June 14, 2018
One of the more difficult challenges facing a business owner is the formulation of a viable and economically beneficial exit strategy at retirement. Typically, the main goals of such an exit strategy are: 1) to identify a qualified buyer; and 2) to receive fair compensation for the business, which would, in turn, translate into a desirable retirement income. One obstacle in realizing these goals is the substantial capital gain that is often attributable to the sale of company stock. For some owners, one method of finding a suitable buyer, and at least delaying payment of capital gains taxes, is to sell stock back to the company in the form of an employee stock ownership plan (ESOP). For others, the realization of a significant capital gain proves to be a major psychological stumbling block that delays action, and results in maintaining stock ownership much longer than desired or initially anticipated. In either case, the charitable remainder trust (CRT) can be a practical mechanism for eliminating the capital gains tax issue altogether, while assisting the business owner in meeting his or her goals.
The CRT is a highly effective financial planning tool that can: 1) remove assets from a donor’s estate; 2) avoid current capital gain on the transfer of appreciated assets; 3) provide the donor with a potentially significant charitable deduction; 4) benefit a donor’s charity of choice; and 5) provide the trust beneficiary (usually the donor) with a steady income stream for life or over a term of years (not to exceed 20 years). The minimum income payout from a CRT is 5%, while the maximum is 50% (the payout rate must also satisfy rules under the Taxpayer Relief Act of 1997). Typically, the payout rate is somewhere between 5% and 12%. In addition, the charitable deduction is based on the amount of time the charity must wait to receive payment, the percentage rate payable to non-charitable beneficiaries, and the current rate of return as determined by the applicable federal rate (i.e., a monthly rate based on the interest rate the federal government pays on borrowed funds).
An owner who has already sold stock to an ESOP, as well as an owner who has yet to do so, can equally benefit from using a CRT. However, an owner who has already sold all, or a portion, of his or her stock to an ESOP will face additional technical requirements that merit closer examination.
ESOPs are defined contribution retirement plans and are subject to the same guidelines imposed on 401(k) and profit-sharing plans. However, ESOPs are designed to invest primarily in the stock of the business in which the employees work. As such, an ESOP gives all employees a vested interest in the profitability of the company—as the company’s fortunes increase, so does the value of each employee-shareholder’s stock.
An ESOP basically functions as a private marketplace, enabling retiring employees to recognize a retirement benefit by selling their shares back to the ESOP. For example, an ESOP is then used to buy out the interest of a retiring owner, providing an alternative to selling the business (or an owner’s share of the business) to an outsider. Frequently, the ESOP borrows from a commercial lender and uses the funds to purchase the shares of the withdrawing shareholder. The corporation is entitled to an income tax deduction for contributions to the ESOP, which are then used to pay both principal and interest payment on the loan.
Another significant benefit is that gain on the sale can be deferred under Internal Revenue Code Section 1042 if the ESOP holds at least 30% of the retiring owner’s company stock after the sale and the seller reinvests the proceeds into qualified replacement property (generally defined as securities of U.S. domestic operating corporations). This so-called “Section 1042 rollover” must take place within a “qualified period” (beginning three months prior to the date of the sale and ending twelve months after the sale), and the ESOP must have no publicly-traded stock outstanding. However, nonrecognition of gain is only allowed if the owner-shareholder has held the shares for at least three years prior to the sale to the ESOP.
While a retiring owner can liquidate his or her interest in the business on a tax-advantaged basis using a Section 1042 transaction, he or she should be aware of some limitations. From an investment perspective, the definition of qualified replacement property is somewhat restrictive. —it does not include mutual funds, real estate investment trusts (REITs), or U.S. government and municipal bonds. In addition, the deferral of taxation ends once the qualified replacement property is sold. Thus, active management of a qualified replacement property portfolio is not possible without incurring capital gains taxes. When these factors are taken into consideration, some estate planners have come to view qualified replacement property assets as ideal for funding a CRT. (Note: There may be a 10% excise tax for the plan sponsor if the ESOP does not hold on to the newly acquired stock for at least three years.)
Timing of the Stock Transaction
While the ESOP does serve a critical purpose (by creating a marketplace for the owner’s company stock), it is not necessary to sell stock to an ESOP prior to funding a CRT. Thus, an owner who has yet to take action may be better served to transfer the stock directly to the CRT, and then allow the CRT to sell the stock to the ESOP (or other qualified buyer). By doing so, the tax reporting and technical requirements for qualified replacement property under Section 1042 become a nonissue. Nevertheless, an owner who has already sold all, or a portion, of his or her stock to an ESOP may enjoy the same benefits of a CRT—the only difference being the reporting and technical requirements under Section 1042.
Since the CRT is a tax-exempt entity, it can sell the funding assets with reduced capital gains consequences. The CRT can then reinvest the proceeds without restrictions—with the ultimate goal of the donor (in this case, the selling shareholder) being the recipient of a steady income stream from the trust assets (in actuality, a portion of the income payout may be a capital gain distribution).
Moreover, there may be additional flexibility if the CRT is designed as a unitrust, as opposed to an annuity trust, because a unitrust can accept additional contributions while an annuity trust cannot. Since there is often a desire to sell company stock to an ESOP (or other buyer) in stages, the opportunity exists for funding the unitrust in stages.
A Viable Combination
An owner planning for withdrawal from his or her business (such as retirement) faces a variety of challenges that can have an impact on both the business and the owner’s estate. While an ESOP assures ownership will remain within the company, the CRT/ESOP combination can be a powerful business liquidation/estate maximization strategy. However, it is important for a business owner to recognize that how assets are transferred to the CRT (either in the form of qualified replacement property or actual company stock), generally, will have little impact on the effectiveness of the CRT. Thus, individual circumstances often play a greater role in dictating the timing of the sale of stock to an ESOP. Regardless of the situation, as is the case with all advanced planning issues, a thorough review of a business owner’s long-term goals and objectives is essential to determine an appropriate course of action.
April 26, 2018
Now that the 2017 tax season is a wrap for most Americans, it’s time to start contemplating how the 2017 Tax Cuts and Jobs Act (TCJA) will impact your current and future tax plans. One of the frequently asked questions we’ve been fielding is on charitable giving: How can you keep giving, and get a little back on your taxes? Following are four practical possibilities to consider for charitable giving under the TCJA rules.
- Stagger Your Giving
Technically, you can still itemize charitable deductions. However, it’s now much more difficult to benefit from doing so annually. The TCJA not only restricts or eliminates several other formerly itemizable write-offs, it essentially doubles the standard deduction to $24,000 for couples filing jointly and $12,000 for single individuals.
As a result, many families who used to itemize and realize tax benefits from their deductible donations will usually decide they’re better off taking the standard deduction instead – even though it means they’ll receive no tax benefit for their charitable giving that year. In February 2018, the National Council of Nonprofits estimated that the higher standard deductions would effectively put the charitable deduction “out of reach of more than 87% of taxpayers.”
A possible work-around is to stagger your giving and other deductible expenses. For example, you may be able to double up your charitable giving every-other year, in an effort to itemize in alternate years. In year one, give twice as much as you normally would if you can combine it with enough other deductibles to itemize and write off the expenses against taxes due. In year two, do what you can to minimize donations and other deductibles, and take the standard deduction instead … and so on.
- Unload a Highly Appreciated Holding
If you’re going to be donating anyway, consider doing so with highly appreciated securities like stocks, stock funds, property, or similar holdings that are worth considerably more than when you acquired them. If you sell a highly appreciated holding outside of a tax-sheltered account such as an IRA, you’ll pay capital gains taxes on the difference between its cost and its sale price, less expenses. If you instead donate it “in kind” to a non-profit organization (i.e., without selling it first), you triple its tax-wise potentials:
- Within the parameters described above plus a cap based on your Adjusted Gross Income, the holding’s full value is available to you as a charitable deduction in the year you donate it.
- You avoid capital gains tax on the unrealized gain.
- The charity is free to keep or sell the holding, also without incurring taxable gains.
- Do a Donor-Advised Fund
We cover DAFs in more detail in a separate post, but here’s a quick take on how they work:
- Make an irrevocable donation to a DAF sponsor, which acts like a “charitable bank.” The full amount of your donation is deductible in the year you fund the DAF. Plus, many DAFs accept in-kind holdings as described above (whereas not all individual charities can).
- Over time, you advise the DAF’s sponsoring organization on when and to whom to grant the assets. The DAF sponsor has final say, but you can expect they’ll honor your request unless your intended recipient is not a qualified charity or there are other unusual circumstances.
- Until the funds are distributed, the DAF sponsor typically invests the donated assets; any returns or appreciated value grows tax-free, givng your initial donation added impact.
In this manner, a Donor-Advised Fund (DAF) can help you stagger your charitable donation deduction as described above, without having to stagger your usual annual giving. For example, you could fund a DAF with five years’ worth of anticipated donations, and then make annual requests that donations be made to your charities of choice across five years. This should allow you to itemize the entire DAF donation in year 1, and take the standard deduction the rest of the time. Plus, you can fund your DAF using appreciated holdings.
In short, DAFs can be a handy giving tool. That said, they aren’t ideal for every donor, every time. Let us know if we can show or tell you more.
- Retirees: Donate Your Required Minimum Distribution
Again, if you’d be making charitable contributions anyway, it may well be tax-wise to donate your Required Minimum Distribution (RMD) as allowed by the IRS, instead of taking it as ordinary income.
During your working years, there are many advantages to funding tax-favored retirement accounts. But, eventually – when you reach age 70½, to be exact – you must begin taking RMDs from your tax-sheltered havens, whether or not you want to. There is a steep penalty if you fail to do so (with Roth IRAs being an exception to this rule).
RMDs are taxed the year you take them at your ordinary income tax rate. You can avoid extra taxes and higher taxable income (which may impact your Medicare premiums and have tax ramifications on your Social Security income) by donating some or all of your RMD to charity. The IRS allows you to donate up to $100,000 annually in this manner.
No New, But Possibly Improved Opportunities
It’s worth mentioning that none of these four tax-planning possibilities are new; they’ve all been available well before the TCJA passed. The difference is, they may be more applicable to you under the new tax codes.
As we always do with tax topics, we recommend touching base with your tax professional before making any big decisions. As a service to our clients, we are happy to arrange a group meeting among you, your accountant and a member of our firm to offer personalized advice and to best coordinate our efforts on your behalf. We’re also available for planning conversations or to answer additional questions you may have about your tax-wise giving goals.
March 21, 2018
After nearly a decade of leaving the federal funds rate at zero percent, the time finally came on December 16, 2015: The U.S. Federal Reserve (the Fed) raised the federal funds rate by 0.25 percent. Because it was the first rate increase since June 2006, it was reported as “a historic moment.” Since then, the Fed has made several modest increases. You can find the most recent rate changes reported here.
But what do these rate changes mean to your financial well-being? Is there anything you should “do” to your investment portfolio when they occur? As is nearly always the case for economic events over which we have no control, we typically recommend that you remain informed – but that you act only on factors you can expect to manage within your personal investing.
In that context, let’s take a moment to share some insights about the Federal Reserve funds rate.
What Is the Federal Reserve?
As described on its consumer education site, the Federal Reserve is the central bank of the U.S. It was created by Congress as an independent government agency in 1913 “to provide the nation with a safer, more flexible, and more stable monetary and financial system.” Jerome Powell is its current board of governors’ chair. Before Powell, the chairs were Janet Yellen, Ben Bernanke and Alan Greenspan.
Powell and his board of governors are based in Washington, DC. They also oversee 12 regional reserve branches across the country and are tasked with three main roles:
- Monetary Policy – Promoting “maximum employment, stable prices and moderate long-term interest rates”
- Supervision and Regulation – Overseeing U.S. banks and gathering information to understand financial industry trends
- Financial Services – Serving as a bank for U.S. banks as well as for the country’s monetary operations – issuing currency, managing the government’s bank accounts, borrowing money in the form of U.S. Savings bonds and more
What Is Going On?
While you wouldn’t want to run a country without all three of these roles in place, monetary policy is where much of the headline-grabbing action is often found. The Fed continuously grapples with when, by how much, and how often it should raise the federal funds rate.
The Federal Reserve sets monetary policy through its Federal Open Market Committee (FOMC), which includes the Fed’s board members and a rotating representation of Reserve Bank presidents.
The FOMC holds eight regularly scheduled annual meetings to consider what actions to take (if any). In the days before those meetings, the financial press often reports on expected outcomes as if they were a done deal, and markets often respond accordingly. In reality, until those meetings have taken place, nobody knows what their outcome will be.
Still, while the FOMC has a number of ways to seek balance among the competing demands of the economy, raising or lowering the federal funds rate has long been one of its more powerful management tools. So, it’s no wonder the question becomes the media’s central focus whenever the FOMC is set to meet. It’s also no wonder that investors are bombarded with the usual volume of conflicting coverage on what is and is not at stake, and what may or may not come to pass. Depending on who you heed, higher federal funds rates could be anything from a panacea, to a global scourge, to a non-event in the markets.
What Does All This Mean to You and Your Money?
First, it helps to understand that there is an intricate interplay between developed nations’ monetary policies, global interest rates and the markets in general. Anyone who claims to know exactly what will happen in one arena when we pull a lever in another had best be able to present a functioning crystal ball if he or she is to be believed.
To cite one example, consider this March 2018 column by Wall Street Journal columnist Jason Zweig, in which he chastises various brokers for their still-anemic sweep account yields despite rising interest rates: “The Federal Reserve has driven short-term interest rates up a full percentage point since late 2016; one-month Treasury bills were yielding 1.6% this week. But you’d never know any of that from looking at the returns on the cash in your brokerage account.”
This illustration also demonstrates that the only interest rate the Fed has direct control over is the U.S. federal funds rate, which is the rate at which depository institutions (mostly banks), lend and borrow overnight funds with one another.
The resulting cash flow is the grease that turns the wheels of the country’s federal banking system, so it’s an important factor. But as Zweig illustrates, that doesn’t mean that there is a consistent cause-and-effect relationship between federal funds rate movements and other yields-based financial instruments such as U.S. or international fixed income funds, interest-earning accounts, mortgages, credit cards and so on.
A separate Wall Street Journal article substantiates: “Think all rates would tick a little higher as the Fed tightens? That isn’t how it works. … The impacts will be uneven. Some borrowing costs are likely to rise closely in sync with short-term rates, but others won’t.”
Why is this so? It’s partly the result of those multiple global factors at play, with the Fed’s actions representing only one among many others. A post by “The Grumpy Economist” John Cochrane even suggests that the Fed’s actions may be one of the less-significant factors involved: “Lots of deposits (saving) and a dearth of demand for investment (borrowing) drives (real) interest rates down, and there is not a whole lot the Fed can do about that. Except to see the parade going by, grab a flag, jump in front and pretend to be in charge.”
What Should You Do?
Whenever you’re wondering how best to respond to a shifting landscape such as that wrought by rising (or falling) interest rates and any related repercussions, begin by asking yourself: What can I do about it?
Unless you are Fed chair Jerome Powell, there is probably nothing you can do to personally influence what the Feds are going to decide about ongoing interest rates, or how the global markets are going to respond to the news. But there is plenty you can do to help or harm your own wealth interests.
First, if you already have a solid financial plan in place, we do not recommend abandoning it in rash reaction to unfolding news. If, on the other hand, you do not yet have a well-built plan and portfolio to guide the way, what are you waiting for? Personalized financial planning is a good idea in all environments.
Next, recognize that rising or falling interest rates can impact many facets of your wealth: saving, investing, spending and debt. A conversation with a wealth manager is one way you can position yourself to make the most of multi-factored influences in unfolding economic news.
Together and through varied interest rate climates, we can help put these and many other worldwide events into the context they deserve, so you can make informed judgments about what they mean to your own interests. The goal is to establish practical ways to manage your debt; wise ways to save and invest; and sensible ways to spend, before and in retirement.
These are the factors that matter the most in your life, and over which you can exercise the most control – for better or for worse. Give us a call today if we can help make things better for you.
March 1, 2018
No matter how the 2017 Tax Cuts and Jobs Act (TCJA) may alter your tax planning, we’d like to believe one thing will remain the same: With or without a tax write-off, many Americans will still want to give generously to the charities of their choice. After all, financial incentives aren’t usually your main motivation for giving. We give to support the causes we cherish. We give because we’re grateful for the good fortune we’ve enjoyed. We give because it elevates us too. Good giving feels great – for donor and recipient alike.
That said, a tax break can feel good too, and it may help you give more than you otherwise could. Enter the donor-advised fund (DAF) as a potential tool for continuing to give meaningfully and tax-efficiently under the new tax law.
What’s Changed About Charitable Giving?
To be clear, the TCJA has not eliminated the charitable deduction. You can still take it when you itemize your deductions. But the law has limited or eliminated several other itemized deductions, and it’s roughly doubled the standard deduction (now $12,000 for single and $24,000 for joint filers). With these changes, there will be far fewer times it will make sense to itemize your deductions instead of just taking the now-higher standard allowance.
This introduces a new incentive to consider batching up your deductible expenses, so they can periodically “count” toward reducing your taxes due – at least in the years you’ve got enough itemized deductions to exceed your standard deduction.
For example, if you usually donate $2,500 annually to charity, you could instead donate $25,000 once each decade. Combined with other deductibles, you might then be able to take a nice tax write-off that year, which may generate (or be generated by) other tax-planning possibilities.
What Can a DAF Do for You?
- Make a sizeable donation to a DAF. Donating to a DAF, which acts like a “charitable bank,” is one way to batch up your deductions for tax-wise giving. But remember: DAF contributions are irrevocable. You cannot change your mind and later reclaim the funds.
- Deduct the full amount in the year you fund the DAF. DAFs are established by nonprofit sponsoring organizations, so your entire contribution is available for the maximum allowable deduction in the year you make it. Plus, once you’ve funded a DAF, the sponsor typically invests the assets, and any returns they earn are tax-free. This can give your initial donation more giving-power over time.
- Participate in granting DAF assets to your charities of choice. Over time, and as the name “donor-advised fund” suggests, you get to advise the DAF’s sponsoring organization on when to grant assets, and where those grants will go.
Thus, donating through a DAF may be preferred if you want to make a relatively sizable donation for tax-planning or other purposes; you’d like to retain a say over what happens next to those assets; and you’re not yet ready to allocate all the money to your favorite causes.
Another common reason people turn to a DAF is to donate appreciated stocks in kind (without selling them first), when your intended recipients can only accept cash/liquid donations. The American Endowment Foundation offers this 2015 “Donor Advised Fund Summary for Donors,” with additional reasons a DAF may appeal – with or without its newest potential tax benefits.
A DAF isn’t for everyone. Along the spectrum of charitable giving choices, they’re relatively easy and affordable to establish, while still offering some of the benefits of a planned giving vehicle. As such, they fall somewhere between simply writing a check, versus taking on the time, costs and complexities of a charitable remainder trust, charitable lead trust, or private foundation.
That said, planned giving vehicles offer several important features that go beyond what a DAF can do for a family who is interested in establishing a lasting legacy. They also go beyond the scope of this paper, but we are happy to discuss them with you directly at any time.
How Do You Differentiate DAFs?
If you decide a DAF would be useful to your cause, the next step is to select an organization to sponsor your contribution. Sponsors typically fall into three types:
- Public charities established by financial providers, like Fidelity, Schwab and Vanguard
- Independent national organizations, like the American Endowment Foundation and National Philanthropic Trust
- “Single issue” entities, like religious, educational or emergency aid organizations
Within and among these categories, DAFs are not entirely interchangeable. Whether you’re being guided by a professional advisor or you’re managing the selection process on your own, it’s worth doing some due diligence before you fund a DAF. Here are some key considerations:
Minimums – Different DAFs have different minimums for opening an account. For example, one sponsor may require $5,000 to get started, while another may have a higher threshold.
Fees – As with any investment account, expect administration fees. Just make sure they’re fair and transparent, so they don’t eat up all the benefits of having a DAF to begin with.
Acceptable Assets – Most DAFs will let you donate cash as well as stocks. Some may also accept other types of assets, such as real estate, private equity or insurance.
Grant-Giving Policies – Some grant-giving policies are more flexible than others. For example, single-entity organizations may require that a percentage of your grants go to their cause, or only to local or certain kinds of causes. Some may be more specific than others on the minimum size and/or maximum frequency of your grant requests. Some have simplified the grant-making process through online automation; others have not.
Investment Policies – As touched on above, your DAF assets are typically invested in the market, so they can grow tax-free over time. But some investments are far more advisable than others for building long-term giving power! How much say will you have on investment selections? If you’re already working with a wealth advisor, it can make good sense to choose a DAF that lets your advisor manage these account assets in a prudent, fiduciary manner, according to an evidence-based investment strategy. (Note: Higher minimums may apply.)
Transfer and Liquidation Policies – What happens to your DAF account when you die? Some sponsors allow you to name successors if you’d like to continue the account in perpetuity. Some allow you to name charitable organizations as beneficiaries. Some have a formula for distributing assets to past grant recipients. Some will roll the assets into their own endowment. (Most will at least do this as a last resort if there are no successors or past grant recipients.) Also, what if you decide you’d like to transfer your DAF to a different sponsoring organization during your lifetime? Find out if the organization you have in mind permits it.
Deciding on Your Definitive DAF
Selecting an ideal DAF sponsor for your tax planning and charitable intent usually involves a process of elimination. To narrow the field, decide which DAF features matter the most to you, and which ones may be deal breakers.
If you’re working with a wealth advisor such as Hiley Hunt Wealth Management, we hope you’ll lean on us to help you make a final selection, and meld it into your greater personal and financial goals. As Wharton Professor and “Give and Take” author Adam Grant has observed, “The most meaningful way to succeed is to help others succeed.” That’s one reason we’re here: to help you successfully incorporate the things that last into your lasting, charitably minded lifestyle.
January 31, 2018
If there is a universal investment ideal, it is this: Every investor wants to buy low and sell high. What if we told you there is a disciplined process for doing just that, and staying on track toward your personal goals while you’re at it? Guess what? There is. It’s called rebalancing.
Rebalancing: How It Works
Imagine it’s the first day of your investment experience. As you create your new portfolio, it’s best if you do so according to a personalized plan that prescribes how much weight you want to give to each asset class. So much to stocks, so much to bonds … and so on. Assigning these weights is called asset allocation.
Then time passes. As the markets shift around, your investments stray from their original allocations. That means you’re no longer invested according to plan, even if you’ve done nothing at all; you’re now taking on higher or lower market risks and expected rewards than you originally intended. Unless your plans have changed, your portfolio needs some attention.
This is what rebalancing is for: to shift your assets back to their intended, long-term allocations.
A Rebalancing Illustration
To illustrate, imagine you (or your advisor) has planned for your portfolio to be exposed to the stock and bond markets in a 50/50 mix. If stocks outperform bonds, you end up with too many stocks relative to bonds, until you’re no longer at your intended, balanced blend. To rebalance your portfolio, you can sell some of the now-overweight stocks, and use the proceeds to buy bonds that have become underrepresented, until you’re back at or near your desired mix. Another strategy is to use any new money you are adding to your portfolio anyway, to buy more of whatever is underweight at the time.
Either way, did you catch what just happened? Not only are you keeping your portfolio on track toward your goals, but you’re buying low (underweight holdings) and selling high (overweight holdings). Better yet, the trades are not a matter of random guesswork or emotional reactions. The feat is accomplished according to your carefully crafted, customized plan.
Portfolio Balancing: A Closer Look
In reality, rebalancing is more complicated, because asset allocation is completed on several levels. First, we suggest balancing your stocks versus bonds, reflecting your need to take on market risk in exchange for expected returns. Then we typically divide these assets among stock and bond subcategories, again according to your unique financial goals. For example, you can assign percentages of your stocks to small- vs. large-company and value vs. growth firms, and further divide these among international, U.S., and/or emerging markets.
One reason for these relatively precise allocations is to maximize your exposure to the right amount of expected market premiums for your personal goals, while minimizing the market risks involved by diversifying those risks around the globe and across sources of returns that don’t always move in tandem with one another. We are guided by these tenets of evidence-based investing.
Striking a Rebalancing Balance
Rebalancing using evidence-based investment strategies is integral to helping you succeed as an investor. But like any power tool, it should be used with care and understanding.
It’s scary to do in real time. Everyone understands the logic of buying low and selling high. But when it’s time to rebalance, your emotions make it easier said than done. To illustrate, consider these real-life scenarios.
- When markets are down: Bad times in the market can represent good times for rebalancing. But that means you must sell some of your assets that have been doing okay and buy the unpopular ones. The Great Recession of 2007–2009 is a good example. To rebalance then, you had to sell some of your safe-harbor holdings and buy stocks, even as popular opinion was screaming that stocks were dead. Of course history has shown otherwise; those who did rebalance were best positioned to capture available returns during the subsequent recovery. But at the time, it represented a huge leap of faith in the academic evidence indicating that our capital markets would probably prevail.
- When markets are up. An exuberant market can be another rebalancing opportunity – and another challenge – as you must sell some of your high flyers (selling high) and rebalance into the lonesome losers (buying low). At the time, this can feel counterintuitive. But disciplined rebalancing offers a rational approach to securing some of your past gains, managing your future risk exposure, and remaining invested as planned, for capturing future expected gains over the long-run.
Costs must be considered. Besides combatting your emotions, there are practical concerns. If trading were free, you could rebalance your portfolio daily with precision. In reality, trading incurs fees and potential tax liabilities. To achieve a reasonable middle ground, it’s best to have guidelines for when and how to cost-effectively rebalance. If you’d like to know more, we’re happy to discuss the guidelines we employ for our own rebalancing strategies.
The Rebalancing Take-Home
Rebalancing using evidence-based investment strategies makes a great deal of sense once you understand the basics. It offers objective guidelines and a clear process to help you remain on course toward your personal goals in rocky markets. It ensures you are buying low and selling high along the way. What’s not to like about that?
At the same time, rebalancing your globally diversified portfolio requires informed management, to ensure it’s being integrated consistently and cost effectively. An objective advisor also can help prevent your emotions from interfering with your reason as you implement a rebalancing plan. Helping clients periodically employ efficient portfolio rebalancing is another way we seek to add value to the investment experience.
December 29, 2017
We interrupt your busy holiday season with a quick post on last week’s U.S. tax code overhaul. While the ink still dries on this sweeping new legislation, you may be wondering whether there are ways you can or should spring into action immediately, before year-end, to reposition yourself for the new law of the land.
First, we want to emphasize that the new rules are not retroactive. Your 2017 tax return – the one due this April – will still be prepared under pre-reform law.
Practically speaking, this means there is probably not a great deal you must do right away. If we’re aware of particular circumstances in your life that might warrant otherwise, we will be in touch with you directly to assist – if we haven’t been already. And of course we remain on call as always, to promptly assist with any questions or requests you may have at your end.
In the meantime, here is our general take on how to position your year-end tax planning choices.
Do you value your limited holiday season time with loved ones far more than the potential to shave off some future tax dollars owed? If so, even if you might forgo potential savings, you might prefer to opt out of making any special tax-planning moves at this time (beyond those you’d be doing anyway).
Would you rather ensure every tax-related dollar is spared, even if it takes a little extra immediate time to do so? If that’s the case, there are at least two areas you may want to consider right away: your charitable giving habits, and the timing of your taxable income.
First, let’s talk about your charitable giving. By design, most Americans are likely to fare better in 2018 by taking the higher standard deduction available under the new law instead of itemizing deductions on Schedule A. If it’s likely you will no longer submit a Schedule A next year, then charitable contributions will no longer help you reduce your taxes.
BUT, if you’ve been itemizing in years past – i.e., submitting a Schedule A – you’ll probably still itemize in 2017. Thus there may be benefits to making your 2018 charitable contributions before year-end, when they might still “pay off” for you and your recipients alike (subject to existing limitations). You can write those checks directly. Or, this might be a good time to consider funding a Donor Advised Fund, from which you can distribute donations in the future while taking the tax break today.
One other general consideration as we approach year end: Many Americans’ tax rates are expected to decrease next year. Thus, if there are reasonable (legal) ways to shift any reportable income into 2018, you may end up paying less tax on it.
As always with tax planning, there are a ton of caveats, catches and exceptions to these rules of thumb. If you are thinking of taking action before year-end, we hope you’ll be in touch, so we can discuss the details with you. Either way, we will no doubt be having much deeper discussions in 2018 about what the new tax law means to your tax planning, your personal wealth and your lifetime goals. We look forward to being here for you – today, tomorrow and throughout the years ahead.
September 25, 2017
One of the toughest realities to prepare for after a divorce—and especially after a difficult one—is the division of financial assets. Wealth accumulated throughout a life’s hard work could be severely and negatively impacted in a matter of months, creating problems that could continue for years if the proper details are not attended to during the divorce proceedings. That is why today we will be discussing one of the most important acronyms to pay attention to during a divorce settlement: QDRO.
What Is a QDRO?
A qualified domestic relations order (QDRO) is a court order, judgment, or decree that allows a qualified retirement plan, such as a 401(k), 403(b), or pension, to pay benefits to the former spouse (or other dependent individual) in addition to the individual who controls and contributes to the plan. Without a QDRO, the alternate payee (the person assigned to share these types of benefits) is not entitled to receive any monies the plan will pay out. A QDRO agreement does not extend to include outside workplace retirement accounts such as savings/checking accounts, houses, etc.
Steps to Acquire a QDRO
Approval of a QDRO, which is finalized when the divorce itself is finalized, is generally granted before the divorce judgment is handed down. Any competent divorce attorney will know the steps needed to obtain a QDRO during the negotiation phase of a divorce.
But let’s say that a QDRO was not drafted for approval by your spouse, the retirement plan itself, or the judge during the proceedings for your divorce. This does not mean that you are out of luck. There is still a chance that you can obtain a QDRO and receive a fair portion of your now-ex-spouse’s retirement account. Here is what you need to do in order to make that happen:
- Sit down with an attorney who specializes in QDROs. Generally speaking, negotiating a QDRO during the divorce proceedings makes the division of assets easier. Once that time has passed, however, meeting with a lawyer to discuss how to obtain a QDRO will still ensure that you have the best chance to receive a post-decree settlement. The American Academy of Matrimonial Lawyers is one resource you could consider using to locate an attorney who specializes in family law which includes QDROs. It is important to lay out a clear legal plan before the proceedings.
- Send the resulting QDRO draft to the retirement/pension plan administrator. This is the most important step in the QDRO process. If the retirement/pension plan rejects your draft, you’ve wasted valuable time, which could prove costly. Oftentimes, the plan will return a copy of the draft with suggestions for changes based on the plan’s own rules and regulations. Consulting with an attorney with expertise in the QDRO process might enable you to circumvent some of these issues.
- Get the needed signatures from a judge and all affected parties. Once the retirement/pension plan has given its approval, it is important to obtain signatures from a divorce judge and all interested parties. The sooner this step is completed, the closer you will be to receiving your share of the benefits.
- Send a copy to the pension/retirement plan. Send the pension/retirement plan administrator a copy of the QDRO for approval. This will ensure that the benefits are paid out.
The steps listed above might take only a few months to complete, if everything happens quickly. Any delay, however, will mean more time before you receive the benefits, assuming all is in order. If your former spouse remarries or dies, it will become almost impossible to get any portion of the retirement account from the employer.
Divorce is one of the most difficult events a person may have to go through in life, and the aftermath of a divorce can be harder to handle if the marital assets were not divided well. A QDRO could be one of the most important financial documents obtained during this emotionally charged period of time. Seeking advice from a team of legal and financial experts will do wonders for your financial well-being and give you peace of mind.
September 1, 2017
The average price tag for four years at a private college exceeds $170,000, according to the College Board’s Trends in College Pricing 2014. That’s 17% higher than seven years previously. In fact, rising tuition costs are outpacing inflation at the same time that federal grant aid is lagging behind inflation.
While funding four years of college can be a challenge, research also proves that higher education remains a valuable investment. According to the College Board’s Education Pays 2013, in 2011, women with bachelor’s degrees earned 70% more than women with only high school diplomas; college-educated men earned 69% more than men who graduated from high school but did not have college degrees.
There are a variety of savings vehicles and planning strategies that can help you overcome the financial challenges and reach your education goals. One tax-efficient vehicle is the Coverdell Education Savings Account (ESA), which can be used to pay for college expenses, as well as for the cost of attending qualified K-12 schools.
With a Coverdell ESA, funds have the opportunity to grow tax deferred, and withdrawals used for qualified educational expenses, such as tuition, are tax free. A beneficiary can be anyone under the age of 18 (or older, if qualified as a special needs beneficiary). Any individual (including the beneficiary) may make contributions to a Coverdell ESA, as long as his or her modified adjusted gross income for the year is less than $110,000 ($220,000 for married couples filing joint tax returns). Other features include the following:
- Contribution limits are $2,000, per beneficiary, per year.
- Individuals may contribute to both a Coverdell ESA and a 529 plan for the same beneficiary, without incurring any tax penalties.
- Corporations and nonprofit groups are eligible to contribute to ESAs. Unlike individual contributors, corporations or nonprofit organizations are not subject to earning restrictions.
- Contributions can be made up to the April tax-filing deadline.
- It is permissible to claim either the American Opportunity Tax Credit or the Lifetime Learning Credit in the same year that you take a tax-free distribution from an ESA, provided the ESA distribution is not used for the same expenses for which the credit is claimed.
- In addition, distributions from ESAs may be used to fund the following qualified education expenses:
- Tuition and fees incurred by the beneficiary at any eligible educational institution, including qualified elementary and secondary schools (K-12), as well as qualified post-secondary educational institutions.
- The cost of books, supplies, and equipment, including uniforms, computers, and related technology peripherals (if the computer-related equipment and services are to be used by the beneficiary during any of the years he or she attends school).
- Room and board, if the beneficiary is enrolled at least half-time in an eligible educational institution. Room and board expenses are limited to one of the following: The school’s regular, posted room and board charges for students living on campus, or $2,500 for each year the student is living off campus, but not at home.
By expanding the definition of qualified educational expenses to include primary and secondary education expenses, as well as room and board, the Coverdell ESA is proving to be a welcome addition to the various tax-favored options for saving for educational expenses.
Note: Nonqualified distributions may be subject to an additional 10% federal tax penalty on earnings.
August 1, 2017
Many of us may perceive trusts as a complex subject better left to our attorney. However, a trust is simply a contract initiated by a grantor who agrees to transfer assets to a beneficiary, who then receives the assets as stipulated in the trust contract. A trustee, who may also be the grantor, manages the trust assets and ensures the stipulated terms of the trust are faithfully executed.
A trust is designed to help individuals manage a variety of family and tax-related estate planning concerns. Here are a few ways in which trusts can be used:
Revocable Living Trust. A revocable living trust is an estate planning trust that deeds property to an heir but allows the grantor to retain control over the property during his or her lifetime. Upon the grantor’s death, the property passes to the beneficiary, avoiding probate, which is the judicial process wherein a court appoints an executor to carry out the provisions of a will. While the revocable living trust does not provide tax savings for the grantor during his or her lifetime, the trust becomes ‘irrevocable’ upon death, and the beneficiary is then entitled to tax advantages.
Irrevocable Living Trust. An irrevocable living trust is an estate planning trust wherein the grantor does not retain control of assets or property. Through the transfer of assets or property into the trust, the grantor may be eligible for certain tax savings. An irrevocable living trust may also be used to avoid probate.
Irrevocable Life Insurance Trust (ILIT). An irrevocable life insurance trust is designed to provide tax savings through the ownership of a life insurance policy. Assets in the trust are generally not considered part of the grantor’s estate. ILITs may be funded or unfunded. With a funded ILIT, income-generating assets are transferred into the trust, and the generated income is then used to pay the premiums on the life insurance policy. With an unfunded ILIT, the grantor makes yearly gifts to the trust, and this money is then used to pay the premiums on the life insurance policy.
Credit Shelter Trust: A credit shelter trust, also called a bypass trust, is an estate planning tool used to protect assets from successive estate taxes. While current law permits an unlimited amount of assets and property to pass to a surviving spouse without being subject to Federal estate taxes, children and other beneficiaries must pay taxes for inheritances valued in excess of the applicable estate tax exclusion amount, which is $5.49 million per individual in 2017. If a married couple wishes to take advantage of a credit shelter trust, they generally arrange for certain assets to pass into the trust for the benefit of the surviving spouse, rather than passing all assets directly to the spouse. This trust, which would not be considered part of the surviving spouse’s estate—and generally does not exceed the applicable exclusion amount—may pay the surviving spouse income for life and then, upon his or her death, may pass to a beneficiary, such as a child, free of estate taxes if under the exclusion limit. In addition, the gross estate of the surviving spouse upon his or her death could pass to the same beneficiary, and up to $5.49 million in 2017 would be free of estate taxes.
Charitable Remainder Trust (CRT): A charitable remainder trust is an arrangement in which assets are donated to a charity but the grantor continues to use the property and/or receives income from it. A CRT may allow the grantor to avoid capital gains taxes on highly appreciated assets; receive an income stream based on the full, fair market value (FMV) of those assets; receive an immediate charitable deduction; and ultimately, benefit the charity of his or her choice.
Dynasty Trust: This trust is often used by individuals to pass wealth to their grandchildren free of generation-skipping transfer taxes.
A trust can be an effective way to accomplish your long-term estate planning goals, but often involve complicated tax laws. Consult with your tax and legal professionals about your particular situation and how a trust may enable you to share your wealth with family, friends, or charities.
July 12, 2017
Americans donate billions to charity annually. If you give to charity, you need to know about one of the best tools to facilitate generosity: Donor-Advised Funds (DAFs).
DAFs date from the 1930s but did not become popular until the 1990s. DAFs act as vehicles for receiving gifts, often of appreciated stock, and then distributing cash grants to charities selected by the one making the donation. DAFs make the process of transferring appreciated stock and designating checks as simple as a bank’s bill-paying system.
All DAF donors receive a tax deduction on the date of transfer. You can also transfer stock during one calendar year and receive a deduction even if the DAF completes distribution of grant money to a charity in a subsequent year. According to Internal Revenue Service rules, you calculate the value of your donation and the resulting fixed deduction based on the average of the high and the low market price on the day of transfer. (You are responsible for computing
After receipt, the stock you gifted is sold and the DAF, itself a charity, pays no tax on any capital gain realized. The proceeds may remain in cash or you may direct the DAF to invest those assets for potential further appreciation (usually in a professionally managed separate account). Any subsequent change in the value of the account does not change the amount you can deduct on
As the donor, you direct to which charities the DAF distributes assets. Officially, the DAF owns the assets and is not legally bound to use them as you direct, but it is exceedingly rare for a DAF to not follow the donor’s advice.
Most DAFs also maintain a database of 501(c)(3) tax-exempt charities (based on those organizations’ IRS 990 filing) from which you chose. After you suggest an amount to gift and a charity to receive the gift, the DAF vets and processes your suggestion to ensure the organization qualifies as a public charity under the IRS code. DAFs also handle all record keeping and due diligence and can protect your identity if you want to give anonymously.
Donor-advised funds are the fastest growing charitable giving vehicle in the United States, with more than 269,000 donor-advised accounts holding over $78 billion in assets. To put that in perspective, the Bill and Melinda Gates Foundation has about $39.6 billion in assets.
Besides consider a DAF, here are other ways to make your charitable giving more significant:
Focus your effort. Passionate giving is more sustainable than spreading donations to every good cause or everyone who asks. Consider focusing your donations to just a few charities. Think through why you are giving and what you feel passionate about.
Find bang for the buck. Fund programs that produce the greatest effect for the least money and focus on long-term positive outcomes.
Include the next generation. You can include your children in the giving process or even help them gift some of their own money.
Talk to Your Financial Advisor. If you’re considering a DAF or want to learn more, give Hiley Hunt Wealth Management a call so that we can walk through the process together.