problems, as the IRS will see this repayment as a distribution with accompanying early withdrawal penalties and income tax due.

Discuss with your financial and tax professionals whether any loan is a necessity, as well as other alternatives, before you take a 401(k) plan loan. Be sure to consider how this or any loan may affect your long-term savings strategy.

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Beware of Tax Scams

Don’t fall victim to scams during this tax filing season. Recognize these red flags.

The IRS doesn’t initiate contact with taxpayers or request personal or financial information through phone, email, text message or social media. You’ll usually receive several letters from the IRS before an agent calls you or comes to your home or business.

Also, the IRS doesn’t call to demand immediate payment using a specific method, like gift cards or wire transfers. Any tax payments should be made directly to the United States Treasury.

IRS personnel will never threaten to send local police or immigration officers to arrest you if you don’t pay.

If you’re ever in doubt about the legitimacy of messages or letters you receive, contact your tax professional right away, or call the IRS.

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The Benefits of Financial and Tax Strategies

A well-coordinated financial strategy encompasses more than just your investments. It considers every aspect of your finances, from budgeting to retirement saving, to ensure you’re making decisions that can help you reach all your goals.

THE BIG PICTURE

A successful strategy should provide a complete view of all your finances. By knowing how much savings you have accrued and the debts you owe, you can come up with a roadmap for spending, saving and investing. Identifying your short- and long-term goals is a good place to start. Paying off debt might be a short-term goal, while saving for retirement generally is a long-term goal that could be years in the future. Setting aside money for a child’s education might be a mid-term goal.

WORK TOWARD YOUR GOALS

A cornerstone of your strategy should be the probability of reaching all the milestones you’ve identified. You and your financial professional choose a target asset allocation based on your goals, time frame and risk tolerance. Whether you’re an aggressive or a conservative investor, it’s essential to periodically check your progress toward your goals and adjust your strategy as needed.

YOUR RETIREMENT PICTURE

What you want to do in retirement can be a factor in how much savings you’ll need to accumulate. If you plan to travel, relocate or even start your own business, you’ll need to have sufficient funds for those endeavors. Your financial professional can help you estimate your future financial needs and build the wealth you’ll need to meet them.

MARKET UPS AND DOWNS

Periods of market volatility and high inflation can affect your investments’ performance over the short term. Investors may panic and sell investments when values are down. Historically, markets have always recovered their losses. Your financial professional can help you make investment decisions that aren’t driven by short-term market fluctuations.

HELP WITH TAXES

Taxes can impact your finances both before and during retirement. A tax professional can help you create a tax-efficient estate plan, advise you on charitable donations and explain any tax breaks and deductions that are available to you.

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Boost Retirement Savings

Do you ever wish you could find extra money for your child’s college expenses or retirement? Maybe you would like to take a bucket list vacation or buy a larger home. Whatever your financial goals, finding the money to help pursue them can be challenging but not impossible. Here are some ways to find more money:

Retirement investors typically pay attention to whether their contributions are deductible or not. There are a wide variety of investment accounts, from 401(k) and 403(b) plans, that offer this benefit regardless of income.

For high-net-worth individuals, limits to how much they can contribute to these plans may leave them looking for another place to put additional monies. A Roth IRA, which doesn’t offer deductible contributions but does feature tax-free qualified distributions. However, high net worth individuals often get shut out of investing in a Roth IRA due to income restrictions. If this describes you, look into a non-deductible traditional IRA. Additionally, the percentage of your contributions to investment gain also won’t be taxed when you begin distributions.

There are other alternatives, including taxable investments and potentially qualifying for the Roth in some years by shifting income, so talk to your financial and tax professionals to see what option is best for you.

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Slicing the Inheritance Pie

ASSET RICH, CASH POOR

Let’s say you own a $2 million business, which you intend to pass to your daughter. But, you also have a son who isn’t involved in the business and doesn’t want to be a future part of it. How do you fairly treat family members who aren’t involved with the business when other family successors inherit your company?

ESTATE EQUALIZATION

You could have your heir who won’t be in the business inherit an equal amount of other assets and cash. What, however, do you do if your portfolio is asset-rich but cash-poor? With sufficient time and careful investing, you could sock cash into an account you will use to equalize your estate.

Or, you could buy a life insurance policy with a $2 million death benefit going to your son as beneficiary, while your daughter becomes beneficiary of your company.

Talk to you legal and tax professionals to learn how you might structure an estate equalization approach that works for every family member.

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February 2025 Question and Answer

QUESTION:

My company is thinking about offering a student loan repayment benefit for our employees. How does it work?

ANSWER:

This benefit, which pays off anywhere from a few hundred to a few thousand dollars a year in student loan debt for employees, has grown in popularity among Fortune 1,000 companies and may make sense for smaller companies.

To protect your investment, define parameters such as eligibility, reimbursement limits and consider implementing retention agreements to require employees to stay with the company for a period after receiving benefits. Also, ensure that you reimburse for education related to your company goals. Consult your tax pro for guidance.

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When Fixed Annuities Make Sense

If you’re risk-averse, are concerned that investments in stock or bond mutual funds may lose principal or you’re looking for some guarantees in retirement, a fixed annuity* may be one answer.

WHEN YOU WANT CERTAINTY

If your only guaranteed income in retirement is Social Security and your employee retirement plan doesn’t offer an annuitization option, a fixed annuity can provide one avenue of dependable income in retirement. While fixed annuities are backed by the financial strength of the insurance companies issuing them, the guaranty fund of your state guarantees them up to certain limits if the insurer can’t meet its obligations.

A fixed annuity grows tax-deferred, so you are not taxed on gains until you begin withdrawals, and it offers payment options called “period certain,” which is the number of years specified in your contract. You may also choose a lifetime benefit option.

WHEN YOU ARE UNINSURABLE

You might also buy a fixed annuity to provide a financial legacy to loved ones or as a way to pay for your potential long term care costs, in the event health makes insurance unaffordable or unavailable. While annuities offer certain advantages, they can be costly (see the disclaimer below), so make sure to compare annuity contracts from financially strong insurance companies with the help of a financial professional.

*An annuity may impose charges, including but not limited to surrender charges, mortality and expense risk charges, administrative fees and underlying fund expenses. You will have to pay federal income tax on any earnings you withdraw from the annuity. Payments and guarantees are subject to the claims-paying ability of the issuing insurance company.

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Family-Owned Business

  • 64% of the Gross Domestic Product is contributed by family businesses
  • 60% of the US workforce are employed by family businesses
  • 78% of all new jobs are created by small businesses
  • 1.2 Million businesses run by a married couple
  • 74% of family businesses report stronger values and culture

Source: SCORE 2024

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February 2025 Client Profile

Mark owns an architectural firm in a North Carolina region that Hurricane Helene flooded badly and will not be able to deal with company or individual federal taxes for some time. Will he still owe a penalty?

The IRS announced that Hurricane Helene victims in all of North Carolina have until May 1, 2025, to file various federal individual and business tax returns and make tax payments.

The May 1, 2025, deadline also applies to any payments due during this period, including quarterly estimated taxes due on January 15 and April 15, 2025, and quarterly payroll and excise tax returns normally due on October 31, 2024, January 31, 2025, and April 30, 2025.

The IRS automatically identifies taxpayers located in the disaster area and applies filing and payment relief. But if you live or have a business located outside the covered disaster area call the IRS disaster hotline at 866-562-5227 to request relief.

Client Profile is based on a hypothetical situation. The solutions discussed may or may not be appropriate for you.

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All In the Family

Here are three ways business owners can turn younger family members into eventual company owners, short of buying the company with ready cash (with its various tax implications).

OWNER FINANCING

Also known as the installment plan, you might create an agreement with the help of an attorney to receive a down payment on the sale of your business, with the rest paid in installments.

Pros include potentially lower interest on payments for the buyer and a stream of income the seller can use in retirement. Cons include less cash flow for the new owner to operate the company and the chance installment payments to the previous owner will stop before full payment.

SINKING FUND

If you have a well-structured buy-sell plan and intend to pass the business on in a specified number of years, you might consider establishing a sinking fund, which becomes a company asset until used to purchase the business. You can schedule regular payments to an interest-bearing account or investment-type fund, with funds growing over time to theoretically fund a future purchase.

LIFE INSURANCE

You may also want to examine the potential of funding a cash value life insurance policy to use in the future purchase of the business. Like a sinking fund, the life insurance policy becomes a company asset. Unlike a sinking fund, which doesn’t help if the existing owner dies before the fund accumulates sufficient cash, life insurance covers a potential sale, whether unexpected or planned.

GET HELP

Work with your legal and tax professionals to better understand the tax implications for you and family successors before deciding which funding method to choose.