Withdrawals from an Estate and Tax Planning Perspective

Withdrawals from an Estate and Tax Planning Perspective

Families often ask us how best to fund their obligations or monthly cash flow from their various account types. When making this decision, it’s best to revisit your goals and consider the tax and estate planning implications.

Tax Perspective

Withdrawals from taxable and after-tax retirement accounts like a Roth IRA can be made tax-free, or by paying less tax than a withdrawal from a pre-tax retirement account taxed at your ordinary income tax rates. This leads to less tax owed now.

Inheritance Perspective

For a beneficiary, it’s most advantageous to inherit taxable and after-tax retirement accounts, such as a Roth IRA. Beneficiaries receive more after-tax dollars than if they inherited a pre-tax IRA because of the step-up in basis, which eliminates capital gains in the taxable account, and because withdrawals from the inherited Roth IRA are tax free. (more…)

Think Twice Before Moving Into Your Rental To Avoid Taxes

Think Twice Before Moving Into Your Rental To Avoid Taxes

Many families hold on to and rent out their former residences with the goal of moving back in the future. Some plan to move back into the rental full-time for at least two years prior to selling to take advantage of the gain exclusion of $500,000 ($250,000 if single), which can wipe out all or most of the gain on the property. This was allowed at one time, but that’s not quite the case anymore.

Depreciation Recapture

One of the benefits of having a rental is the ability to claim depreciation on the property, which allows you to offset rental income that would otherwise be taxed as ordinary income. The depreciation you take reduces your basis in the property, potentially resulting in more capital gains when you ultimately sell the property. If you sell the property for a gain, the amount up to the depreciation you took is taxed at the maximum recapture rate of 25%. Any remaining gains are taxed at the lower long-term capital gains rate.

When the Property Sells for a Loss

If you sell your home for a loss, whether it’s currently a rental or is now your primary residence, you aren’t subject to depreciation recapture or other gains taxes. Due to depreciation decreasing your cost basis in the property each year until it reaches zero, it’s more common that sales of former rental homes result in gains. (more…)

Not All CFPs Are Equal

Not All CFPs Are Equal

I recently met with a prospective client, looking to hire a financial planner. She saw a TV ad from the CFP Board about hiring a professional planner. She visited their website and realized she didn’t know how to differentiate between them all. She wanted to ensure that the planner would help her look at all aspects of her financial life, and she realized that just because someone was a CFP® it didn’t mean they all operated in the same fashion. Her search was proving to be more difficult than she had anticipated.

It’s true, not all CFP® professionals are created equal. This article discusses why you might want to seek out a CFP® and some common differences to help you in your search. It’s important to educate yourself on what financial planning really means and to ask a lot of questions before deciding who to hire.

When looking to hire a financial professional, one of the most desirable credentials is the Certified Financial Planner™, or CFP®, designation. The CFP® mark indicates the highest standard in financial planning because CFP® professionals must meet certain educational requirements, pass a lengthy examination and have at least 6,000 hours of work experience for the standard pathway to certification. They must also adhere to specific standards of ethics and practice as outlined by the CFP Board.

Sounds great, right? The problem is that many financial professionals who have the CFP® designation use it as a marketing tool. There’s been a big marketing push to hire those with a CFP® by the CFP Board, and consequently financial firms are encouraging more of their advisors to obtain the CFP®. While there’s an educational benefit to anyone with the CFP®, it doesn’t always carry over into the work they do for their clients. (more…)

Why We Now Incorporate Your Held-Away Accounts in Your Investment Plan

When creating and monitoring a retirement plan, and providing advice on how to best achieve your financial goals, we often run into a roadblock on implementation when a large portion of your wealth is tied up in an employer retirement plan. This isn’t to say that participating in your employer plan is a bad thing; it’s more an issue related to investment options, fees and how to best align that account with your overall investment plan. By incorporating your outside retirement plans into your overall allocation, we can now pick the best investment options available in your retirement plan and manage your wealth like it’s one portfolio, instead of viewing accounts separately.

The benefits of incorporating your outside retirement plan into your overall asset mix include the following.

  • Higher net-of-fee, risk-adjusted expected returns through:
    • Stronger small and value tilts
    • Greater diversification with more international exposure, larger exposure to specialized risk premiums (Reinsurance and Marketplace Lending) and reduction in concentrated stock positions
    • Closing the behavior gap (reduced performance chasing)
    • Lower expense ratios
    • Disciplined rebalancing
  • Increased tax efficiency and reduced trading costs
  • More comprehensive reporting of returns and portfolio history

We can enhance what we do for you by bringing your employer retirement plan onto our Merriman web portal. This allows us to monitor your total portfolio allocation on a daily basis. By using the best of what’s available in your retirement plan and augmenting it with the accounts Merriman manages, we can estimate a net-of-fee performance improvement annually that’s specific to your situation. In many cases, there may be just two to five funds utilized in your retirement plan.

If you have a taxable account, we can move the international holdings into it, so you may be able to deduct the foreign taxes that are withheld, and place the less tax-efficient investments, like REITs, Reinsurance and Marketplace Lending, in your IRAs.

We suggest speaking with your advisor about how to incorporate your employer retirement plans into your overall investment allocation.

Remaining Q&A from Breakfast with Paul Merriman

We recently hosted an event with Paul Merriman, which ended with a Q&A. There were so many great questions asked, we didn’t have time to respond to them all, but we hate to leave any question unanswered. Here are some of the questions we didn’t get to, with answers written by Merriman Advisor Michael Van Sant, and our Associate Advisor team.

question_markWhat factors should be considered in deciding if a couple has enough net worth to self-insure for long-term care?

There are a number of factors to consider in deciding whether to self-insure for long-term care:

Income streams and portfolio assets: Determine your income streams (including Social Security, pensions, and annuity distributions) and compare this value with your spending needs to maintain your desired lifestyle, plus the cost of long-term care. If a gap exists between income and needed funds, determine if your portfolio can be called upon to close the gap.

The most expensive long-term care facilities price out at an average of $300/day, with a typical stay in a nursing home lasting 3 years for a total of $328,500 per person. Taking the benefit of income streams into consideration, long-term care for a couple lasting 3 years would likely result in an out-of-pocket expense of $500,000. If your portfolio can handle that expense, it may be wise to self-insure. A general rule of thumb is that if a couple’s net worth is more than $2,000,000 they can likely afford to self-insure. Some people consider their home as part of their net worth when making this decision. Be sure to consider whether you are truly willing to sell your home and move if necessary. Many people envision receiving care in their homes and should not factor the value of their home into their net worth for these purposes.

Genworth offers useful tools and calculators to determine the costs of care in your area.

Bequest goals: Do you have a desire to leave your children an inheritance of a specific amount? Paying for long-term care out of pocket in the event you will need it could cause that desire to go unrealized. Purchasing long-term care insurance can provide for help in guaranteeing your heirs the inheritance you wish to leave them. Think of long-term care insurance as ensuring an inheritance floor for your survivors.

Sleep at night: Purchasing long-term care insurance, even if you could self-insure, can help you not to worry about the “what-ifs.”

Other care options: Who will care for you if you do not have coverage or the means to pay for long-term care? If your children are not close by or you can’t or don’t want to rely on them for care, long-term care insurance will provide for a caretaker.

Do you believe in the bucket strategy?

The bucket strategy is a financial planning concept that involves separating money into different buckets to achieve different goals. At a minimum there are two buckets. The first is for any expenses you are expecting in the next 2-3 years. The money in this bucket is always kept as cash or cash equivalent, with the belief that investing in the market is too risky and volatile in the short term. The second bucket is money you won’t need in the near term and is therefore invested in stocks and bonds. There can be multiple buckets and deeper planning involved, but this the basic description.

Back to the question, does Merriman believe in the bucket strategy? While we certainly weigh your short-term needs with your long-term goals, our strategy dives much deeper than the idea that everyone’s lives can fit into two buckets. We spend a lot of time up front covering all areas of your financial life to get a truly comprehensive understanding of your situation before we recommend an investment strategy. Only in this way can we ensure we are recommending an investment strategy designed to help you stay on track. We believe prudent asset allocation is the most powerful tool to align portfolios with client return objectives and risk tolerances. We also hold regularly scheduled reviews and make necessary adjustments to stay on track to meeting short and long-term goals.

What is the best investment to generate income and preserve principal?

At Merriman, we believe in a total return approach that is designed using academic research to achieve long-term growth. We do not use any specific investment to generate income. Rather, we use dividends, interest and appreciation to fund each client’s income needs.

We have two different core strategies (MarketWise and TrendWise) available for clients, and we build portfolios from those and other specialized securities, based on their risk tolerance

  • Our MarketWise portfolios, which are fully invested at all time, use low-cost mutual funds that are diversified among various asset classes.
  • TrendWise is an actively managed strategy that uses a trend-following discipline to limit downside potential.

When frequent withdrawals are needed from the portfolio, your advisor will help to preserve principal by being sensitive to costs associated with trading fees. If your advisor knows of an upcoming distribution, they will allow cash from dividends and interest to build up to reduce trading costs.
If you need to withdraw from the portfolio and there is not cash available, your advisor will use appreciation to trim from the asset class that is most overweight. This allows for a periodic rebalance to ensure your portfolio is in line with its target allocation. Using this approach, we are able to sell high while letting the underperforming investments recover.

How does Merriman add value to investment accounts?

Merriman adds value to the investment accounts in two ways:

First, we build our portfolios using an academic approach that is evidence-based. We recognize that markets are generally efficient and, through broad diversification and proper asset allocation, we create portfolios that meet each client’s risk tolerances and long-term objectives. The universe of investment products is very large and new products come out all the time; 95% percent of them are worthless, 5% of them are worth investigating, and 1% of them are actually worth investing in. Merriman’s research department culls through this vast and complex set of products to find those that will truly enhance investor returns and reduce their risk over the long-term. The average individual investor has neither the time, nor the expertise, nor the access to find the needles in the haystack. We provide portfolios that offer better value over the long run by combining carefully selected investments that have higher expected returns, like small companies and value companies, while including other assets classes that have a lower correlation to US equities, like reinsurance, international equities, global real estate, and peer-to-peer lending.

Second, as your Wealth Manager, we provide guidance and behavioral coaching through different market cycles. As an example, portfolios are regularly rebalanced to restore target allocations by trimming asset classes that have done well and adding to asset classes that have lagged – this is done with an objective perspective. This disciplined approach will help ensure your investments are still the right fit for your wealth management plan.

Is it reasonable to evaluate performance by comparing returns to appropriate index?

When evaluating performance, comparing returns to an appropriate index can be helpful, but an investor must also keep in mind the long-term goals of the portfolio. It should be stressed that comparing returns to an appropriate index is sometimes easier said than done. Typically, a well-diversified portfolio made up of many different asset classes will not compare accurately with some of the most commonly referenced indices – e.g. The Dow Jones Industrial Average, S&P 500 or the NASDAQ.

Your advisor should be able provide the most appropriate index that can be used for comparing returns. An investor should also be careful to recognize the long-term goals set forth when creating a portfolio. Often, short-term market volatility will not reflect the long-term objective of a portfolio, and typically comparisons made in the short run provide little to no help.

If Merriman can’t see the future or rely on past performance, how do you use research?

As stated in the question, past performance is unlikely to repeat exactly, and because of that, we’re not able to predict the future. However, over periods of time long enough to include multiple market cycles, there are trends that emerge with investing. By studying the past, research helps us identify strategies to improve client performance in the long run.

First, research helps create our asset allocations. History has shown that various asset classes (US stocks, international stocks, bonds, real estate, etc.) have rotated in and out of favor at different times. Research helps identify the correct amount to hold in each asset class to provide the greatest expected return for a given amount of risk.

Next, research helps identify appropriate times to rebalance portfolios. If a client’s appropriate portfolio is 50% stocks and 50% bonds, and stocks do very well over the next year, the client will have a portfolio with more risk than appropriate one year later. Research helps us identify how far the portfolio can drift from our original allocation before we need to rebalance and move back to the original allocation.

Third, research helps client performance by identifying the most tax-efficient ways to invest. There are some investments we only hold in taxable accounts, and some we only hold in tax-deferred accounts, like IRAs. We will also use Roth IRA conversions for some clients, and research helps us identify when that is appropriate and how much to convert.

While we believe that you can’t rely on past performance, as stated in the question, we use research to develop our best estimate for the expected return and volatility for a portfolio (such as a 50% stock portfolio that is rebalanced appropriately). These expected return and volatility numbers are used when we create a financial plan and help clients identify if they are on target for meeting their goals.

Finally, we rely on research to help identify the best investments to use when creating client portfolios, which takes us into our next question:

Do you still rely exclusively on Dimensional (DFA) funds?

Our research department looks at all investments to find the best options for our clients. We do use DFA for all of the stock and some of the bond holdings in our MarketWise portfolios, which make up about 80% of Merriman accounts. DFA has consistently proven to be the best option, and we use their funds much more than any other investment.

DFA’s funds are broadly diversified. Also, they don’t try to pick individual companies that are expected to outperform the market. However, because they are not index funds, they have some additional flexibility that helps to lower costs and increase returns.

DFA also relies on academic research to identify types of stocks that are likely to perform better over the long run – specifically value and small-cap stocks. DFA slightly overweights these stocks, and slightly underweights stocks with the opposite characteristics.

Our research department is constantly evaluating various investment options. For now, the combination of tilting toward small and value stocks, broad diversification without being tied to an index, and low fees have consistently made DFA the best option for many of our portfolios.

How Are Oil Prices Impacting Your Portfolio?

oil price volatility

As consumers, we love low oil prices for the savings we receive at the pump. As investors in energy companies, we love high oil prices for the earnings and dividends.

Over the past 18 months, we’ve seen oil prices fall precipitously from around $100 per barrel to below $40 per barrel as of year-end. Similarly, big oil players such as ExxonMobil, Chevron and BP have seen declines in their stock prices of 23%, 31%, and 41%, respectively. Is this a value investment opportunity? Could be. Can oil prices fall further? Possibly. However, why worry or attempt to time or choose specific sectors of the stock market to invest in like energy, technology or healthcare? Just like other market events, it would be difficult, if not impossible, to consistently predict drops like we’ve seen in oil, and to determine how long prices will stay this low.

Instead, let’s consider how the prolonged drop in oil prices and the corresponding decline in energy stocks play into the overall stock market indices. For the MSCI All Country World Index (ACWI), the energy component makes up just 6.1% of the overall index. Over that same 18-month period, the global energy sector fell in price by 43%, while the overall MSCI ACWI declined by just 7%. If you owned only a market index, which would remove company- and industry-specific risk from your portfolio, the decline would have been dampened. In fact, when oil prices drop, consumers use those savings from the gas pump to buy products and services that boost other parts of the economy. In addition, industries whose costs are heavily impacted by oil prices, such as airlines and transports, greatly benefit from this shift. This leveling effect provided by investing in various indices can more importantly help keep you from falling off course from reaching your financial goals.

As a result, we continue to believe in the long-term benefits of broad-based diversification provided by investing in indices across the globe.