Lavish Gifts and Sudden Wealth

Some call Valentine’s Day an excuse to spend money, and with over 15 billion dollars spent each year for the last five years, it’s not very hard to see why.

According to the National Retail Federation, the top five gifts that were planned last year were: candy, greeting cards, an evening out, flowers, and jewelry. While jewelry ranks last on that list of five in percentage of givers (19%), it ranks #1 in terms of dollars spent ($4.4 billion). Click here to see more details from their survey.

What might the affluent or very wealthy be buying? We can’t know for sure, but here’s something in each of the categories that might fit the bill:

Candy: High-priced chocolate. At www.toakchocolate.com, one might be able to have a chocolate experience like no other since they trace the lineage of their cocoa trees back 5300 years to the first that were ever domesticated. Starting at $270 for a 50 gram bar.

Greeting Cards: Sending a card could be sending a piece of art: At www.GildedAgeGreetings.com, you can do just that and order a artisan’s hand-crafted Valentines day card for your loved one. The cards have limited editions, and start at $395.

An Evening out: Elton John announced last month that he’s retiring after his final 2018-19 tour. Unfortunately none of the venues are in NJ, but one could take a sweetheart to hear Sir Elton sing “can you feel the love tonight” at Madison Square Garden in October. Ticket price at this writing was starting at $343 per ticket.

Flowers: How about real roses that will last from one Valentine’s Day to the next? Called the “Eternity DE Venus™ – Square”, these real roses will last a whole year without watering or maintenance. A small square starts at $299, has 16 roses, and can be purchased online here: https://www.venusetfleur.com

Jewelry: Though not a Valentine’s Day gift, Edward McLean and his bride Evalyn bought “The Star of the East” as a wedding present. It is a 94.8-carat diamond, which cost $11.9 million.

Speaking of huge diamonds, last month the fifth largest diamond in the world was discovered in Lesotho. Analysts’ project it could be worth over $40 million.

Not surprisingly, finding a huge diamond isn’t the most common source of sudden or new wealth. Lump sum distribution of retirement benefits, insurance settlements, inheritance, or the sale of a business or investment real estate can create large sums of money for talented people who may not have experience with wealth management.

We can provide that experience and explain whether a trust could be useful.

Special Needs Planning 101: Why you should act NOW

“In 2015, U.S. health care costs were $3.2 trillion. That makes health care one of the country’s largest industries, equaling to 17.8% of gross domestic product (GDP). In comparison, health care costs were $27.2 billion in 1960, just 5% of GDP.” 1

“Advocacy group Autism Speaks reports that the cost of caring for a person with autism can run an estimated $1.4 million over the course of their lifetime.” 2

Unfortunately, caregivers of special needs children and adults know all too well the financial and emotional challenges they face now, and often dread the idea of trying to plan for when they’re no longer around. But taking the time to properly plan ahead for a child’s care in the future will help to alleviate some of the stress being felt currently.

First and foremost, visit with an estate planning attorney with extensive experience in the field of special needs planning. These are experts in a complex and dynamic field, in which the rules are frequently changing. For loved ones who may be eligible for governmental assistance programs such as Medicaid or SSI, that eligibility could be lost if the child receives a lump sum from a lawsuit or inheritance( For example, 2018 Medicaid eligibility requires that an applicant own no more than $2,000 in countable assets). Therefore, if one is planning to leave a relatively large sum of money  to a child who may currently be or may eventually be eligible for these types of “means-tested” benefits, it’s critical that the family speak with an attorney about creating a third party Special Needs Trust (also referred to as a Supplemental Benefits Trust). If anyone is planning on making smaller, periodic lifetime gifts to the disabled child, ask the attorney about the benefits of an ABLE account. Both of these vehicles are designed to receive assets on behalf of the beneficiary, allow those assets to be made available for supplemental needs or qualified disability expenses, and yet still allow the beneficiary to retain eligibility for certain governmental benefits. (More detailed articles to follow on both vehicles)

Next, speak with your financial advisor and/or insurance professional. If you will be creating a third party SNT during your lifetime or under your wills, it’s critical to ensure that beneficiary designations for any qualified plan (401(k), IRA, pension, annuity, insurance policy, etc) are made payable to the third party SNT and not to the disabled child outright. Failure to do so could result in disastrous consequences such as causing the child to become ineligible for valuable governmental benefit programs. For example, in the state of New Jersey, the loss of Medicaid eligibility can simultaneously result in the loss of housing and other services provided through the Division of Developmental Disabilities (DDD).

You will also want to speak to your tax advisor regarding any special needs planning you undertake. They will be able to provide necessary advice regarding the tax laws surrounding the gifting or bequeathing of various assets to a loved one. If you haven’t already done so, introduce all of your trusted advisors to one another to ensure that everyone is up to speed with the latest planning taking place. Failing to inform an advisor of a loved one’s special needs and any plans currently in place/in progress could not only unravel the plan, but cause devastating consequences like the one previously cited.

Lastly, if a third party SNT is created, it’s extremely important to consider the use of a professional trustee to manage the trust on behalf of a loved one. While many individuals’ first thought is to name a family member or friend as trustee, there are almost always significant drawbacks to that decision. SNTs are extremely complex, and the laws governing them are frequently changing. Individual family member/friend trustees almost never have the necessary time, experience, expertise, objectivity or energy to devote to the role of trustee, and they may not be able to serve when their role is called upon (death, disability, too busy, moved away). In nearly all circumstances, the use of a professional trustee is the better choice. (See previous article comparing family member trustees and professional trustees).

In this age of rising health care costs, it becomes even more critical to plan NOW for the care of loved ones with special needs. Assembling a team of professionals ahead of time will ensure peace of mind for the family, as they will know that there is a proper plan in place to care for their loved one when they are no longer able to do so.

For more information regarding Special Needs planning, and the role a professional trustee can serve in that planning, contact Sean Rice, CTFA, srice@gstrustco.com, (856)-281-1300

1 https://www.thebalance.com/causes-of-rising-healthcare-costs-4064878
2 https://blog.mint.com/planning/the-cost-of-raising-a-special-needs-child-0713

Timing Your Passing

It’s never a “good year” to die; however, if you live in New Jersey and made it to 2018 with a sizable estate, it’s possible your estate’s tax exposure just fell considerably.

The amount exempt from the federal estate and gift tax had been scheduled to rise to $5.6 million so as to take into account inflation since 2011. With the tax legislation signed on December 22nd 2017, the exemption doubles, to $11.2 million in 2018. Should both partners of a married couple die in 2018, the exemption potentially could shield $22.4 million. However, the higher exemption expires in 2026.

Additionally, New Jersey finished phasing out its state estate tax completely for deaths after January 1st 2018. We still have an inheritance tax, so that’s something to consider depending on the relationship the beneficiary or transferee has to the decedent.  For the most part, no tax will be due if the beneficiary will be a spouse, parent, grandparent, or child (relationship defined as Class A). However, brothers, sisters, and more distant transferees may face an inheritance tax.

Click here for a chart of what the tax rates will be for 2018.

Click here to see which class someone would belong to.

Consider gifting

A program of tax-free annual gifts (up to $15,000 per beneficiary in 2018, $30,000 per couple) can be an easy and effective method for reducing future estate taxes. For example, grandparents with three children and seven grandchildren can give up to $300,000 to their descendants every year, or $1.5 million in just five years.

If the transferees or beneficiary are not as closely related, so that they would fall into class C, or class D, a gifting strategy could help avoid the New Jersey inheritance tax, but only if the gifts are not “death-bed gifts”. Under New Jersey law, any gift made within three years of death is presumed made “in contemplation of death”, and would have the inheritance tax applied as a death-bed gift. So this strategy should be started early on.

Should you worry?

It’s been estimated that perhaps only 1,000 estates nationwide will pay the federal estate tax in 2018. However, the higher exemption expires in 2026, and some politicians already have announced an intention to reduce the exemption should they come into power.

Estate plans will need to remain flexible as tax laws change.

The greatest reason to have an estate plan is still to decrease hardship for the beneficiaries, reduce arguments and fights, and clarify your preferences for how your property should be distributed.

Our Professionals at Garden State Trust Company

We have experience dealing with the problems and pitfalls of families’ wealth management and transfer. Our staff is sensitive to the types of issues that could arise, and would be glad to speak with you about how to best achieve your goals.

Click here to schedule a meeting.

End of Year Review

As we are nearing year-end it makes a lot of sense to review your current Will, especially if any of the following occurred during 2017 –

  • A named beneficiary died
  • A possible beneficiary was born
  • A named beneficiary divorced
  • A named beneficiary is very sick or has a drug dependency
  • You are moving or moved to a different state
  • The value of your assets changed significantly

These are just a few events that should prompt a review of your Will and your Estate Plan.

The professionals at Garden State Trust Company will be happy to meet to review your Will and Estate Plan at no obligation to you.

http://www.gstrustco.com/boomers—beyond.html

Vacation Homes

The last recession took a toll on the value of vacation homes. The National Association of Realtors reports that, from the end of 2007 through 2012, when primary homes were dropping in value by 14.8%, the value of vacation properties fell by 23%. The good news is that prices have come back strongly. The median price of a vacation home rose 28% in 2015 and another 4.2% in 2016, reaching $200,000.

The main reason for owning a vacation home is—or should be—for rest and relaxation. The vacation home also may serve as a “tryout” for a destination for retirement living. In some cases, it may become the home one retires to.

But vacation homes have investment and tax angles to consider as well.

Rental income from the property may help cover some of the expenses of maintenance and improvement. If the property is rented for 14 or fewer days, the income is tax free. Rentals for longer periods may be offset with income tax deductions for mortgage interest, property taxes, insurance premiums, utilities, and other expenses, but the biggest tax benefits are available only to owners who use the property for 14 or fewer days during the year.

When It’s Time To Sell

The $250,000 exclusion from capital gains ($500,000 for married couples filing jointly) for the sale of a principal residence does not apply to the sale of a vacation home. At one time, it was possible to get around this rule by selling one’s principal residence and moving into the vacation home, living in it as the principal residence for at least two years. At that point a new exclusion would become available. This strategy was curtailed, beginning in 2009. Now the exclusion is not available for the portion of your ownership attributable to vacation home use.

Example. You bought a $1 million vacation property in 2010. In 2017 you sold your primary residence to begin living in the vacation home. Now assume that you decide to sell that home in 2020, after living in it for three years, when it is worth $1.5 million. That period is 30% of your total ownership, so only 30% of your gain of $500,000 ($150,000) is excludable from income. The same dollar limit of $250,000 also applies.

Query: Did the adoption of this tax rule in 2009 contribute to the decline in the value of vacation homes around that time? No one can say with certainty.

Estate Planning

The issue of capital gains taxes evaporates if ownership of the vacation home continues until the death of the owner. At that moment the tax basis of the property steps up to fair market value, so there would be no capital gain on a sale soon after.

If there is an intention to keep the vacation home in the family, a Qualified Personal Residence Trust (QPRT) should be considered. One can think of this as a major gift scheduled for a future date. The home is placed in a special trust that lasts for a specific number of years. The homeowner retains the right to live in the home for the full duration of the trust, and the children (or other beneficiaries) receive the home when the trust terminates.

The home transferred to a QPRT must be a personal residence, but it does not have to be a primary residence. Vacation homes and associated property, for example, are eligible for this estate planning strategy. And the trust may include other structures on the property if they are suitable for a personal residence, taking into account the neighborhood and the size of the house.

A gift tax return will be required when the home is placed in the QPRT.

However, the value of the gift will be discounted to reflect the delay until the gift takes effect. The discount can be very substantial, and it is a function of the current market interest rates as well as how many years will elapse before the gift takes effect.

For the strategy to succeed, the owner must survive to the end of the trust term. But if the owner dies during the trust term, the estate is in no worse position than if the QPRT had not been undertaken.

© 2017 M.A. Co. All rights reserved.

IRAs for Charity

Charitable giving in the U.S. rose 2.7% last year, reaching an all-time record of $390.05 billion. That’s also a record in inflation-adjusted dollars, reports the Giving USA Foundation in its annual report on philanthropy. Individuals, foundations, and corporations contributed to the robust growth in philanthropy, while bequests were projected to have declined by 9.0%. Some 72% of charitable gifts come from individuals—an average of $2,240 per U.S. household.

Religious organizations are the largest beneficiaries of charitable giving, receiving 32% of the total gifts. Education comes in a distant second, at 15%, followed by human services with 12%.

The charitable IRA rollover

One reason for the growth in giving may be the growth in assets. As the stock markets touch new highs, people can afford to be more generous. Another factor might be that as top marginal tax rates have increased, the value of charitable deductions for top taxpayers has grown as well.

A popular charitable giving tax break has been made permanent, one that has been dubbed the “charitable IRA rollover.” Those who are over age 70½ may want to consider the gift of a direct distribution from their IRAs. Up to $100,000 may be transferred to charity in this manner. Couples may transfer up to $200,000 if each partner has an IRA. In contrast to normal IRA distributions, amounts transferred directly to charity won’t be included in ordinary income (and so no charitable deduction is appropriate).

The definition of who is permitted to take advantage of this tax strategy dovetails perfectly with those who are required to take required minimum distributions (RMDs) from their IRAs. So some taxpayers simply opt to direct their required minimum IRA distributions to charity, because the distribution requirement will be satisfied, even though the amounts distributed aren’t included in taxable income.

Extra tax advantages

In some sense, the income tax exclusion for a transfer to charity from an IRA might not seem like such a big deal. After all, one always has been allowed to follow an IRA withdrawal by a charitable contribution and claim an income tax deduction. However, the full benefit of that deduction is not available to all taxpayers.

  • Nonitemizers. There are a great many taxpayers who do not itemize their deductions, even in the upper tax brackets.
  • Big donors. Percentage limits on the charitable deduction mean that some donors can’t take a full charitable deduction in the year that they make a gift.
  • Social Security recipients. An increase in taxable income may cause an increase in the tax on Social Security benefits for some taxpayers. The direct gift from an IRA avoids this problem.

Accordingly, if you are 70 ½, you should consider a charitable gift from your IRA if:

  • You do not itemize tax deductions;
  • Your charitable deductions have been maximized; or
  • You do not need the additional income made necessary by your required minimum distribution.

As welcome as this tax planning opportunity is, every taxpayer’s situation is unique. See your tax advisor before taking any action.

© 2017 M.A. Co. All rights reserved.

The IRS Opens a Facebook Page. Yours.

Two law professors at Washington State University have warned that the IRS has turned to data mining of social media in their enforcement efforts [Houser and Sanders, “The Use of Big Data Analytics by the IRS: Efficient Solutions or the End of Privacy as We Know It?”, 19 Vand. J. Ent. & Tech. L. 817 (2017), http://www.jetlaw.org/wp-content/uploads/2017/04/Houser-Sanders_Final.pdf]. The demise of the Taxpayer Compliance Measurement Program left a data gap that needs to be filled, and social media may provide part of the solution.

The professors warn of the dangers of abuse of secret data collection systems. Taxpayers may have an expectation of privacy when they are online, but this is an error. Anything that may be seen by the public may be seen by the IRS. The Service then pairs this information with its own databases in a process of data analytics. “For the IRS, data analytics is not trying to predict the future behavior of taxpayers, but predicting data that it does not have; that is, predicting whether tax returns are compliant with the tax law.” Given the data breaches that the IRS itself has experienced, as well as questionable IRS targeting practices of recent years, the concerns raised by the professors seem warranted.

Don’t publish anything on social media that would make you uncomfortable if you saw it on the front page of The New York Times.

© 2017 M.A. Co. All rights reserved.

Who Owns Mutual Funds?

There are an estimated 94 million mutual fund investors in the U.S., reports the Investment Company Institute in its 2017 Investment Company Fact Book. Those investors represent 54.9 million households, or roughly 43.6% of all U.S. households. That level of mutual fund ownership has held steady during this century.

43.6% of U.S. households own mutual funds

Year% households
19805.70%
198514.70%
199025.10%
199528.70%
200045.70%
200544.40%
201045.30%
201543.00%
201643.60%

Source: 2017 Investment Company Fact Book

The explosive growth in mutual fund ownership after 1980 may be attributable to the advent of 401(k) plans. Indeed, for 67% of households their first mutual fund purchase was through an employer-sponsored retirement plan. Some 37% of those who own mutual funds own them only inside such plans. Mutual funds owned in IRAs, which first became widely available in 1981, may also account for this spectacular growth.

As one might expect, as household income rises, the odds of finding mutual fund investors rises also. Some 80% of U.S. households with income over $100,000 are mutual fund owners. Still, mutual funds are certainly not just for the very affluent. 17% of mutual fund-owning households reported income of less than $50,000. The median income of households owning mutual funds was $94,300.

Why invest in mutual funds? According to the survey, which permitted multiple answers to the question, 92% are saving for retirement, 46% hold mutual funds to reduce taxable income, 46% are saving for emergencies, and 22% use mutual funds to save for education. For 64% of these savers, more than half of their financial assets are mutual funds.

U.S. mutual funds grew to $16.3 trillion in 2016. Domestic and international equity funds compose 52% of the total industry assets, bond funds 22%, money market funds 17%, and hybrid funds 8%.

© 2017 M.A. Co. All rights reserved.

Could “Stretch IRAs” Be Killed?

Under current law, when an heir inherits a Roth IRA or an IRA from someone who has not yet begun receiving minimum distributions, he or she must make a choice. The money must be distributed either within five years or over the heir’s lifetime. For lifelong distributions, the heir will need to withdraw a minimum amount each year based upon IRS life expectancy tables. This strategy is referred to by estate planners as a “stretch IRA.”

For a young heir, such as a child or grandchild, stretching payments over a lifetime, maximizing the period of tax deferral or tax freedom, can make an enormous difference in the total value of this financial resource. That’s because in the early years the required minimum distributions are likely to be less than the growth in the value of the account, which allows for additional tax-free or tax-deferred accumulations.

Writing in Trust & Estates magazine (June 2017), James Lange explores the alternatives for a 46-year-old heir who inherits a $1 million traditional IRA. Assuming a 7% rate of return, if the child takes only the minimum distributions for life the account will peak at about $2.7 million at age 76, and it will be worth $2.5 million at age 82. On the other hand, if the account is fully distributed within five years and subjected to ordinary income taxes, and the proceeds are placed in a taxable portfolio, the same pattern of withdrawals will exhaust the account at age 82.

Too Good to Last?

Lange’s article is titled “The Latest Developments in the Death of the Stretch IRA.” There hasn’t been much press attention to the issue, but last year the Senate Finance Committee voted unanimously for the Retirement Enhancement and Savings Act of 2016. One critical “enhancement” was the elimination of the vast majority of stretch IRAs in the future.

Under the bill, nearly everyone will have to abide by the five-year rule for inherited IRAs and lump sum death benefits from qualified retirement plans. There are exceptions for surviving spouses and disabled dependents, for whom lifelong distributions would be permitted. If a beneficiary is a minor, the five-year distribution rule would not kick in until he or she reaches the age of majority. There are also exceptions for charities, charitable remainder trusts, and beneficiaries who were born within 10 years of the account owner.

Nothing Can Be Simple

The bill also carves out the first $450,000 in IRA assets from the application of the five-year rule. Therefore, a new wrinkle will be added to estate planning.

In estates in which combined IRA balances are less than $450,000, no change of plans will be needed (assuming that the exclusion isn’t changed in final legislation). Estates with larger IRAs may need to be reviewed and new plans devised, if the new rules are adopted.

Prospects

Lange makes much of the fact that, given the unanimous vote, the elimination of the stretch IRA has bipartisan support. On the other hand, the bill died last year, and it has not be reintroduced as of this writing. Will there be tax reform this year? One of the difficulties of developing a consensus for a tax reform bill is the need to “pay for” tax cuts with other tax increases, so as to stem the revenue loss. The stretch IRA is a low-hanging fruit that looks ripe for harvest by eliminating it. The Joint Committee on Taxation scored the provision as raising $3.8 billion over the next ten years. But if tax reform bogs down, and gets pushed into 2018 (at this moment, the most likely outcome), the stretch IRA remains safe for another year or so.

©2017 M.A. Co. All rights reserved.

Emotional Investing

We like to think that since the advent of modern portfolio management practices, investing in stocks and bonds has become a cerebral, analytical process with no room for emotion. The truth is that most investors, even institutional investors, are buffeted by emotional turbulence from time to time, and that truth is reflected in the volatility of the financial markets.

But if a little emotionalism when it comes to investments is unavoidable, too much emotion can be hazardous to your wealth. Here are four symptoms of problem emotions, financial behavior that is inconsistent with sound investment practice.

Fear of loss. Investors are generally motivated by fear or by greed. Behavioral scientists have learned that, for many people, the pain of loss is larger than the sense of satisfaction from a gain of the same size. Similarly, some investors will accept larger risks in order to avoid a loss than they will in seeking a gain.

Taken to an extreme, fear of loss leads to investment paralysis. An excessively risk-averse investor may park funds in ultra-safe, low-yielding bank deposits or short-term Treasury securities until a decision is made, accepting long periods of low returns. Or winning investments may be sold off too quickly in an attempt to lock in gains, while losing investments manage to stay in the portfolio indefinitely.

Following the herd. It’s difficult to be a contrarian, to find value that everyone else has overlooked. Many people find it easier to go with the crowd, to own the current hot stock or hot mutual fund. At least that way, if the investment does poorly, one has plenty of fellow sufferers with whom to commiserate.

But when “crowd” is defined as one’s family and friends, the crowd’s investment goals may be very different from one’s own.

Hair-trigger reflexes. Markets move on news. In many cases, the first market response is an overreaction, either to the up side or to the down. Sometimes “news” is only new to the general public, and it’s already been reflected in the share price through trading by those with greater knowledge. The true importance of any news event can only be discerned over the longer-term.

Generally, it’s better to watch the market react to news than to be a part of the reaction. Remember that market dips may present the best buying opportunities but they’re also the toughest times, emotionally, for making a commitment to an investment.

Betting only on winners. Some 85% of the new money going into domestic equity mutual funds goes to funds with MorningStar ratings of four or five stars, according to one estimate. This may be one reason that the government requires this disclosure for investment products: Past performance is no guarantee of future results. The disclosure is required because it is true. High returns are usually accompanied by high risks; ultimately, those risks may undermine performance.

Abnormal returns, whether they are high or low, tend to return to the average in the long run. Investing on the basis of the very highest recent returns runs a significant risk of getting in at the top of the price cycle, with a strong chance for disappointment.

THE ALTERNATIVE APPROACH

To avoid impulsive decisions that may be tainted with emotion, one needs an investment plan. The best way to moderate the impact of stock and bond volatility in difficult markets is to own some of each. Assets do not move up down in lockstep. When stocks rise, bonds may fall. Or at other times, bonds also may rise when stocks do. The movements of each asset class can be mathematically correlated to the movements of the other classes. Portfolio optimization involves the application of these relationships to the investor’s holdings.

Expected returns need to be linked to the investor’s time horizon. Longer time horizons give the investor more time to recover from bad years, more chances to be in the market for good years.

©2017 M.A. Co. All rights reserved.