Make sure your beneficiary designations are up to date and accurate.
- Check that the person or persons listed on all accounts that have beneficiary designations are the people you intend them to be.
- Make sure that the percentages given to these individuals are how you want them.
- Understand the type of designation you are making and what happens if one of your beneficiaries passes away before you do.
- Lastly, make sure that the beneficiaries on all of your accounts are coordinated properly with your wishes and other estate planning documentation.
This chart comes from the College for Financial Planning and provides a quick reference guide for those wondering if they need estate planning.
Ultimately everyone can use some degree of estate planning weather it is simple Wills and Powers of Attorney to more sophisticated Trust structures designed to avoid taxation and provide instruction on who gets what and how they receive it upon death.
|Client Situation||Primary Concern|
|Clients with minor children||Need to provide for the personal and financial care of the minors in the event both parents die prior to the minors’ attaining the age of majority|
|Clients owning assets in multiple states||Need to avoid ancillary probate so as to avoid increased administrative costs and estate shrinkage|
|Small-business owners||Interest younger family members in the business; assure marketability of the owner’s interest if the interest is to be sold at retirement or death|
|Clients who have sufficient wealth to leave a taxable estate at death||Ensure sufficient estate liquidity to pay taxes without having to sell estate assets|
|Clients who want specific assets (or a specific amount of assets) to pass to a specific beneficiary at death||Need to avoid intestate distribution when property is not disposed of by will or will substitute|
|Clients in high-risk occupations, such as a doctor||Need to protect personal assets from the claims of potential creditors|
|Clients who have non-U.S. citizen spouses||Need to provide for spouse’s financial well-being after client’s death, but keep estate taxes to a minimum; the marital deduction is available only in limited circumstances|
|Clients who may become disabled in the future||Need to appoint decision maker for medical and financial decisions; possibly qualify for Medicaid|
|Clients with domestic partners||Need to avoid intestate distribution when property is not disposed of by will or will substitute|
Roth IRAs have a specific advantage vs. Traditional IRAs when it comes to distributions.
For a Traditional IRA all distributions are deemed to consist of both contributions and earnings. This makes the entire distribution taxable becasue the contributions where made with pretax money.
Roth IRA potential distribution advantages over a Traditional IRA are based off of the order of distributions. There are three types of distributions that occur with Roth IRAs:
1) Return of Contributions: Principle is returned first, and there is no income tax or 10% penalty assessed on this portion.
2) Return of Conversion Amount: If there was a conversion of Traditional IRA money to a Roth IRA this money will not be subject to income tax, since it was taxed when converted. If the individual is under age 59 1/2 it will be subject to the 10% early withdrawal penalty if the funds have not been in the Roth IRA for at least 5 years from date of conversion.
3) Return of Earnings: Earnings come out last. They will not be taxed if it is a qualified distribution. Qualified Distribution is a distribution of money for an individual attaining 59 1/2 and the five year holding requirement has been met. If it is not a qualified distribution, then it will be subject to income tax and the 10% early withdrawal penalty for individuals under 59 1/2 years old.
Being able to distribute contributions first and avoid taxation is a big advantage of Roth IRAs.
Social Security offers three distinct types of benefits for retired workers and/or their spouses:
- Retired Worker benefit, which is based on his or her own earnings record.
- Spousal Benefit, which provides a worker’s spouse with a benefit once the worker has claimed his own benefit.
- Survivor Benefit, which provides a surviving spouse with a benefit after a worker’s death.
Taking time to get a complete understanding of a family’s total financial picture is key to developing strategies to effectively manage taxes. Taxes are inevitable and after tax returns are crucial to achieving wealth planning goals.
One strategy called Asset Location is a technique that can greatly enhance the amount of return that is kept and not paid out in taxes. Asset Location refers to how an investor distributes their investments over taxable accounts such as a Trust brokerage accounts, tax-deferred accounts such as IRA’s and 401ks, and tax-exempt accounts such as Roth IRA’s and Roth 401k’s. Allocating assets that pay the lower long term capital gains tax rates to your taxable accounts and allocating assets that pay higher income tax rates to tax deferred and tax exempt accounts allows investors to keep more of the return they make.
One simple example: An investor with $1 million in an IRA and $1 million in a Family Trust may have an asset allocation of 50% Equities and 50% Fixed Income. If currently both portfolios are situated with this allocation, shifting the assets that are taxed as ordinary income, 39.6% Federal rate, to the tax-deferred IRA and shifting assets that are taxed at the more favorable long term capital gains rates of up to 20% Federal to the taxable trust account could generate tax savings. The potential shift may be to move the taxable fixed income assets over to the retirement account and move the more tax favorable long term capital gains taxed assets, such as equities and ETFs intended to be held for longer than a year, to the taxable account. This will change the allocation percentages inside of each account; however with proper execution the overall 50% Equities, 50% Fixed Income allocation will remain constant in order to achieve the desired total investment allocation and risk profile.
Shifting assets in this way must be looked at and executed carefully. It may take time to implement in order to keep fees generated low and to minimize the unnecessary triggering of a realized tax liability.
In order for this type of strategy to work requires viewing all investment portfolios through one asset allocation strategy that all the accounts make up. Having the ability to get consolidated performance reporting for all of your accounts from your advisor no matter where they are held is important to monitoring the success of this strategy.
Cash as an asset is very comfortable for many people to own. It is an asset you can actually touch, feel and hold. Prudent financial and investment planning suggest that you should hold some cash, especially for emergency purposes. Often, 3 to 6 months and sometimes more depending on your personal situation is a good rule of thumb. There are some situations where holding more cash might be prudent. One example that comes to mind are people that have specific known medical conditions that require cash to cover the expenses of healthcare that insurance does not cover. Having cash often helps provide a sense of safety and a feeling of being able to sleep better at night. That is completely understandable!
I have found that the job of a professional advisor is to listen to a client’s needs and craft a plan that has the greatest chance of achieving those needs. I tell my clients that my job is not to tell you what makes you feel good but to advise you on what needs to be done to achieve those goals. That said let’s take a look at Cash as an asset and how potentially the good feeling of having lots of cash, “Cash Is King” may not be the best and potentially could be increasing your risk.
In order to understand that cash may not be king we must understand the effects of inflation on our buying power, and current and historical interest rates on cash. We will use CPI (Consumer Price Index) as the proxy for inflation and the 30 day treasury bill rate for the interest rate on cash, as is customary.
First: inflation as measured by CPI can be defined as a sustained increase in the general price we pay for goods and services over a period of time. We all know that the price of a loaf of bread has gone up since we first started eating it in our childhood. So we understand that things get more expensive over time. If we put money in our mattress when we were 3 years old to buy 10 loafs of bread at the price we would have paid for it then and took it out several years later we would likely not be able to buy as much bread. That can be what holding cash can do if no interest or rate of return is achieved on it.
Second: cash as an asset class is typically not stored in mattresses. More commonly it is stored in bank accounts and brokerage accounts. Rates of interest on cash have varied widely over the past 20 years and for quite some time have averaged 0% in most cases.
Let’s now assume that for a period of 5 years inflation averaged 2.5% and cash averaged 0% interest. Our simplistic real rate of return on that cash is not 0% it is negative 2.5%. Hence we have been losing money during that time and not even potentially realizing it because, well, we still have the same amount of dollars on hand so “I did not lose any of them.” That is factually correct that you have not lost any of the dollars you can count but you have lost on the amount of goods you can turn those dollars into.
Starting off in a position where you are in a negative return scenario right out of the box is a hard perspective for investors to grasp but that is exactly what has been happening for the majority of the last 5 years. Looks to me like holding cash is risky and potentially more risky than many know. This is at the core of why Financial Professionals after understanding a person’s current situation, future goals, feelings and family dynamics, as well as one’s understanding of risk and tolerance for it may need to recommend less cash as a percentage of portfolio holdings than someone may find comforting. We as professionals need to strike the best balance we possibly can in order to achieve those goals. Even if the goals are not exactly achievable, it is our duty to provide a plan that can make the money invested last as long as possible, to achieve as much of the goal as possible. Ultimately, however, investors comfort levels are important and should they decide that holding cash still feels best in light of what we just reviewed then "Maybe Cash Is King" for those investors.
For those of you who are technically and visually minded the following chart will illustrate this issue. It is a 20 year chart dated 03/18/1995 to 03/18/2015:
This chart illustrates the relationship between the inflation rate (measured by CPI) in the United States and interest rates on cash (measured by 3 month treasury rate). We have named the blue line US Inflation rate which is the monthly inflation rate measured by CPI. The Orange line is the cumulative growth of the consumer price index which illustrates the cumulative effect of inflation on goods and services. The Red line is the average monthly rates of return on a 90 day treasury bill, our proxy for interest rates on cash.
What we see is that although inflation rates and 90 day treasury bill rates diverge, cumulative inflation continues to increase, showing that our goods and services get more expensive over time and interest rates on cash do not always help us combat this phenomena. Furthermore, we can be in periods of time, which are multiple years in length, where cash interest rates are lagging behind the rate of inflation. This greatly reduces the effectiveness of our cash as a purchaser of goods and services. Also important to understand is that these negative divergences require us to spend more money on an item in times of low interest rates or negative real interest rates on cash, further hampering the ability for our money to grow when cash rates of return are higher. Why is this, it is because we have to spend more of the cash during these times and we have less of it saved for when rates are above inflation helping us actually grow our money.
Ultimately we must all be comfortable with our investment portfolios and cash is a major component of the mix of assets we own. Hopefully next time you here the phrase “Cash is King” you remember that maybe it truly isn’t as safe as you once thought.
Disclaimer: The Charts provided in this article was produced by Ycharts a third party provider of analytical data and charts. We believe that the information used to create this chart is accurate to the best of our knowledge however we cannot guarantee the accuracy of its content.
ETF's offer clients a great opportunity to put together a tax efficient asset allocation that is well diversified, lower cost, low conflict of interest, tactically tradeable and very liquid. Building a core asset allocation using ETF's can provide exposure to all the necessary portfolio constituents without high minimums. At Prominence Capital we use ETF's to generate core portfolios that strategically expose our clients to investments that meet their risk tolerance and investment objectives.
As an independent registered investment advisor, and independent business owner, Prominence Capital is able to make decisions on working with our clients that are not driven by a board room decision.
Recently the Wall Street Journal published an article on Bank of America Merrill Lynch and its corporate decision to push accounts under $250,000 out to a telephone service division. This will require brokers to try and do very creative house-holding tricks with client accounts to be able to get paid on them and keep them from going to a call center. Here is the link:
This is very important to people especially those who are younger, building wealth and want to have a direct relationship with an advisor. There has been a proliferation of Robo-Advisors and Large Brokers and Banks pushing out relationships that do not meet minimums. Robo-Advisors can be a good option for some investors. For those people who want continuous conversation and an experienced person seeing and feeling the emotions behind a face to face conversation Robo-Advisors may not the best place.
As independent registered investment advisor, Prominence Capital is not beholden to corporate decision making on how we can run our business. We make the decision to work with any client on a case by case basis where account size does not disqualify a potential business arrangement. Fee based only registered investment advisors, such as Prominence Capital, are not compensated by the products they sell (commission). We are paid directly by the investor. We do not push a firms proprietary products either. We are held to a fiduciary standard which is a higher standard than the suitability standard that most brokers at large firms are held to. Transparency of all fee's, disclosure of all conflicts of interest and putting our clients interest ahead of our own is what we are obligated to deliver. As a fee based only advisor, we charge a percentage on assets we manage, Prominence Capitals success in tied to the success our clients achieve with their investments.
To learn more visit us on the web at www.prominencecapital.com or call us at 310-433-5378
I often get asked questions about how much mortgage interest is deductible and what size loan to use when financing a home purchase. Also it is common to get into a discussion about if paying points to pay down interest make sense and if they are deductible.
While every situation is different with regard to mortgage size, and I am a fan of getting the largest mortgage that one can possibly afford in most cases but not all, I will tackle the deductible nature of interest and points here to clarify how it works.
Mortgage Interest: Interest paid on a qualified residence is limited to interest on the acquisition indebtedness secured by a principal or secondary residence up to a maximum debt level of $1,000,000, plus home equity indebtedness secured by a principal or secondary residence up to a maximum debt level of $100,000.
Points Paid: Points paid on a loan are really nothing more than prepayments of interest. Generally points must be capitalized and amortized over the life of the loan. However, the points incurred on a loan that is used to buy or improve a principal residence generally are deductible in the year the points are paid.
Points Paid on Refinance: These points must be deducted ratably over the life of the loan (amortized). If it is a second refinance the un-amortised (not deducted) points from the first refinance are deductible in full when the first refinance loan is paid off.
Choosing to pay down loan interest by paying points can help lower a payment to a level that is more affordable. Often I suggest that not doing so is the better decision. Buyers will have use of the funds used to pay the points and often through investment may be able to generate a better return on those funds than paying down the points would generate over time. However, doing so really is specific to the home purchasers own situation. In many cases, home purchases are as much an emotional decision as they are a financial decision and if paying down points to make a payment more affordable gets a buyer in the home they love and want that may in itself make paying points well worth it.