Recent market declines have 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.
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 and review your plan.
As you revisit your plan with your tax, legal, and financial advisors, you may be able to apply some strategies that take advantage of current conditions. In other words, “When given lemons – make lemonade!” When asset values are depressed and interest rates are relatively low when compared to historical norms, there are many planning tools that could be deployed, which, under the right circumstances, could produce benefits for your family. Below are some planning techniques for you to consider with your advisors.
The Setting Every Community Up for Retirement Enhancement (SECURE) Act compressed the payout. For most beneficiaries of traditional individual retirement accounts (IRAs). Accordingly, now may be the time to consider converting your traditional IRA to a to Roth IRA. 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, as the tax bite will be much smaller. A Roth conversion makes the most sense if you can pay the tax out of non-IRA assets. Using funds from a traditional IRA to pay income tax on a Roth conversion will cause an additional income tax.
Also, an immediate income tax resulting from a Roth conversion would reduce your net worth (perhaps, including your investable assets). Be sure there is sufficient time between payment of the income tax caused by the Roth conversion and the ultimate distribution of the Roth IRA to recoup the amount lost to tax. Your PNC Private Bank Wealth Strategist can illustrate your crossover point.
Grantor-Retained Annuity Trusts (GRATs)
The GRAT could be another helpful tool, especially during these volatile times. Assets transferred to a zeroed-out GRAT must appreciate over the IRS Section 7520 rate (for GRATs created in January and February 2023, 4.6%) 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. With a properly constructed and administered zeroed out GRAT, your costs may be limited to administrative, legal, and tax costs.
Although a GRAT works best in a low interest rate environment, notwithstanding that interest rates have risen and may continue to rise, detailed analysis may show a GRAT could still be useful in your particular situation.
Defective Trust Sales
A defective trust sale is a technique allowing you to freeze the growth in your estate with respect to assets transferred to the trust to the applicable federal rate (AFR). Although interest rates rose in 2022, they remain relatively low when compared to rates over history. Relatively 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 relatively low interest rates to shift business interests to more junior generations.
Following a market pull back, it is important to review the performance of variable life insurance policies, particularly those invested in equities. A PNC Private Bank® Insurance Strategist can help you obtain an “in-force illustration” for your policy and review its performance. You may be able to replace an under-performing policy with a new policy in a tax-free exchange.
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 2023, individuals can make gifts of up to $17,000 and remain 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 asset’s fair market value.
- Contribute to 529 plans: Giving cash today to a 529 plan allows it to be invested in the plan’s mutual funds while the market is down, providing for greater appreciation within the plan when the market improves.
- Consider using lifetime exclusions: Assets may be removed from the donor’s 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. Gifts of this type could also provide a lifeline to junior generation members who might be struggling financially.
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.
Be Smart About Debt
Although interest rates rose in 2022, they remain relatively low when compared to historic rates. You may wish to consider the following in a rising interest rate environment:
- Evaluate current mortgage structure(s); consider replacing an adjustable rate mortgage with a mortgage with a fixed interest rate.
- 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 a line of credit would be useful if the current market pull-back continues for a long time. The ability to have ready cash may help avoid selling securities in a down market, or may be used as “dry powder” to provide liquidity to make investments at market lows.
Exercise Compensatory Non-qualified Stock Options
If you have non-qualified stock options, consider exercising the options and holding the shares. The reduced spread between the strike price (the price at which the option can be exercised) 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
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 can run high in times of uncertainty, and when reason is overwhelmed by emotion, decision-making often suffers. Your PNC Private Bank team is here and ready to work with you and your tax and legal advisors to help guide you through your choices by illustrating the potential impact of your options and how choosing among your options could affect your overall long-term plan.
For more information, please contact your PNC Private Bank advisor.