The first six months of 2020 have brought about a lot of uncertainty for most Americans. Individuals have been worried about their health and jobs while employers have been concerned about demand for their products and services, as well as the financial well-being of their companies. All the while, health- care providers and government officials have been ex- hausting all of the resources they have at their disposal to keep us safe and do what they can to allow for the economy to survive.
As a result of the uncertainty (and people hav- ing more time on their hands than they know what to do with it), many individuals have been inclined to act. Whether it’s a matter of finally taking another look (or a first look) at their long-term goals and ob- jectives, or eventually sitting down with an advisor to address a shortcoming, individuals and families are seemingly motivated to act. And so are their advisors. I recently spoke with Whitney Maxson, an estate plan- ning attorney with Katz Teller here in Cincinnati, about some of the opportunities we’re seeing with our wealth management and estate planning clients. Excerpts of our conversation are below.
CB: Have you noticed a shift in your clients’ demean- or as a result of everything that has transpired thus far in 2020? Is it easier to get them to the table, so to speak, for conversations that need to be had?
WM: It seems, not surprisingly, that people are now much more in touch with their own mortality. The COVID-19 pandemic has created personal uncertain- ty and financial stress for many individuals. While they always knew that estate planning was something they should do, the time, effort and expense may have kept it low on the priority list.
With newfound time on their hands due to living in quarantine, a news cycle that constantly reminds them of the preciousness of life, and seemingly incessant market volatility, it has, frankly, taken very little on my part to motivate. My clients are engaged and eager to make decisions and implement. The peace of mind of- fered by having an estate plan in place is perhaps now more important than ever, and may be one of the few things that you can have control over these days.
In addition, the focus of the conversations has shift- ed. My clients are incredibly concerned with having in place the appropriate health care directives, and tru- ly understanding their meaning and application. What used to be a bit glossed over is now at the forefront of the planning process.
WM: Are you seeing any glaring planning opportu- nities with your clients right now?
CB: We are, and they’re not just investment orient- ed. The government put in place a number of initiatives to stimulate the economy and lessen the impact of the virus on individuals and their retirement savings. One of the efforts geared towards individuals entailed the elimination of required minimum distributions (RMDs) in 2020. For many individuals, RMDs are a necessary evil as the government requires individuals who are now (since the recently enacted SECURE Act) older than 72 to withdraw money from their pre-tax retirement ac- counts, regardless of whether or not the distributions are needed. This reality results in many individuals and couples having a decent amount of taxable income in their 70s and 80s, most of which may be entirely un- avoidable.
Well, this year a lot of this income is avoidable because the government granted everyone an RMD hiatus. So, for the individuals or couples whose in- come is typically made up of mostly RMDs, it pres- ents a planning opportunity that may very well not present itself for the rest of their lifetimes. And that’s because a couple whose income without an RMD is relatively low might have the opportunity to convert a significant amount of their IRA to a Roth IRA with- out having to pay more tax than they would in a typ- ical year. For older individuals who plan on passing along a sizeable amount of their wealth to their chil- dren, this could be even more impactful considering their children (who might be in a relatively high tax bracket) will eventually inherit a Roth IRA whose dis- tributions will not be taxed.
CB: Are there any estate planning strategies that are particularly attractive right now considering in- terest rates and/or some asset values are so low?
WM: Indeed, it is a sensible time to engage in estate planning, not only because the pandemic has shown the importance of personal planning, but be- cause reduced asset values and historically low in- terest rates enhance the ability to engage in tax-ef- ficient wealth transfers. Grantor Retained Annuity Trusts (“GRATs”) are one such option, providing an effective, low-risk mechanism to transfer future ap- preciation to your heirs with no transfer tax implica- tions.
How does a GRAT work? You transfer assets, which may be marketable securities or an interest in a closely held business, to the GRAT and retain the right to receive from the GRAT annual annuity pay- ments. The total value of the retained annuity pay- ments is determined by reference to an interest rate set monthly by the IRS known as the “7520 rate” and the annuity is typically set at an amount that, when discounted by the 7520 rate, equals the value of as- sets transferred to the GRAT. Because you retain the full value of the transferred assets, little or no gift is being made for gift tax purposes to the GRAT re- mainder beneficiaries. At the end of the GRAT term, assuming you survive, any remaining trust assets (e.g., the appreciation) passes on to the remainder beneficiaries, free of gift or estate tax.
Why is now such an opportune time to create GRATs? For the GRAT to transfer appreciation, the actual rate of return on the assets transferred to the GRAT must exceed the 7520 rate as of the date the GRAT is created. The more the rate of return exceeds the 7520 rate, the more appreciation is transferred to remainder beneficiaries. The 7520 rate is 0.6% for July, its lowest point ever. Couple the historically low rates with the potential recovery of the stock market, and you have the perfect beneficial opportunity.
WM: How are your clients handling the volatility we’ve encountered thus far in 2020?
CB: Somewhat surprisingly, they’ve been more understanding and patient than I would have expect- ed. A lot of our clients are still in the midst of adding to their accounts, as opposed to drawing on them during retirement, so many of them have looked at the instability as an opportunity to “buy low.” For the individuals who are reliant upon their accounts for in- come, most (if not all) of them have exposure to fixed income. They’ve been able to generate cash from the investments within their portfolio that haven’t been nearly as impacted by the volatility as other parts of their portfolio (namely, stocks), some of which might have been down more than 30% in late March. Most portfolios for retirees will likely have at least 3-5 years of exposure to conservative investments that can be turned into cash in the event selling equities is unde- sirable.
CB: Do any charitable strategies work nicely in this environment for individuals who would like to support their favorite organizations at a time when vulnerable populations are especially in need?
WM: I am blessed to work with a number of char- itably minded clients, many of whom are stepping up now to support their favorite causes. My job is to help facilitate that giving in a way that meets their philanthropic goals while providing them with the most tax-advantaged mechanism possible. One op- tion that works particularly well in a low interest rate environment is a charitable lead trust (CLT). A similar technique to GRATs for those with charitable interests, a charitable lead trust works like this: you make a con- tribution to the trust; fixed annuity payments from the trust are disbursed to the selected charity for a term of years; at the end of the term, the remaining assets are distributed to your heirs. Just like GRATs, any re- maining trust assets after the annuity payments to charity pass to your heirs at reduced (potentially zero) gift tax cost.
Anyone considering a significant gift to chari- ty should consult with their tax and estate planning advisors to compare the benefits of various options for charitable giving and determine the best vehicle and strategy for your situation. You may want to ad- ditionally communicate your philanthropic goals and intentions, including your use of one these charitable giving vehicles, to your family.
Individuals and families are clearly making the most of the extra time they have right now to engage with their advisors. We encourage you to do the same with the idea of identifying matters that ought to be addressed, as well as opportunities that can be taken advantage of considering the environment we’re in right now.
Chris Brennan, CFP®, with MAI Capital Management, can be reached at 513.579.9400 or by email at chris.brennan@mai.capital.
Whitney Maxson, Esq., with Katz Teller, can be reached at 513.977.3462 or by email at wmaxson@ katzteller.com.
Disclosures:
MAI Capital Management, LLC (MAI) is a privately held independent investment advisor registered with the Securities and Exchange Commission and head- quartered in Cleveland, Ohio with regional offices in Columbus and Cincinnati, Ohio as well as offices in Cal- ifornia, Florida, New Hampshire, New York and Virginia. MAI’s Cincinnati office is located at 625 Eden Park Drive, Suite 310, Cincinnati, OH 45202. For more information, call 513.579.9400 or visit www.mai.capital. The opinions and analyses expressed herein are subject to change at any time. Any suggestions contained herein are gener- al, and do not take into account an individual’s or enti- ty’s specific circumstances or applicable governing law, which may vary from jurisdiction to jurisdiction and be subject to change. Distribution hereof does not con- stitute legal, tax, accounting, investment or other pro- fessional advice. Recipients should consult their pro- fessional advisors prior to acting on the information set forth herein. In accordance with certain Treasury Regu- lations, we inform you that any federal tax conclusions set forth in this communication, were not intended or written to be used, and cannot be used by any taxpayer, for the purposes of avoiding penalties that may be im- posed by the Internal Revenue Service.