Blog Archives

Use Whole Life Insurance As a Hedge - Part B

9/30/2020

In last blogpost, we introduced whole life insurance as a perfect hedging tool. Whole life insurance is also perhaps one of the most tax-advantageous vehicles available.

Now we will list all the benefits of whole life insurance below -

Death benefits protection for your loved ones.
Cash value accumulation over time with a combination of guaranteed cash value growth and potential annual dividend payments.
Tax free policy loans
Guaranteed income tax free death benefit
Tax deferred cash value growth
Tax free withdrawals of basis
Protected from creditors
The risk due to the sequence of returns of a portfolio can be mitigated with whole life insurance.
Can be structured in a trust for minors and distributed later
Can serve as a dual-purpose asset for children (i.e. cash accumulation and death benefit)
Can be pledged as a collateral

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Use Whole Life Insurance As a Hedge - Part A

9/29/2020

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While we cannot control the ups and downs of the market, we can reduce the overall impact of market volatility by using other financial tools that with low or non-correlations with the market, and whole life is a a strong hedge tool to serve this need.

From an individual market perspective, the risk due to the sequence of returns against a portfolio can be the difference between leaving a legacy and running out of money in retirement.

If, during retirement, you are drawing down your investment portfolio through a market downturn, you are leaving fewer dollars to work when market rebound. Using a stable account to draw during market downturn can be of tremendous value. The same holds true during years of high run-ups in the market, quite often the year following a downturn. Withdrawal from the portfolio stunts growth.

If you are looking for a solution to mitigate potential rate hikes, political issues or global conflicts that may impact your portfolios today or in the future, a whole life insurance hedging strategy can help reduce risk and allow you to rest easier during stock market adjustments, large or small. Also, it can provide an attractive and steady stream of income regardless of market activity.

In next blogpost, we will discuss the specific benefits of a whole life insurance policy.

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Tax Strategies to Take Before November Election - What Not To Do and What to Consider

9/28/2020

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In our last blogpost, we shared ideas about what to do before the November election. Now what not to do.

Avoid “impetuous planning.”

Don’t freak out ahead of the election and implementing planning strategies that don’t make sense. It is easy enough to avoid a repeat of the giving mistake of 2012: Don’t give away more than you can afford. But a fear of increased income taxes by a new Congress could prompt people to change plans that still make sense.

One strategy to avoid is selling stocks and paying capital gains tax now, out of fear that the capital gains tax rate could go up next year. There is value in those unrealized capital gains, even if the prospect of the tax rate’s jumping to more than 40 percent from 20 percent is daunting.

Do not change investment plan based on what might happen. If it makes sense along a 10- or 15-year time period, then it’s fine - it all ties back to what is your long-term objective.

What to consider?

In life, having an acceptable hedge is always a bonus.

Roth I.R.A. conversions can fit in here. A good hedge would be to convert some portion now and more after the election. Another strategy would be to see how the public markets respond to the election. If stocks go down, complete the Roth conversion then; the lower market value will translate into a smaller tax bill.

There are risks. Income tax rates could actually fall, and you could end up paying a lot of taxes you don’t need to pay.

People looking to transfer money to heirs can make a loan to a trust now and then, depending on how the election goes, keep the loan in place or forgive it. If the loan is forgiven, that amount will count toward their gift exemption.

The ultimate flexibility for couples is to create trusts that move the money out of one spouse’s estate but maintain the other spouse’s access to it. Called spousal lifetime access trusts, they can act as a safeguard against changes to a tax strategy that could backfire.

One downside, though, is that your spouse could die or divorce you, shutting off your access to the money. The money will go to other beneficiaries named in the trust.

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Tax Strategies to Take Before November Election - What To Do

9/27/2020

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In unpredictable times, the desire to create a better tax strategy becomes more urgent, but that could result in some regrettable changes to perfectly good plans.

WHAT TO DO
The main criterion for committing to a new plan now is that it is something you would have done eventually. Adjustments should not be something that springs to mind out of fear of the November election.

One easy change is converting an individual retirement account to a Roth retirement account. The money in a traditional I.R.A. is taxed when it is taken out. With a Roth I.R.A., you pay the tax on the deposits, and the money grows tax free. But a conversion requires the tax to be paid now, which can be a hard check to write, even if the long-term gain is better.

There are ways to offset the tax owed by claiming a loss this year. People who own rental properties that have generated passive income, or revenue that requires little to no effort to earn, can depreciate the value of the property and use that to offset the tax owed on a Roth conversion.

Another simple change involves charitable giving. A provision in the CARES Act allows for 100 percent of charitable donations made in cash to be counted against your income this year. Normally, the deduction is capped at 50 percent of your income, with any amount more than that carried forward to subsequent years.

Giving to heirs before the end of the year also makes sense as a tax strategy. And as the exemption level goes up each year, you can consider topping the gift off annually.

In a tax overhaul passed by Republican lawmakers in 2017, the exemption on the estate tax was doubled to more than $23 million for a couple (with a 40 percent tax rate on any amount over that). But that benefit expires in 2025. One concern among wealthy taxpayers is that a Democratic sweep on Election Day could bring that date forward, lowering the exemption amount back to what it was in the Obama era and increasing tax rates to pay for the ballooning federal deficit.

Whether that will happen is hard to predict, so advisers are counseling clients to make big tax-free gifts now only if they were planning to do so anyway.

In next blogpost, we will discuss what not to do.

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A New Stock Exchange for Stocks for the Long Term

9/26/2020

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A new stock exchange has been open for business since early 2020 - the "Long Term Stock Exchange" (LTSE). It's a idea from Silicon Valley entrepreneur and founder of the ‘Lean Startup’ movement Eric Ries who is also the CEO of LTSE.

The new “Long Term Stock Exchange” (LTSE) was built around five core principles of staying long-term focused on strategy, stakeholders, compensation, boards, and investors. The rise of the LTSE comes as companies in general are becoming more wary of public markets and IPOs, from more and more companies staying private before they go public, recent direct listings from Spotify and Slack, and the rise of the Special Purpose Acquisition Vehicle (SPAC) that facilitates IPOs via a merger.

It will be interesting to see if LTSE could attract some interesting firms to list or dual list in it.

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Marijuana or Cannabis Use and Life Insurance - Part B

9/25/2020

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In last blogpost, we discussed considerations for marijuana/cannabis use in life insurance. Now we will discuss underwriting for its use.

The primary questions to be asked of a proposed insured that presents with marijuana use history are:

Is the use for recreational or medicinal purpose?
If for medical concerns, what is the underlying health condition?... and what is the severity?
What is the frequency of use?
How is it used?...smoked/inhaled or ingested? (some carriers treat this type of use differently)
Have there been any problems with law enforcement?...or Dr’s concern over use?
Any other drug use or alcohol concerns?

With many carriers, the underwriting of an applicant with marijuana use will often end up with Standard Smoker offers at best...but we do have some who look at this more aggressively. Depending on frequency and/or whether it’s for medicinal use, we still have a few that can rate at Standard Non-smoker or, occasionally, even at Preferred classes. Each individual case will be looked at based on its own characteristics. Please contact us if you need help.

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Marijuana or Cannabis Use and Life Insurance - Part A

9/24/2020

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An increasingly common impairment we’re getting requests for - and underwriting concerns with - is marijuana or cannabis use. The frequency of use has increased in today’s society, along with legalization in some states for recreational use. Many more have OK’d the use of marijuana for medicinal purposes. As a result, marijuana has become a frequent topic for underwriting discussion.

Regardless of your personal views on the subject, use of the drug is more prevalent than ever and we must address the issue when it arises during the life insurance application and underwriting process.

What Is Cannabis?
Cannabis is a natural psychoactive drug that comes from the flowers and leaves of the hemp/marijuana plant. Tetrahydrocannabinol (THC) is the primary ingredient in cannabis that causes euphoria and intoxication. Cannabis is most commonly smoked as a cigarette or in a pipe. It can also be taken orally, either by eating it directly or mixing it with food products.

Short-term memory, attention, motor skills reaction time, and skilled activities are impaired while the individual is intoxicated. Cannabis contains carcinogens, and evidence suggests that heavy use may be associated with oral cavity, pharynx, esophageal, and lung cancers. Because of those concerns, many carriers will assign smoker/tobacco use rates for any use.

Considerations
For underwriting consideration, the first thing we must determine is whether the use is recreational, or if the proposed insured has been issued a prescription for medical use. If for medicinal purposes, underwriting is going to be looking at the specific issue the marijuana is being used to treat.

Medical legalization is intended to provide beneficial treatment for those suffering debilitating symptoms. However, severity is subjective and open to interpretation. These uses may include severe pain, muscle spasms, severe arthritis, cancer or HIV-related symptoms, weight loss, nausea, glaucoma, and seizures from epilepsy. This highlights the need for full information considering not only potentially serious and uninsurable conditions, but also the high potential risk for misuse.

For recreational use, the underwriter is going to want to know the frequency of use. Classification of marijuana use can be any of the following:

Experimental or intermittent use, for those who have tried but no longer use or are using up to a couple of times a month or less
Moderate use, for those whose use is as frequent as 8-16 times monthly
Heavy use, for those whose use frequency is more than 4 times weekly, or daily use.

There is evidence that many cannabis users do not abuse other drugs. However, multiple drug and alcohol use can be encountered with cannabis use; when combined, it is more toxic than each drug alone.

In next blogpost, we will discuss underwriting for Marijuana/Cannabis Use.

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Annuity Wealth Transfer Strategy - Part II

9/23/2020

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In last blogpost, we introduced annuity wealth transfer strategy. Now we will discuss the details.

Annuity Wealth Transfer
The Annuity Wealth Transfer Strategy is appropriate for some individuals who are in or near retirement and do not believe they will need any of the money from the annuity for retirement income. For those individuals who wish to pass these assets to loved ones at their death, this concept may dramatically increase the benefits they can provide their loved ones through the purchase of life insurance.

First, determine the after-tax income available either through annual withdrawals from the deferred annuity or from transferring the deferred annuity to a Single Premium Immediate Annuity (SPIA) to ensure the premium dollars will be available for the life insurance premium pay-in period whether it is a lifetime premium or a limited pay premium. Once the after-tax income is determined, illustrations can be run to determine what the maximum death benefit would be and how best to fund, i.e. ten pay, lifetime pay, etc. Keep in mind the exceptions to avoiding the 10% penalty on early distributions prior to age 59½.

For individuals with taxable estates, an Irrevocable Life Insurance Trust (ILIT) should be used to hold the policy in order to avoid taxation of the death benefit. The Irrevocable Life Insurance Trust will keep the death benefit out of the insured’s estate thereby allowing all of the death benefit to be available for loved ones. An ILIT allows present interest gifts of $15,000 per beneficiary to the trust as of 2020. If there are insufficient beneficiaries to fund present interest gifts to the trust, the individual can use a portion of their $11,580,000 (2020) lifetime exclusion for gift tax purposes to fund or could also make private loans to the trust if that was more taxadvantaged.

The Annuity Wealth Transfer Strategy can help individuals who do not need income from deferred annuities and would rather use this unneeded asset to maximize what they are able to provide for loved ones. It can take an asset that may be heavily taxed at death and use the advantage of life insurance to dramatically increase what beneficiaries receive. However, if the client needs the money for their own retirement, this is not an appropriate strategy for that client.

The after-tax income from the annuity will fund a larger death benefit than one realized from just leaving the annuity alone and passing it to your loved ones at death.

What happens if the insured winds up needing the money for their own retirement in later years? All of the well-meaning plans can go awry if markets decline dramatically and there is not sufficient retirement income available from the life insurance policy cash value. If that event should occur, the insured can choose a paid-up policy or take loans to pay premiums on the policy. The income stream from the annuity used to purchase the life insurance policy can then be redirected to the insured to fund lifestyle shortfalls.

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Annuity Wealth Transfer Strategy - Part I

9/22/2020

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Below is an article from American National that discusses annuity wealth transfer strategy. It's a great strategy if you fit the situation it describes.

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There are several ways to help guide clients to a financially secure future through the sale of an annuity or life insurance policy. However, steering individuals to the right plan can be a difficult task without the right preparation. Check out this new series on product sales tactics to brush up on your skills and learn how you can enhance your clients’ portfolios!

Annuity Wealth Transfer Strategy
Deferred annuities are one of the best places to grow assets tax-deferred because the build-up is not taxable until distributed. Assets grow faster if they are not taxed annually and can compound free of taxes. Many of our clients purchased deferred annuities many years ago and the growth of the account has dramatically increased the value of these annuities.

For those individuals who will not need their deferred annuities for retirement income, there is a way to use these funds to provide a larger benefit for their families. Using distributions from the deferred annuity, the Annuity Wealth Transfer Strategy leverages up these distributions into a significantly larger death benefit upon the annuitant’s death.

Double Taxation Trap
While deferred annuities are a good place to grow money, there can be issues. The reason is that if you have a large estate you may pay taxes twice on the money. First, the entire annuity is taxable in the individual’s estate. Secondly, after a partial deduction for any estate taxes paid on the deferred annuity, the remaining gain in the annuity is taxed to the beneficiaries of the annuity, potentially leaving a fraction of the deferred annuity for heirs.

In next blogpost, we will discuss the annuity wealth transfer strategy.

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Presidential Election and Preparation of Tax Changes

9/21/2020

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To prepare for potential changes, you may want to consult with a tax advisor to assess your current situation and then decide if you need to change your long-term financial strategy. If you are concerned that tax rates will rise in the future, you may want to consider taking advantage of current rates in a variety of possible ways.

Review your tax return to assess how much of your income is subject to taxes. Looking at your taxable income (e.g., adjusted gross income minus deductions) will keep you better informed about potential impacts as new tax legislation occurs.
If you have investments in taxable accounts, you may want to assess your long-term investing plans and see if tax-loss harvesting makes sense for you.
If you are concerned about increases in your tax bracket as soon as next year, consider accelerating some income into 2020 to pay the tax on it in the current year.
If you are considering making a large charitable contribution, evaluate the timing of it in light of how the value of the potential tax deduction would change if future tax rates increase or if limits change on charitable deductions.
If you have concerns about your tax bracket increasing in retirement, it might be a good idea to consider shifting some of your tax-deferred savings now into a Roth IRA, which will have tax-free growth potential and will not be subject to required minimum distributions (RMDs), helping to lower your taxable income in the future.
If you are concerned about the estate tax exemption changing to a lower amount than the current $11.58 million per individual, look at your estate plan and see if you want to make any changes.

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Small Business Retirement Plan Q&As from American National

9/20/2020

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You own a small business, but you may not be aware of all the positives of adopting a plan or the options available to you. Read the Retirement Plan related Q&A provided by American National below so you could fully understand them before making your decision.

“Retirement plans are only for big corporations. My CPA said the only type of plan I can have is a SEP.”
Not so! Just about any kind of business can adopt a plan other than a SEP. We have set up all sorts of retirement plans for businesses having as few as only one employee.

“These plans are always so expensive.”
American National offers low-cost administration and handles all your plan needs in one place. Most plans are only $600 to set up and can cost as little as $420 for annual administration. They offer a variety of investment options depending on the plan and your objectives. You may qualify for a tax credit for setting up a plan and when you take into account the tax deduction you get for making plan contributions it may be costing you money by not having a plan!

“My income fluctuates from year to year. I don’t want to get locked into anything I can’t afford.”
Several plan designs allow for flexible funding from year to year. They can let you fund more in years when you need the deduction or less in years when you don’t (or can’t afford it). What does it hurt to look at the options available and make sure you aren’t missing out?

“I don’t want to make large contributions for my employees.”
Of course you can’t exclude your employees from a plan altogether but depending on your particular situation some plan design options can limit what must be given to employees. Some designs can skew contributions specifically to a particular group if you want to favor yourself or a group of key employees. We can look at the options for your situation and see what might work for you.

“These plans are too complicated and too much work.”
American National handles all of the plan set up and administration. They will explain everything to you about your plan so that you understand the benefits, the features, and your responsibilities. They are great at walking a client through the steps, answering any questions, and handling the complex details.

“I need to talk to my tax advisor/attorney about this. “
That is a good idea. American National actually encourages that your professional advisors be involved and they would be happy to get on the phone with us and answer any questions your advisor/accountant/attorney might have.

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How to Dodge a Nasty December Tax Surprise?

9/19/2020

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If you a person who plans ahead, you know waiting until year end to factor in portfolio volatility is risky business.

In this Financial-Planning.com article, it explains the need and how to prepare in order to dodge a nasty December tax surprise. Although it is an article for financial advisors, it is a good read for consumers who want to take charge of this matter themselves.

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3 Residual Choices for Income Protection Product

9/18/2020

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Everyone needs residual income protection. If you can work only part time, you will still need your full-time incomes.

This article below from Standard highlights the differences between the Basic and Enhanced Residual Disability riders to help you find the appropriate rider.

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Get More Out of Your Life Insurance Policy

9/17/2020

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Many people work a lifetime to accumulate assets to pave the way for a comfortable retirement and to leave an inheritance for their children. The last thing anyone wants is to see their hard-earned savings depleted to pay for long-term care services.

Long-term care services, however, can quickly erode a person's assets. The Help Preserve Your Client’s Estate flyer from Mutual of Omaha below discusses the need for long-term care services. It also includes a case study that examines the impact a life insurance policy with a long-term care rider can have on a consumer's estate using two contrasting scenarios.

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Who Are the Right People For Term Life With Living Benefits Riders

9/16/2020

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Q. What are the target people for term life with living benefit riders?

A. The ideal people for such term life policies are:

Age 40 and older. People in this age bracket are thinking about retirement and legacy planning and may be ready to obtain permanent life insurance.
Financially savvy. These people are looking to get ahead financially and may find the leverage, flexibility, and tax advantages of life insurance attractive.
Caring for parents AND children. These people understand the challenges of caregiving and don’t want to be a burden on their children.
Known to have a family history of illness. Those in this category know the challenges of chronic illness and how expensive it can be.
Small business owners. These individuals may plan to work well into their 70s. A chronic illness would derail those plans.

If you are interested in term life with free living benefits riders, or you currently have term life but without living benefits riders, please contact us, we will find you the most competitive product out there.

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How to Estimate Your Life Expectancy In a Customized Way

9/15/2020

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You can imagine that the time horizon of retirement is an absolutely essential input to determine what someone can safely spend in retirement and/or how much they need, so how do you estimate your life expectancy as accurate as possible?

It turns out that while in the aggregate we actually are pretty good at estimating life expectancy (i.e., ‘the wisdom of the crowds’ holds up quite well), at the individual level many people are drastically far off in their estimates, where some with health issues who predicted a ‘0% probability’ of surviving to age 75, and others with great health and thought they had a ‘100%’ chance really only have 80% odds.

Of course, the reality is that health conditions do vary, and as a result, the planned period of retirement should be personalized – both for individual preferences, and simply factual contextual data points like current health, smoking status, and even income (which is correlated to longevity) – which can easily result in one person having a life expectancy estimate that is 15+ years different from another (and in turn could change required savings to retire by 30%+!).

In practice, in most of financial planning tools, financial planners use a generic number such as 90 or 95 as someone's life expectancy,

Here is the good news - there are online tools available for you to use. The most popular option appears to be the site LivingTo100, which draws on data from the New England Centenarian Study to try to get a good picture of how likely it is for the client to live to age 100 and what his/her individualized life expectancy would be.

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4 Phases of Retirement Life

9/14/2020

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Historically, the classic definition of retirement was ‘life after work’. But as medical advances improve not just longevity and the age at which we die, but also our ‘productive’ years of an active lifestyle, the retirement phase itself is becoming longer, and a phase in which we are capable of doing more than simply ‘not working’.

In the article - 8,000 Days Of Retirement: An Entire Phase Of Your Life Waiting To Be Invented, author Coughlin suggests that the best way to think about retirement is as the fourth of a series of 8,000-day life segments.

The first 8,000 days – which is about 22 years – takes us from birth to adulthood, when we graduate college and become (hopefully!) productive adults.
The second 8,000 days takes us from college graduation to ‘midlife’ (age 44),
The next 8,000 days takes us from midlife to ‘retirement’ (at age 66).
And prompts the question: what do you want to do with those next/last 8,000 days?

The significance of framing this way – as 8,000 days – is that it’s a lot of days, and helps to emphasize to prospective retirees how much time they’ll really have… and how bored they may get without either a plan or at least a readiness for retirement itself to grow and evolve. After all, ‘play more golf’ may sound appealing as a retirement plan… but probably not if it’s going to be 8,000 days of golf! In fact, 8,000 days can actually be such a big retirement phase to tackle, that Coughlin suggests breaking it down further into four sub-phases:

the Honeymoon phase (what you do with the early active years of retirement, which might include more travel, more volunteer work, or even more ‘work’, as the labor force participation rate of those aged 65-74 is projected to hit 30% by 2026);
the Big Decision phase, as we transition into our 70s, when work really begins to fade from view, health may be less vibrant, but there’s an opportunity to make or renew social connections (e.g., grandparenting, volunteering, social hobbies), and the big question becomes, “Where will we live, and where will we go every day?”;
the Navigating Complexity phase, when health, unfortunately, deteriorates further, and health management itself can become a more full-time job with additional doctor’s appointments, medication management, and rising mobility challenges; and
the Solo journey phase, which sadly may entail the death of a spouse, or a fall or stroke that brings about a sudden and drastic change in needs and lifestyle… and thus requires making more of a plan about where Helping Hands (family, hired care, or otherwise) may come from.

Of course, not everyone will navigate the stages in the same manner and timeline, and some of them have sad challenges associated that may be tough to think about… yet ultimately, isn’t preparing for such situations what financial planning is really all about?

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How to Take Advantage of Negative Income - A Case Study

9/13/2020

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For people who have tax deductions that exceed their total income – in essence, having negative income – they can benefit from a 0% tax rate on Roth conversions or other ordinary income tax events (as increasing income from negative to zero still won’t owe any taxes on the additional income).

A Case Study

Blanche is a 60-year-old widow who lives in a fully-paid-off Florida home, living primarily off her husband’s Social Security survivor benefits of $24,000/year, plus $500/month that she generates via tax-free municipal bond interest from a $300,000 brokerage account (while she leaves her $300,000 IRA untouched until the RMD phase more than a decade from now).

For income tax purposes, Blanche’s Social Security benefits are not taxable (as her Social Security provisional income is 50% x $24,000 + $6,000 (bond interest) = $18,000, well below the $25,000 threshold that triggers taxation of Social Security.

As a result, Blanche’s total taxable income is $0 (as her $24,000 of Social Security benefits are not taxable, nor is the $6,000/year of municipal bond interest), which means with a $12,400 standard deduction, Blanche’s taxable income will actually be -$12,400!

Accordingly, Blanche decides to do a $10,600 partial Roth conversion, which increases her income by $12,400 (as it causes her Social Security provisional income to rise to $28,600, causing $1,800 of her Social Security benefits to become taxable). Still, though, Blanche’s actual tax liability is not increased, as her standard deduction of $12,400 is still enough to offset the $12,400 of additional income.

Thus Blanche is able to move $10,600 from her IRA to a Roth IRA at a tax rate of 0%.

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Income Tax Free Harvesting Case Study

9/12/2020

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Income harvesting strategies can be especially appealing in scenarios where the income itself can actually be harvested tax free (i.e., at a 0% tax rate).

For instance, those who are in the bottom two ordinary income tax brackets (i.e., the 10% and 12% brackets) are eligible for a 0% long-term capital gains rate on any capital gains (or qualified dividends) that also fall within those tax brackets (at least for federal tax purposes).

A Case Study

Rose and Charlie retired early at age 55, living off $50,000/year of Charlie’s insurance trails (as a former insurance agent), plus $1,000/month from the dividends generated by a $400,000 brokerage account (which include $70,000 of embedded capital gains from recent market growth), while they wait for their Social Security benefits to begin (and wait to tap Charlie’s $300,000 IRA).

With a standard deduction of $24,800 in 2020, the couple’s ordinary income (after deductions) is only $50,000 – $24,800 = $25,200, placing the couple at the bottom end of the 12% tax bracket (which in 2020 runs from $19,750 to $80,250 of income after deductions). In fact, even with the additional $12,000/year of dividends, the couple’s income would still be in the 12% tax bracket… which means their (assumed-to-be-qualified) dividends are eligible for a 0% tax rate.

Accordingly, the couple chooses to proactively sell the most appreciated investments (a $90,000 ETF with a $50,000 cost basis) in their brokerage account to cause a $40,000 long-term capital gain. That brings their total income up to $50,000 + $12,000 + 40,000 – $24,800 = $77,200.

Because their total income after deductions is still below the $80,250 upper threshold for the 12% tax bracket, they will enjoy a 0% federal tax rate on both the qualified dividends and the $40,000 of long-term capital gains.

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Why Defer Might Not Optimize Your Tax - A Case Study

9/11/2020

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For people who are not already in top tax brackets, deferring income too aggressively can cause future tax liabilities to increase by more than the discounting benefit of deferring them in the first place. In such scenarios, it’s often actually better to take advantage of lower current tax rates instead.

Dorothy is a 60-year-old widow who recently retired with $25,000/year in Social Security widow’s benefits and an inflation-adjusting survivorship pension of $45,000/year. In addition, she has a $300,000 brokerage account, and a $1.5M IRA. When Dorothy turns 72, and RMDs begin, her IRA is projected to be almost $3.4M. That will produce an RMD of almost $132,000… which, stacked on top of her inflation-adjusted pension and Social Security benefits (which will rise to almost $100,000/year at a 3% inflation rate) will drive Dorothy up into the 32% tax bracket, with more and more of her future RMDs taxed at 32% as the RMD obligation grows with age.

To manage the exposure, Dorothy decides to begin doing partial Roth conversions today of $90,000/year, all of which will be taxed in either her current 22% tax bracket or the 24% tax bracket. By repeating this process every year, Dorothy is able to substantially slow the growth of her pre-tax IRA to be ‘only’ $2.1M by age 72, which will result in an RMD of only $84,000… similar to her ongoing withdrawals during the interim years, and leaving her room to avoid ever being subjected to the 32% tax bracket in the future.

In essence, the value of income harvesting strategies is tax-rate arbitrage — the opportunity to shift income from higher-tax-rate years (in the future) to lower tax rate years (today). For income that was otherwise inevitably going to be recognized and taxable someday, triggering that income in lower tax rate years instead of higher tax rate years is effectively ‘free’ wealth creation (in that it doesn’t require taking on risk to generate the additional wealth, simply harvesting the available tax rates).

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When to Defer to Optimize Tax Harvesting?

9/10/2020

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Most financial advisors have a straightforward recommendation for managing and minimizing clients’ long-term tax liabilities: defer, defer, defer, avoid, avoid, avoid.

In the long run, it’s cheaper to defer those taxes and pay them with discounted future dollars. In the best of outcomes, the taxes can be avoided altogether.

Even so, there is such a thing as being too good at tax deferral. People who pay higher tax rates on higher income may see deferred tax bunching up in a manner that pushes their tax rates even higher.

And for those who are not already in top tax brackets, deferring income too aggressively can cause future tax liabilities to increase by more than the discounting benefit of deferring them in the first place. In such scenarios, it’s often actually better to take advantage of lower current tax rates instead.

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Reframing the Annuity Puzzle

9/9/2020

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Below is a flyer from AIG about how fixed annuities could be looked at using the consumption framework. It's a good read for anyone who is seriously thinking about retirement.

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Do Active Funds Do Better in Bear Markets?

9/8/2020

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One of the longstanding claims of those who advocate for active management is that it’s hard to beat the indices in a raging bull market (where the investors who are most rewarded are usually the ones who just throw caution to the wind and dial up the risk), but when the bear market comes, prudence and (active) risk management will be rewarded.

The recent pandemic volatility and March/April bear market sell-off provides a perfect situation to test this claim.

in its midyear installment of the Morningstar Active/Passive Barometer report, 51% of active funds that were around at the beginning of the year survived and outperformed their average index peer during the first half of the year… which means active funds were not categorically better than passive funds during the market volatility (though they were not worse, either).

Notably, though, there was some variability within fund categories, as only 48% of active U.S. stock funds beat their passive peers, but nearly 60% of foreign stock funds did, yet only 40% of active intermediate core, corporate, and high-yield bond funds managed to do so. On a longer-term 10-year basis – which includes the bull market of the 2010s and the bear market that started the 2020s – the results are generally worse, as even amongst lower-cost funds with only 19% of large-growth funds outperforming (and just 3% of high-cost funds in that category) and 36% of foreign large-stock funds outperforming (and only 19% of high-cost). Although 54% of low-cost emerging markets funds did outperform, along with 60% of low-cost global real estate, and 63% of low-cost high-yield. And ironically, the Morningstar research finds that on average, investors do tend to pick above-average (and lower-cost) fund managers than the rest, but often still end out underperforming passive peers simply because their timing of when they buy active managers is still not good.

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The New Definition of Accredited Investor by SEC

9/7/2020

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The SEC has issued new guidance on the Accredited Investor rules, expanding the Accredited Investor definitions to be based not only on income or net worth, but also on alternative measures of “financial sophistication”.

Specifically, the income and net worth thresholds – earning $200,000/year (or $300,000/year of combined income if married) for at least the last two years, or having a net worth of $1M outside the value of the primary residence – were not altered,

However, there is a new category - financial advisors holding either the Series 7, Series 65, or Series 82 (for offering private securities), will qualify as Accredited Investors, as will Registered Investment Advisers themselves.

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Free Financial Planning Tools from Schwab

9/6/2020

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Many people don't have access to financial planning, either due to failure to meet minimum balance requirements or fees are out of reach or because financial planning experience is just to overwhelming ... to solve this problem, Schwab has a free tool will generate customized financial plans for people in as little as 15 minutes, the offering has no minimum asset requirement.

The tool, dubbed Schwab Plan, will be similar to what professionals use, but streamlined for people wanting to start a plan on their own.

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The New Definition of Accredited Investor by SEC

Free Financial Planning Tools from Schwab

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