Tapping Retirement Funds to Pay for College

Dear Garden State Trust Company:  

Should I withdraw or borrow from my 401(k) plan to help pay for my child’s college expenses?—PUZZLED ON FUNDING

Dear Puzzled: 

As a general rule, impairing your retirement savings to meet current spending needs is not a good idea, even for higher education expenses.  There are other sources of funds for education needs—in contrast, in retirement, when one is on a fixed income, borrowing to meet expenses is problematic. 

What you take out of your plan now can be hard to replace later.  It’s been estimated that it can take six to ten years to fully restore a retirement account that has been tapped to meet four years of college expenses.  In part, that’s because one misses out on the compounding of investment income during the period.  For longer time frames, the stock market has produced higher total returns than the interest rates on student loans.  The other part is that it can be hard to get back into the saving habit.

The better approach is to save for higher education early, separately from retirement savings, so as to put time on your side and minimize the need for loans when the college years arrive.

Do you have a question concerning wealth management or trusts? Send your inquiry to contact@gstrustco.com.

© 2017 M.A. Co.  All rights reserved.

Choosing a Trustee: Pro vs. Average Joe?

From the perspective of a trust officer, the benefits of a professional trustee are endless and obvious. Professional asset management, trust administration, and tax planning are the most commonly cited, but they don’t even scratch the surface in terms of the full job description. With such a wide array of services provided, we at Garden State Trust Company tend to hear only two recurring reasons against working with a professional trustee:

  • Fees for their services
  • Lack of familiarity between the family and the corporate trustee

Fees

Often times the first question asked by potential new clients is simple: “What are your fees?” An understandable question, as professional trustees do not work for free. Similar to an accountant, investment manager, or attorney, there is a cost in obtaining professional trustee services. However, as Einstein might say, “It’s all relative!” See below a more productive question that considers the alternative options.

Q: I’m fee conscious. How do the trustee costs compare between your company and my Uncle Joe?

A: Great question! First and foremost, Uncle Joe should be entitled to compensation for his services as a fiduciary, in addition to reimbursement for expenses incurred related to his duty as trustee. Is Uncle Joe an experienced investment manager? If not, he may be best suited to hire a professional investment manager (0.75%-1.5% annually). How about taxes? Has Uncle Joe been exposed to proper fiduciary accounting rules and regulations? Hiring an accountant is most certainly prudent (many accountants charge $500-$1,000 to file the annual 1041 fiduciary income tax return, in addition to their hourly rate for providing trust accounting services). What happens when Uncle Joe needs guidance as to the administration of trust? It would be wise for him to seek legal advice from a trust and estates attorney ($300-$500/hr rates)

Let’s do a cost comparison.  Keep in mind that individual trustees in New Jersey are generally entitled to a statutory fee/commission schedule for their services as trustee equal to 0.5% on the first $400,000 of assets, and 0.3% on amounts over $400,000. In addition, Uncle Joe would be entitled to 6% of any income generated from the trust assets. Conversely, professional trustees are instead (generally) entitled to their published schedule of fees.

$1M Trust Example Chart

As you can see in this example, even the most conservative estimated costs of hiring investment management services produce a higher total annual cost to the trust than the total fees of a professional trustee. Also, it should be noted GSTC’s cost for filing the annual 1041 tax return is significantly lower than the average cost for an individual seeking accounting services. Additionally, an individual, less-experienced individual trustee may need to seek legal guidance more frequently than a professional trustee when it comes to properly administering the trust document.

Family Familiarity

Q: I want an experienced trustee, but I also want someone who is close to my family. What do you suggest?

A: A common knock on professional trustees is their unfamiliarity of the specific dynamics of a particular family. A fair point during the first meeting, but this argument fizzles over time as the relationship develops. In these types of situations, we may recommend a co-trustee arrangement between a family member trustee and the professional trustee. The family member trustee is able to be the eyes and ears on the ground, and relay the news and needs of the beneficiary to the professional trustee on a regular basis. Meanwhile, the family benefits from having an objective, professional trustee available to handle the investment management, accounting, and daily administrative duties that otherwise might be burdensome or impractical for the family member trustee. Most importantly, should the individual trustee become incapacitated or pass away, the professional trustee is readily available to continue the administration of the trust for the family without interruption.

Serving as a trustee is an ongoing commitment and, for many individuals, an unfamiliar job in which they have had little to no experience. Aside from the fiduciary obligations, family dynamics can put individual trustees in difficult situations. The trustee may have a close relationship with a beneficiary who is making incessant requests for distributions that the trust creator would have never approved. This can potentially cause uncomfortable situations between trustee and beneficiary that both parties would prefer to avoid. A co-trustee arrangement with a professional trustee can help alleviate these types of issues. Let the professional trustee be the “bad guy” who is saying no to the constant requests for a Porsche from an 18-year-old trust beneficiary.

Q: What services do professional trustees provide?

A: A professional trustee takes on an extraordinary role. Held to a higher fiduciary standard than an individual trustee (family member, friend, e.g.), a corporate trustee holds a duty of care and loyalty to the beneficiaries. In addition to the duty to manage the assets, coordinate the tax preparation and filing, and administer the trust document properly, trustees are of service to the beneficiaries. Whether they’re planning and paying for higher education, coordinating the sale and purchase of a new residence, or simply arranging for the payment and installation of a new kitchen appliance, the roles of a trustee are endlessly defined. For many beneficiaries, their trusts are their main financial source and, as a result, trustees take on an enormous responsibility.

Garden State Trust Company possesses capabilities and expertise in the investment management, financial planning, and fiduciary administration areas. When one considers that all of these services are included in our annual fee, it pales in comparison to the cumulative, a la carte professional expenses hired by an individual, inexperienced trustee. Additionally, consider the fact that the trust responsibilities and liabilities fall on the shoulders of the trustee. Not only does the individual trustee need to take the time to seek out competent professionals to perform the necessary work, but they need to ensure the work is done correctly and in a timely fashion. This can involve many phone calls, emails, and meetings on an ongoing basis. Often times, individual trustees can only contribute part-time attention to their role as trustee. After all, they have jobs, children, parents, and all of life’s obligations to worry about each and every day.

Professional trustee fees can actually be a bargain when you compare them to the alternative expenses required by an inexperienced individual trustee. Individuals can benefit from partnering with experienced, professionals who efficiently and accurately perform all of the services required as a trustee. This partnership allows the family to preserve and grow their personal relationships while the professionals preserve and grow their wealth.

Living Trusts & Financial Privacy

Remember when “hidden treasure” resided in chests buried by pirates? Today’s precious assets may be invisible to the naked eye until retrieved from a hard drive.

Case in point, Pirate Latitudes, an adventure yarn set in Jamaica in the 1600s, found in computer files left by author Michael Crichton.

Although Crichton is best remembered for Jurassic Park and other techno-thrillers, in 1975 he wrote another historical adventure, The Great Train Robbery. HarperCollins published Pirate Latitudes in November 2009, more than a year after the author’s death.

Crichton died in 2008 of throat cancer. Five times married, he left a prenup and a living trust. Here is what is known at this date about the John Michael Crichton Trust:

It was a revocable living trust created in May 1998.

It has been amended three times.

That’s all.

We have no indication of the size of the trust or the identities of the beneficiaries.

Crichton’s will was filed with the probate court, but one lawyer observed: “The main significance of this probate is really to nominate who’s going to be in charge.  There are really no assets in this estate; it’s all in the trust.”

Among the many reasons for having a living trust, financial privacy is likely the one most important for celebrities such as Crichton.  However, there are more advantages to considered.

You remain in charge

When our clients place investable assets in flexible trusts, they give us their instructions in an attorney drawn trust agreement. Under the terms of that agreement, they retain the right to cancel the trust or change their instructions. Nothing’s tied up.

From a practical standpoint, then, our trust clients maintain exactly as much investment control as they wish, just like the clients who have their personal investment accounts or IRAs with us.

Typically, we provide professional management or guidance tailored to each trust client’s needs and preferences. 

Always, our role as trustee is to do exactly what our trust clients have instructed us to do. There’s no doubt whatsoever about who’s in control. If any client ceases to be satisfied with our services, he or she is perfectly free to terminate the trust or employ another trustee.

Put our experience to work for you and your family

If you would like to learn more about our personal trust services and how they might help you do more with your financial assets, we invite you to meet with us in person.

We look forward to discussing your goals and requirements.

© 2015 M.A. Co. All rights reserved.
Any developments occurring after January 1, 2015, are not reflected in this article.

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.

Home Office Deductions: The Easy Way & The Hard Way

Beginning in the 2013 tax year, the IRS gave taxpayers a choice when it comes to the home office deduction.  To avoid the necessity of detailed recordkeeping, a new “safe harbor” deduction was created for home offices.  The simplified deduction was set at $5 per square foot of the home office space, up to a limit of $1,500 (300 square feet).

The existence of the new safe harbor and relief from recordkeeping does not change the other requirements for taking the home office deduction.  The office must be used regularly and exclusively for business.  The office should either be the principal place of business or used for administrative or management activities when the taxpayer has no other office for handling those chores.  An office kept for the convenience of the employer, such as a salesman who lives away from company headquarters might have, also will qualify.

In many cases, the actual expenses for the home office will be greater than the safe harbor.  These may include, for example, a share of utilities and insurance costs. For example, the IRS reported that for the 2010 tax year, the average home office deduction was $2,600, so many people will find the safe harbor limit too low.  The taxpayer may choose the traditional route of actual expenses instead of the safe harbor. What’s more, that choice may be made for each tax year, without regard to the choices made in earlier years. Thus, the taxpayer may alternate between methods, choosing the one most favorable each year.

The somewhat harder way

With the traditional method of calculating the deduction, a proportionate depreciation deduction is permitted for the office space. The amount of the depreciation is recaptured and taxed as income when the house is later sold.  The safe harbor alternative does not generate depreciation recapture.

The deduction for the home office may not exceed the net income of the business.  If the business is showing a loss for the year, the loss may be carried forward when the traditional method of calculating the deduction is used.  However, the carryover is not permitted with the safe harbor approach. What’s more, any carryover loss created from the actual home office expense calculations may not be deducted in years in which the safe harbor is elected.

Although the simplified deduction was intended to make life easier for taxpayers, the reality is that many taxpayers will have to figure the deduction both ways to decide which is the better way to go.

The IRS reports that the number of taxpayers claiming the home office deduction has held steady over the last six years, at roughly 3.4 million.  The aggregate value of the deductions claimed has dipped, falling from nearly $11 billion in 2010 to $9.5 billion in 2014 (most recent available data).  Most of the reduction in deductions occurred in 2013 and 2014, suggesting that there was, in fact, a significant shift to the easier way of claiming the home office deduction. The IRS does not break out those figures.

© 2017 M.A. Co.  All rights reserved.

401(k) Protection Programs

Dear Garden State Trust Company:

When I retire in about a year, I’m expecting a six-figure distribution from my employer’s 401(k) plan.  The success of my retirement turns on what I do with this money, and I’m more than a little unsettled by the prospect.  What should I do to keep my all my options open?

—LOOKING AHEAD TO FINANCIAL INDEPENDENCE

Dear Looking: 

I have two words for you: IRA Rollover.  With this arrangement, you can continue the tax deferral that your 401(k) account has enjoyed so far.  Be sure that you use a “trustee-to-trustee” transfer of the funds to avoid the 20% tax withholding that otherwise would apply to your distribution.

Will your distribution include shares of stock in your employer?  If so, you should consider not rolling those shares over, but accept them for your taxable portfolio.  Income taxes on “net unrealized appreciation” in those securities may be deferred in this manner.  Your accountant can give you more details.

You’ll also need an investment plan for your retirement money.  When you undertake this, consider your taxable and tax-deferred funds as part of one large portfolio.  The plan that you or your investment advisors come up with needs to take all of your resources into account, as well as your retirement income needs.  You are wise to be looking into these questions a year before you retire.  We can help you with all of these questions if you wish.

Do you have a question concerning wealth management or trusts? Send your inquiry to contact@gstrustco.com.

© 2017 M.A. Co.  All rights reserved.

The Problem of Faithless Trustees

There’s been quite a bit of press coverage of “fiduciary duties” when it comes to professionals giving financial advice.  Bank trust departments and trust companies always have been held to the fiduciary standard, and are proud of it.  Unfortunately, there are some documented cases when individuals with such duties simply ignored them.

Special needs

Lawrence and Millicent Stream, a successful professional couple, had an autistic son, Larry.  Although Larry’s condition was not severe, his parents saved for a trust to provide for him for the rest of his life after they had died.  They accumulated about $2 million in that trust for Larry.

The trustee of Larry’s trust was Layton Perry. We don’t know how the couple knew Mr. Perry, why they chose him as trustee, and why they did not choose a bank trust department or trust company for this important job.  We do know that Perry was a disbarred lawyer.

Fortunately, Perry was not named Larry’s legal guardian.  That job fell to Carolyn Crepps, who had worked as a legal assistant.  She investigated Perry’s management of the trust, and she found that he and his wife had used the assets to buy new cars for themselves, had made mortgage payments on their own home, and had made many personal withdrawals from the trust with no documentation or explanation.  The $2 million fund had been reduced to $200,000.

Crepps asked the probate court to remove Perry as trustee, and he was removed.  The court ordered the sale of the Perrys’ cars and home, with the proceeds returned to the trust.  However, that did not bring the trust fund back to its full $2 million balance.

Larry Streams was not stupid, but he was much too trusting of other people.  As were his parents.

Old Money

James Stillman, onetime Chairman of the National City Bank of New York (which years later would be renamed Citibank), was very rich.  At his death in 1918, his fortune was estimated at $1.8 billion in today’s dollars.  His son Chauncey used a portion of that fortune to create a family retreat, which he named “Wethersfield.”  He purchased art, built a mansion suitable for displaying it, and installed gardens in the style of 17th-century Italy.  A family foundation was created to manage the family’s money and implement their philanthropy.

In 1998 the family foundation was worth $103 million.  Unfortunately, there were no family members on the board of trustees to provide proper oversight.  The trustees made grants to institutions that had nothing to do with the Wethersfield Estate, including their own alma maters, and the ex-president directed over $700,000 for his personal benefit.  By April 2015 the value of the foundation had shrunk to $31 million, after 14 straight years in which grants made by the foundation exceeded its revenue.

The heirs finally woke up and brought suit against the trustees, and eventually, they won a settlement of $4.4 million.  The trustees were replaced, and the board now includes family representation.  The legal settlement won’t be enough to save the Wethersfield Estate, so now the heirs have agreed to sell some of Chauncey’s art collection, including works by Degas and John Singer Sargent.  They are hoping to raise $12 million.

There is a saying: Rags to rags in three generations.  The saying is usually interpreted to mean that the first generation creates wealth; the second conserves it, and the third squanders it.  In this case, it was the untrustworthy managers who squandered the fortune, but the third generation did their part by failing to supervise their advisors properly.

© 2017 M.A. Co.  All rights reserved.

The Wrong IRA Beneficiary?

Sometimes mistakes in an estate plan can be repaired after death. Sometimes not.

Charles Sukenik executed his will on November 4, 2004. His estate was to be divided between his surviving spouse, Vivian, and the couple’s private foundation.  His revocable trust was restated at the same time, giving Vivian certain real property and the balance to the foundation.

Roughly five years later, in 2009, Charles designated Vivian as the beneficiary of his IRA, worth some $3.2 million. 

When Charles died in 2013, the heirs discovered that the estate plan was not very tax efficient. Vivian was looking at potential income taxes of $1.6 million on the IRA distributions.  She proposed to reform the estate plan, giving the IRA to the private foundation in exchange for other estate assets of equal value.  The charity was not opposed to the plan.  Being tax exempt, the new plan would make the income tax obligation that comes with an inherited IRA disappear.  Certainly, this approach would more effectively implement Charles’ testamentary intentions.

The Court couldn’t swallow this one, because “the reformation requested here is prompted by neither a drafting error nor a subsequent change in law. Several years after executing his will and trust, decedent himself thwarted the tax efficiency of his own estate plan by making [Vivian] the beneficiary of the IRA. There is nothing in the record indicating why, after executing these estate planning instruments, [Charles] chose to leave additional assets to his wife in this manner or why, in the four years before his death, he did not take steps to cure the unfavorable tax consequences of his choice of IRA beneficiary.”

The Court concluded that if reformation were allowed in these circumstances, the decision “would expand the reformation doctrine beyond recognition and would open the floodgates to reformation proceedings aimed at curing any and all kinds of inefficient tax planning.”

Did Charles have any understanding of the tax time bomb that he included in his estate plan?  It appears probable that he did not consult his attorney before designating his wife as his IRA beneficiary, which is an ordinary, everyday occurrence.  But he should have.

© 2017 M.A. Co.  All rights reserved.

More Trouble for Long-Term Care Insurers

More than 400,000 long-term-care insurance policies were sold in 1992, according to figures published by The Wall Street Journal.  These are the policies that help seniors cover the costs of nursing home stays at the end of life.  At least 400,000 additional policies were purchased each year in the subsequent ten years, peaking at about 750,000 in 2002.

Then sales collapsed, and never again reached the 400,000 level. Last year, reportedly only 105,000 such policies were sold.  What’s more, two Pennsylvania providers of long-term care insurance were on the verge of being liquidated in December.

The need for long-term-care insurance never has been greater.  What happened to the market?

Actuarial errors

A series of actuarial errors were made when long-term-care insurance was first introduced.  The most important of these was the “lapse rate,” the number of policies that will be terminated without ever paying a benefit. This occurs either because the insured stops paying premiums or the insured dies without making a claim.  The actuaries chose a fairly conservative lapse rate of 5%.  At that rate, if 1,000 policies were sold in year one, only 400 would be in force 20 years later.  As it turned out, the buyers of long-term-care insurance thought of their purchase primarily as an investment, not as insurance, and so the lapse experience was closer to 1%, which implies that 800 of every 1,000 policies still will be in force after 20 years.  That led to far higher payouts than projected.

When the unanticipated expenses started to pour in, insurance companies had to raise their rates.  However, in many cases, state insurance regulators would not approve the full amounts requested for existing policyholders.

Two more errors compounded the damage.  The first is that medical advances have lengthened life expectancies, which, in turn, increases the likelihood of making a claim on a long-term-care insurance policy. The second is that the actuaries generally assumed a 7% rate of return on the invested premiums on these policies.  That assumption was fine in the 1990s, but interest rates have been at historic lows since 2008.  When long-term-care policies are priced today, the projected rate of return on premiums is likely to be 2% to 3%, which drives premium costs still higher.

Getting coverage

If you already have a long-term-care policy, you probably want to hang on to it.  For the most part, those who have purchased these policies have profited from them.

New long-term-care policies still are available, although they are more expensive than in the past, and the terms may be less favorable than older policies.  Insurance companies are now using much more conservative actuarial assumptions.

Hybrid policies that combine life insurance with long-term-care coverage have emerged, and they have proved popular as well.

The poorest seniors may have the costs of their long-term care picked up by the government through Medicaid.  The wealthiest may be able to cover the costs without insurance—even though a year’s stay in a nursing home can easily run to $100,000 or more.

For everyone in the middle, planning is necessary. Despite the price increases, long-term-care insurance will prove an important part of that plan for many affluent families.

© 2017 M.A. Co.  All rights reserved.

Retirement Tax Trap

Dear Garden State Trust Company: 

My wife and I have been spending our winters in our Florida home for several years.  What steps do I have to take to change my residency to Florida, so I can stop paying income taxes in my home state?  —FLYING THE COOP

Dear Flying: 

This is a complicated problem, with some angles that you may have overlooked.

My friend Jerry and his wife, Liz, successfully became Florida residents.  About five years later, they decided to sell their lifelong home here.  They had paid $30,000 for it 35 years ago and were told that it now was worth $400,000.  They were excited by the prospective windfall.  Then their accountant gave them the bad news.

Because Jerry and Liz were now Florida residents, their northern home was no longer their principal residence.  Accordingly, the sale of that home would not be eligible for the exclusion from taxes on the capital gain for the sale of a principal residence (up to $500,000 for married couples).  The entire $370,000 profit would be taxed, and the bill might easily come to $100,000.

They immediately took the home off the market.

You should see a lawyer before taking the step of formally changing your residency.

Do you have a question concerning wealth management or trusts? Send your inquiry to contact@gstrustco.com.

(March 2017)

© 2017 M.A. Co.  All rights reserved.