Financial Planning

The Tax Cuts and Job Act (TCJA) that was passed in 2017 contains a number of provisions that are scheduled to expire this year. 

So, given this incredible amount of uncertainty, what should you do?

“First, remember that changes in tax law are by no means permanent,” says Stefan Greenberg, Managing Partner at Lenox Advisors. “Even if income tax rates increase and the estate tax exemption remains the same, do we honestly believe that this will be the case ten years from now? Administrations come and go, and with them come changes that we can’t always anticipate.”

At the same time, however, some states impose an estate tax with exemptions that are not scheduled to change in the near future. Connecticut, for example, imposes a 12% tax on the amount of estates exceeding $13.61 million.

Clearly, it is critical that you remain aware of the rules to which you are subject and whether or not they are changing for better or worse. Either way, however, there are steps you can take in any environment to avoid surprises and achieve greater control over your tax situation: 

• Tax-Diversify Your Investment Portfolio
  Just as you allocate assets to a combination of stocks, bonds, cash and other investments, you may want to think about allocating assets among:
  • Taxable accounts that offer a wide range of investment choices, including stocks, bonds, mutual funds and real estate. They also require you to invest with after-tax dollars and pay taxes every year on any income you earn or capital gains you realize.
  • Tax-free accounts like Roth IRAs that provide you with the ability to invest with after-tax dollars but pay no income or capital gains tax on any withdrawals you make. Other tax-free vehicles include whole, universal or variable life insurance. In addition, municipal bonds offer income that is free from not only federal income tax, but state income tax, if they are issued in the state where you reside.
  • Tax-deferred accounts like a 401(k) plan or traditional IRA. These accounts offer tax-deferred growth but require you to pay tax on any withdrawals you make. What’s more, withdrawals are taxed as ordinary income.

To illustrate the effectiveness of a tax-diversified approach, let’s assume that you’re currently in the 35% tax bracket and that when you eventually retire, you’ll be in the 25% bracket. Let’s also assume that by then, you will have accumulated $2 million in your 401(k) or other tax-deferred account. After taxes, however, you find that your nest egg has shrunk to $1,500,000.

Still, you figure, that’s better than investing your assets in a brokerage or other non-tax-deferred account with after-tax dollars and a requirement that you pay taxes every year on income and/or capital gains.

What you may not realize, however, is that you have other choices.

For example, let’s once again imagine that you are retired and that your tax bracket is now 25%. You withdraw $250,000 from your 401(k) or other tax-deferred account and incur tax liability of $62,500, leaving you with $187,500.

Now imagine you did this instead:

• Withdraw $125,000 from your 401(k)or other tax-deferred account
• Sell $75,000 in stocks, mutual funds or other securities in your brokerage or other taxable account
• Withdraw $50,000 from your Roth IRA, whole life insurance policy or other source of tax-free income.

After taxes, your $125,000 401(k) withdrawal would have decreased to $93,750. Your $75,000 stock or mutual fund sale, however, would be taxed as a long-term capital gain at only 15%, leaving you with $63,750. Add in the $50,000 withdrawal you made from your Roth IRA or other source of tax-free income and you’d end up with $207,500. That’s $20,000 more than you would have been able to keep if you had withdrawn $250,000 from only your 401(k) or other tax-deferred account.

Clearly, it's not what you make. It’s what you keep. Tax diversification can make the difference between having choices in retirement or being forced to compromise your lifestyle.

1. Be tax-aware. Understand what tax bracket you’re in and how short and long-term capital gains are taxed
2. Determine whether your employer offers a Roth 401(k) that allows you to make contributions with after-tax dollars and make tax-free withdrawals at retirement. 
3. Consider converting any traditional IRAs to Roth IRAs and whether incurring tax liability now is worth the prospect of being able to make tax-free withdrawals at retirement 
4. Consider sources of tax-free income you might now have thought about. These might include whole life or other insurance policies that offer cash value, municipal bonds, and even 529 Plans and/or Health Savings Accounts. 
5. Finally, seek professional guidance before you make decisions you might regret later. Tax diversification can be complex and requires a thorough understanding of tax codes and your overall financial situation.

Given the possible reduction in the federal estate and gift tax exclusion described earlier, you might want to consider: 

Making Annual Outright Gifts

Instead of leaving a legacy that you will not be able to see your loved ones enjoy, consider making gifts to your heirs while you are still alive. Each person can gift up to $19,000 per year ($38,000 per married couples) to as many individuals as he or she wants without any gift or estate tax consequences. Gifting removes assets and the future appreciation of those assets from your estate. In addition, it may make sense to gift a highly appreciated asset to an individual who can sell it in a lower capital gains tax bracket. 

Incorporating Trusts in Your Estate Plan

Trusts are an integral component of many estate plans because they enable affluent clients to achieve such objectives as:

• Reducing estate tax 
• Ensuring that assets are managed effectively and distributed according to the trust creator’s wishes 
• Providing for family members who may lack the maturity, judgment of financial experience to manage substantial assets on their own 
• Protecting assets from such wealth eroders as lawsuits and divorce o 

Purchasing Permanent Life Insurance for Its Tax Diversification Benefits, as well as Protection Features

Life insurance is first and foremost about protection — helping loved ones carry on in the event of an untimely passing. But some types of permanent life insurance, such as whole life insurance, have tax-advantaged features that can complement retirement savings vehicles.

For example, permanent life insurance builds cash value over time. In the case of whole life insurance, the cash value grows at a rate guaranteed by the insurance company. Other types, like variable universal life insurance, can earn returns based on the performance of investment accounts. Additionally, some life insurance policies are eligible to receive dividends, which can add to the life insurance protection and cash value as well. In all these cases, cash value grows on a tax-deferred basis, which means the question of taxes doesn’t come up until the value is accessed. This protection, combined with accumulation and access features, make whole life insurance a useful option as a complement to an overall savings and investment strategy and provide for additional tax diversification of income sources.

Making a trust the owner of your permanent life insurance coverage

The death benefit paid by a life insurance policy is not subject to income tax. However, it is subject to estate tax which can erode it considerably. As a result, many individuals establish Irrevocable Life Insurance Trusts (ILITs) that are created for the sole purpose of owning and serving as beneficiary of a life insurance policy. By placing the policy in the trust, you remove it from your taxable estate. When death benefit proceeds are paid, they are paid to the trust and are not taxable to your estate. The result is a death benefit that is passed through the trust to your trust beneficiaries according to your instructions and unreduced by estate and income taxes.

One caveat: If estate tax rates are reduced, direct ownership of your policy may prove to be more advantageous. The premiums you pay are removed from your estate and you’ll be able to spend down assets in retirement with the assurance that your heirs will receive a meaningful death benefit, even after estate taxes are paid.

Taking Advantage of Estate Planning “Freebies”

What’s an estate panning freebie? It’s an action you can take to reduce your estate without using your lifetime exclusion. For example, you can pay a grandchild’s tuition by sending a check directly to his or her college or private school. Or you can help a family member meet medical expenses by sending a check directly to his or her healthcare provider.

The first few months of this year showed us what should be obvious – markets don’t go up indefinitely. Still, even volatile markets can provide opportunities. For example, tariffs are considered inflationary by many and a negative influence on stock prices, but it’s hard to know the actual impact of tariffs until we know exactly what they are and how long they will remain in place. Even during the on-again off-again period of tariffs that we experienced this year, however, there were some interesting results that prompted many perceptive investors to alter their strategies.

For example, the tariffs imposed by the US resulted in a weaker dollar. A weaker dollar resulted in greater profits for some international companies and stronger returns for their stocks. European defense companies, in particular, experienced increases in stock prices due to the prospect that European countries would have to place greater reliance on themselves for national security.

Should you allocate a greater percentage of your portfolio assets to international securities? That’s a question that you should discuss with your advisory team. In fact, it’s critical that you remain in close contact with your team during these uncertain times…and not just for issues concerning your portfolio. For example:

Analyzing Your Cash Flow

How much should you be spending versus how much should you be saving? How much will you need for retirement and how much should you be investing to fill any gaps between you and your goals? If retirement is imminent, which assets should you access for ongoing expenses and which should you leave invested? Other important questions to consider are:

• When should you begin taking Social Security payments?
• If you’re fortunate enough to be covered by a defined benefit pension plan, do you understand your options?
• What Medicare options offer the best combination of protection and affordability?
• What will happen if your sources of income dry up because of death or disability?
• What will happen if you or your spouse incur unexpected expenses that make it difficult or impossible to maintain your lifestyle?

Your team can provide you with a personalized financial plan that will help you answer these questions with greater accuracy and formulate sound strategies for managing risk and cash flow as you enter the next stage of your life.

Protecting Your Finances from Unforeseen Events

You may or may not have the need for life insurance that you did when your family was younger, but unforeseen events, if not planned for, can wreak havoc on your retirement plans and overall financial security.

Long-term care expenses, for example, can deplete the inheritance you hoped to leave your loved ones. That’s why so many retirees have made the purchase of long-term care insurance an integral component of their retirement plans. Many policies not only offer meaningful protection, but the flexibility to leave your loved ones a death benefit in the event you don’t require all your coverage for long-term care expenses.

Disability is another risk that is often overlooked, especially if you are self-employed, but even if you are covered by an employer’s group disability policy. It is important that you understand the specifics of your coverage and whether you and your family will be adequately protected in the event you require benefits:

• A short-term group disability income insurance plan replaces a portion of your income for a relatively brief period of time (3-12 months is fairly common).
• A long-term group income insurance disability plan will kick in when your group short-term plan coverage ends. The question is whether it will replace all the income you were earning or only a portion of it.
• Some group plans only pay benefits if you are unable to perform the duties of your current occupation, while others pay if you are unable to perform the duties of any occupation based on your education, training and experience.
• Highly compensated executives often find that their employer’s group disability income insurance plan does not cover bonuses, stock options or other compensation beyond a portion of their salary.

Clearly, it pays to consult with your plan administrator to determine exactly what your group long-term disability income insurance coverage does or does not provide. Armed with this knowledge, you can work with your advisory team to determine whether you should purchase your own disability policy, compare the coverages available, and select the combination of features that you believe will protect you and your family.

The fires, floods and tornados that have plagued many parts of our country have had a troublesome side effect on people who may not live anywhere near the affected areas.

Premiums for property and casualty insurance have gone up.

Before you renew your current coverage, consider comparing it to coverage offered by other providers. While you’re at it, consider the following fine points:

Does your policy offer named peril or all-risk protection?

Named peril specifies the conditions you are protected against, while all-risk protects your home against all damages except those listed in the policy. To protect yourself against these prohibited conditions, you may have to purchase a separate policy. Still, all- risk coverage may be well worth the additional cost over its named peril counterpart for the added protection it provides. 

Will you receive replacement cost or actual cash value for losses you incur?

Actual Cash Value coverage factors in depreciation when determining payment for your damaged or stolen property. As a result, you may not receive enough to replace that property with a new equivalent. Replacement Cost protection may exact a higher premium, but it will pay the actual cost of replacing your property with no depreciation adjustment 

Are you covered against floods?

Areas of the country that haven’t flooded in the past have been deluged in recent years. Flood insurance is offered by the National Flood Insurance Program, a division of FEMA. By purchasing a single peril policy in addition to your homeowners policy, you can protect yourself to a degree from flood damage to your home and its contents.

25 years ago, you could buy a load or no-load mutual fund that would provide you with a diversified portfolio of actively managed stocks or fixed income investments. Despite all the obvious benefits offered by this approach, you assumed risks of which you might not have been aware:

Duplication

Many funds owned the same stocks so that there might have been significant overlap among the funds you owned. As a result, you could have been overly concentrated in certain positions without realizing it. 

Phantom Income

Fund managers often sell profitable positions and generate gins that are passed through to investors. Gains are generally reinvested in additional shares of the fund but can pose a surprise at tax time because they are taxable at capital gains rates. 

Today, investors have a wide variety of additional choices: 

Separately Managed Accounts offer the professional management and diversification that are available with mutual funds but with a number of important differences. At Lenox Asset Management, the investment arm of Lenox Advisors, for example, we adopt a more personalized approach:

• Many of our clients are senior corporate executives whose wealth consists largely of their employer’s stock. We don’t believe it is prudent to take positions in shares of companies in the same industry that are subject to similar economic and market forces. 
• Nearly every client will require cash flow from their portfolio to fund retirement or other major expenses, and when reviewing their financial plan, asset allocation and periodic investment strategy they’re often left asking two questions that cut right to the core of their financial plan: 
  • Will their portfolio eventually grow to the value defined in their financial plan, or will market volatility erode the growth they’re planning for?
  • Even if they achieve the targeted asset base, could future inflation and lower bond yields erode its ability to fund their future lifestyle? 

Thankfully, ongoing industry developments have provided new tools that allow clients to address each of those concerns head on. Solutions like Registered Index-Linked Annuities (RILAs), an insurance-based vehicle that offers a degree of downside protection, as well as upside potential can protect the growth of one’s balance sheet, allowing clients still saving towards retirement to navigate periods of market volatility with greater assurance. For those nearing or already in retirement, options for securing one’s income stream now extend beyond the use of traditional fixed and deferred annuities, and include solutions like Fixed Indexed Annuities which can allow for guaranteed cash flow but also offer upside potential and the ability to increase one’s income stream under certain market conditions.

• Some investors are subject to SEC, FINRA or other government regulations. Employees of certain government agencies, for example, are not allowed to own individual stocks unless they grant full discretion to an investment manager and participate in a pooled investment vehicle. For other investors, however, the situation isn’t quite as clear. Some of our clients require pre-clearance from their employer’s Compliance Departments. We work closely with these professionals to establish ground rules for any investment strategy we formulate.

Clearly, all investors are not alike, and Lenox Asset Management recognizes what makes you different when developing your investment strategy. Clients often ask us to address such concerns as:

Tax Minimization

 If you are entrusting us with assets in an IRA or other tax-qualified account, taxes are not a concern. For non-qualified plan investors, however, taxes can erode returns by as much as 37% for short-term gains and 23.8% for long-term gains. As we discussed, Congress has been discussing policies that may raise these rates in the future.

At Lenox Asset Management, we employ a tax-conscious approach that is designed to reduce or even eliminate tax liability through a variety of techniques. Index funds and exchange-traded funds (ETFs), for example, enable you to track the performance of various market indexes without buying individual stocks or other securities. In addition, these investments don’t make taxable distributions of capital gains and generally impose lower fees than mutual funds.

Another important strategy of which you should be aware is Tax-Loss Harvesting. As its name implies, Tax Loss Harvesting involves

• Identifying losing positions in your portfolio 
• Deciding whether to sell those positions and harvest losses 
• Using losses to offset gains generated by the sale of other positions 

Some financial firms promote year-end tax planning every autumn. With just a few months left in the year, investors can identify positions with unrealized losses, sell those positions and realize losses that they can use for tax purposes. At Lenox Asset Management, however, we manage tax losses on a year-round basis so we can realize them as needed. By doing so, we can make our investment decisions solely on the basis of whether an individual investment is a viable candidate for future growth, not on whether selling it would trigger a taxable event.

ESG Investing 

ESG is an acronym that has become increasingly well known to investors in recent years. It stands for Environment, Social and Governance and represents an investment approach that focuses on companies seeking to create value by improving the environment, addressing social issues and/or promoting positive change within their organizations.

Lenox Asset Management offers a number of ways for clients to integrate ESG into their investment portfolios. Certainly, we can apply screens to our investment selection process to eliminate companies, sectors and industries that you do not want included in your portfolio. We can also take a more active approach and search for companies with ESG priorities. These may include:

• Companies on the cutting edge of technology that are developing electric cars, cleaner energy or sustainable food sources
• Companies engaged in important social action, providing underserved populations with access to healthcare and affordable housing
• Solid corporate citizens who place a priority on diversity in their workplace, employee satisfaction and safe workplaces

Hedging Strategies & Exchange Funds 

It’s not uncommon for our clients to have a single security they’ve held onto for some time, and even through recent volatility they find it remains at a considerable gain. What’s more, they may be hesitant to engage with their advisor on said position, anticipating the sole recommendation would be to:

“Sell and diversify, regardless the taxes.”

 …That isn’t the only strategy however.

Through cost effective hedging strategies (frequently a cashless collar) or something called an exchange fund, clients may have the ability to maintain their position and/or achieve diversification while deferring their tax liability. These are examples of complex strategies available through Lenox which may require a degree of client prequalification, but we’re a phone call away to discuss what options you may have available.