Recent volatility has reminded us that markets do not always go up and sometimes can change rather dramatically and quickly.
During tumultuous times, it is human nature to experience fear and anxiety as the markets fluctuate.
So what could you be discussing with your advisors at this time? We believe it is important to take a goals-based approach when working with our clients. We follow a process that frames out both your short- and long-term goals, taking your risk appetite into consideration. We then apply a methodology primarily focused on implementing strategies across your balance sheet to help increase the probability of your achieving success, with success defined as having enough money to meet your lifetime goals.
With that in mind, the focus now should be on your goals. We think it is important to ask: “Have my goals changed?” If the answer is no, then it’s likely the plan you developed with your advisor is still appropriate. The plan we developed with you generally considers the long term and includes projections through the end of your life. Although our plans include stress testing for market volatility, now could be a good time to meet with your team to review your plan together.
As you revisit your plan with your tax, legal, and financial advisors, you may be able to take advantage of some opportunistic strategies. In other words, “When given lemons – make lemonade!” When asset values are depressed and interest rates are low, there are many planning tools that could be deployed, which, under the right circumstances, can produce benefits for your family. Below are some ideas regarding those planning techniques for you to consider with your advisors.
With the Setting Every Community Up for Retirement Enhancement (SECURE) Act compressing the payout from traditional individual retirement accounts (IRAs), now may be the time to consider converting to Roth IRAs. Although a Roth conversion will create a current tax liability, future appreciation would be excluded from income taxation. While asset values are significantly depressed, consider converting some, or all, of a traditional IRA to a Roth IRA, since the tax bite will be much smaller.
Remember, we think this solution makes the most sense if you can pay the tax out of non-IRA assets.
Grantor-Retained Annuity Trusts (GRATs)
The GRAT could be another helpful tool, especially during these volatile times. Assets transferred to a zeroed-out GRAT need only appreciate over the IRS Section 7520 rate (for April 2020, 1.2%) throughout the term of the GRAT to pass wealth to the next generation or trust for their benefit without gift tax (or using the lifetime gift/ estate tax exemption). Even marketable securities can fund a GRAT. In certain circumstances, the risks may be limited to administrative, legal, and tax costs.
Defective Trust Sales
A defective trust sale is a freezing technique that takes advantage of the falling applicable federal rate (AFR). Low AFRs mean that business owners may have an opportunity to transfer ownership of their businesses to the next generation. Business owners may be able to take advantage of depressed values, so-called valuation discounts, and low interest rates to shift business interests to lower generations.
With rates this low, irrevocable life insurance trusts can borrow to pay premiums. Split dollar plans to purchase larger death benefits may also be considered.
If you are making annual gifts to family members (or would like to work gifts into your plan), consider the following.
- Make gifts of marketable securities while values are depressed: In 2020, individuals can make gifts of $15,000 within the annual exclusion. Lower market values allow for more shares to be gifted, and when the market rebounds, the appreciation will be outside of the donor’s estate. The recipient of the gift receives the donor’s basis, unless the basis is greater than the fair market value of the property at the time of the gift; then, for the purpose of determining loss, the basis would be such fair market value.
- Contribute to 529 plans: Giving cash today to a 529 plan allows it to invest in the plan’s mutual funds while the market is down, providing for greater appreciation within the plan when the market improves.
- Create trusts: Gifting can also be used to create or add to trusts. Gifting assets in trust can remove the value of those assets, and the appreciation thereon, from estate tax.
- Consider using lifetime exemptions: Assets may be removed from the estate while values are depressed. When the market rebounds, the appreciation on those assets will be removed from the gross estate and may escape estate taxation.
A senior generation member could borrow against assets and gift that cash to a junior generation member, allowing the junior generation to invest in the market without basis issues.
These types of gifts could also provide a lifeline to junior generation members who might be struggling during the coronavirus outbreak with children at home, unemployment, or other financial needs.
It should be noted that when borrowing against investments, you should always consider the impact of market fluctuations on asset values and the possibility that declines in market value may result in margin calls and the requirement to add equity to the collateral pool.
Wealth Management Strategies
Tax Loss Harvesting (Perhaps Offsetting Gains)
In a portfolio with large low-basis positions, recent market declines may allow large positions to be sold and the resulting capital gain to be offset by realized losses on other positions. If the portfolio doesn’t have offsetting positions, perhaps losses can be harvested for use in offsetting future capital gains. Don’t forget to avoid the wash-sale rules when making repurchases.
The wash-sale rule states that after an investor sells a security at a loss, they cannot buy the same security within 30 days before or after the sale date.
Refinance Your Debt
As discussed above, interest rates have declined and are at or near historic lows.
- Evaluate current mortgage structure(s); locking in today’s low rates could potentially lead to significant savings over time.
- While rates are low, consider moving floating rate debt to fixed-rate debt.
- Consider consolidation of high interest rate debt (such as credit cards and auto loans) into lower fixed-rate debt, such as debt secured by a residence.
- Review whether line of credit with lower interest rates would be useful if the current crisis continues for a long time, or may be used as “dry powder” to provide liquidity to make investments at market lows.
Exercise Stock Options
If you have stock options, consider exercising the options and holding the shares. The reduced spread between the strike price (the price at which the underlying stock can be sold) and the current share price may provide an opportunity to reduce the tax that would be due on exercise. Additionally, if you believe the company will eventually perform well, then holding the shares may prove to be a good investment purchased at a bargain price.
Borrowing to Pay Tax
Even though the US Treasury has delayed the date when 2019 tax payments are due, as of this writing, not all states have followed suit. And, at some point, the tax will have to be paid. Rather than liquidating assets at a loss to pay tax, it may make sense to borrow to fund your tax bill and wait for the market values to return, at which time assets can be liquidated to repay the debt.
Emotions may run high in times of great uncertainty, and when reason is overwhelmed by emotion, decision-making often suffers.
Your PNC Wealth Management® team is here and ready to work with you and your advisors to help guide you through your choices by illustrating the potential impact of your actions and how they could affect your overall long-term plan.
For more information, please contact your PNC advisor.