On episode 15 of The Wealth Cast, Charles talks with colleague and partner Pat Runyen about year-end financial planning. They cover pro forma tax returns, the CARES Act, loan refinancing, charitable giving, estate planning, and more. Pat stresses the importance of anticipating both current events and potential future changes in tax law in order to maximize the benefits to you.
On this episode, I’m joined by my colleague Pat Runyen. Prior, Pat worked for PwC, one of the big four accounting firms where he specialized in helping Fortune 500 executives with their retirement planning needs. On this podcast, Pat and I will discuss a number of important year-end financial planning topics. I hope you enjoy the podcast.
Pat, welcome to The Wealthcast. Thanks so much for joining me today to talk about the important planning considerations that people should be thinking about as we get into the end of the year 2020.
Happy to be here Chas, thanks.
You’re very welcome. So you were kind enough to provide me with a list of sort of subjects that you think people should be thinking about as we get closer to year end, and why don’t we just walk through that list.
So, Pat, the first thing on your list was the suggestion to complete a pro forma tax return. Let’s talk about that in the context of 2020.
Yeah, so we’re about ten months through the year, and for most folks, I think most folks have a pretty good idea of what your tax return may look like at the end of the year. So I encourage people to start sketching that out, either working with your CPA or doing it yourself, because there may be some opportunities to do some proactive tax planning ahead of year-end.
So what kind of examples would would there be there?
Yeah, so in 2020, a lot of interesting things are coming together. The first is we find ourselves in a historically low tax environment. That may change—it’s an election year—so you want to take advantage of that when you can. In addition, with everything that’s happened in regard to COVID-19, and the subsequent downturn in the market, a lot of folks likely took capital losses in their portfolio in the March-April timeframe. The CARES Act came out at the end of March, and one of the more interesting provisions for tax planning purposes, is that nobody needs to take required minimum distributions from their retirement accounts in 2020. So unless you need those to live off, of it may be a good year to skip those. That enables you to lower your taxable income this year.
So in a year when taxable income is low, it’s usually a good idea to look for proactive opportunities to pay tax at reasonable brackets. One of the strategies that can be really effective for that is something called a Roth IRA conversion. This is the idea of taking money from a pre-tax retirement account, and proactively moving it to a Roth IRA. Now, the neat thing about this is it’s not an all-or-nothing proposition; you can actually pick the amount that you want to move to a Roth IRA, and that amount becomes taxable income to you this year.
So what we often see and what we encourage people to do is, if they find themselves in a low tax bracket, say the 10%, the 12%, all the way up to maybe even the 24% bracket, there may be opportunities to pay very reasonable tax rates—move the money into a Roth. Now all those proceeds as well as any of the earnings on those dollars are tax free forever. So it becomes a really effective strategy either for tax planning currently, or estate planning over the long run.
And that could be particularly effective for someone who’s in the first full year of retirement where their income has has declined—that provides that particular opportunity?
That’s a great planning strategy, because typically in the in the first four years of retirement, you hang it up, you’re not making a paycheck anymore—and you turn to the next year, and you’re typically living off of more tax efficient assets: Whether it be withdrawals from from cash that you’ve built up, or you’re selling out of high basis, low capital gain assets, and that enables you to really manage your tax bracket in the first few years of retirement. So that’s a great example of an opportunity where people find themselves in really advantageous tax positions.
That’s great. What about deductions and charitable giving here at the end of the year, any special considerations, given 2020?
Yeah, so this is something we’re seeing in combination with everything we just spoke about with Roth. I always say to people, when you give to charity, you want to give to charity, for charitable reasons, not for tax reasons, because at the end of the day, you’re still out the money. But it’s important that if you are giving to charity, there may be more tax efficient ways to do it, so one of the low hanging fruit options is instead of giving cash, you give appreciated securities.
For appreciated securities, let’s say you you hold an investment that has a large unrealized gain. Well, the neat thing about charitable organizations is, they don’t pay any tax. So to the organization, whether you give cash from your bank account to support them, or you give an appreciated security—either way, that’s the same amount of money to them. So what we often encourage people to do is take some of those appreciated securities and donate them to charity, and now you’ve saved tax twice with the deduction you get on your current your tax return, as well as the elimination of the gain from your portfolio.
This is a common discussion that you would have with a client—the benefit of, rather than writing checks out of your money market, give the appreciated securities. The government is subsidizing your gift.
That’s it, it’s really a no-brainer.
So let’s let’s move on then, and talk about the planning opportunities that may have been provided by low interest rates. How should people think about taking advantage of lower rates at this point?
One of the more common ways right now: we’re seeing a lot of people refinance. So if you have a mortgage that maybe you entered into 10 or 15 years ago, and you haven’t really paid much attention to it, and you see that your interest rate is above four, four and a half percent, it’s a very attractive environment right now to refinance. A lot of times, there’s ways that you can do it with what’s called a “lender credit.” There’s really no money out of pocket to do it; they build the the fee into the rate. So you may be able to trade your four and a half percent mortgage for a three and a half percent mortgage, without any type of out of pocket expense, or if there is an out of pocket expense—let’s say it’s a few thousand dollars to execute the refinance—you’re able to do it assuming that you’re going to be in the house for at least five years or so. That’s normally what we see as a breakeven point.
If you’re in a home, and you have a higher interest rate than you’re comfortable with—and we see low rates right now—it might be a really good idea to look at proactively refinancing your mortgage down to a more favorable rate.
And then the other opportunity that I’ve seen is using a pledged asset line for short term borrowing.
Yeah, this is an idea that I see a lot of people either haven’t heard of or don’t don’t realize is even an option. If you have money sitting in a brokerage account—any type of non retirement account—that can be used as collateral to build a loan. Let’s say you have a million dollar brokerage account. You may be able to create the equivalent of a home equity line, but instead of using your home as collateral, you’re using your investment portfolio as collateral.
The most common situation we see people use these in is in a real estate purchase. Let’s say it may be contingent—in order for you to buy a new home, you have to sell your current home first in order to buy the next one. Well, in a competitive environment like we’re in today with real estate, where interest rates are low—a lot of people are at home on realtor.com. I know my wife is all the time. You can really take advantage of not having that that cash in hand by borrowing against your portfolio at a really low interest rate. If you have a million dollar brokerage account, you may be able to borrow four, five, six hundred thousand dollars against that. Put the down payment on the home, you sell your home, you close out the line, and it costs you very little in interest rates given that we’re in a low rate environment.
My favourite part of these is there’s no closing costs. You establish the line, and you only pay the interest when you actually draw down on the line. Most times in a bridge loan type of situation, the line may be outstanding for just a few weeks. So it’s a really efficient way to kind of come up with cash without having to sell securities, pay tax, or whatever the case may be.
I think for those investors that have significant unrealized capital gains in their taxable accounts, this provides the potential opportunity to put that money to work in terms of a new piece of property, real estate, but also to do the tax planning necessary to stretch those capital gains out over into next year or whatever the appropriate tax planning strategy is for that for that individual or that family. That’s a great strategy.
What about low interest rates and the impact on gifting strategies? I know GRATs are one area. We’re going to have a full podcast on taking advantage of GRATs down the road in the next month or so, but let’s talk about that just for a second.
Yeah, sure. GRATs are a really good opportunity to shift assets to the next generation—or other beneficiaries—with very low gift tax impact. In a lot of cases, there’s no gift tax impact. So as you might know, a lot of people utilize the annual gifting exclusion, which is we can give anybody $15,000 without having any type of tax impact. You don’t have to file a gift tax return. It’s a way that you can shift money each year to somebody without any complications.
A GRAT is this idea of taking an investment—and this can be a privately held investments, like shares in a company all the way to just a traditional publicly traded investment—and you put this in a trust. The trust usually runs for three, four or five years. The idea here is: because interest rates are so low right now, the government applies an interest rate discount to what you gifted. There’s a complex calculation, but in essence, what this enables you to do is take this investment, and if it grows, you’re able to pass that growth onto the beneficiary without any gift tax complications—even if the growth is significant and over the annual limit.
So you can structure these in a way that you can kind of have your cake and eat it too, by keeping the investment in your name, getting it paid back to you, but the appreciation goes to the next generation. It’s a really effective technique if you’re trying to pass assets during your lifetime.
That’s great, Pat! In the next several weeks, we’re going to record another podcast, talking specifically about this strategy with some examples. So stay tuned! There’s going to be more information on GRATs and how you might be able to use them for your family.
Let’s move on to the idea of revisiting an estate plan. At this point in time, what opportunities should we be thinking about from a planning standpoint?
Yeah, I think one of the most commonly missed planning opportunities is for people to just check their beneficiary: Retirement accounts, annuities, life insurance policies, all have designated beneficiaries. I don’t think people realize how powerful they are. So for instance, if I wanted to pass my 401(k) to my brother, but I listed my sister as the beneficiary, and my will says, I want it to go to my brother, it’s going to go to my sister every time. The reason is because the beneficiary designation overrides whatever your estate documents say. I would encourage everybody to take a look at their designated beneficiaries, because invariably, things change in your life, and that’s one of the last things you think of the look at.
The other reason that that’s become a more important thing to check on his back at the end of 2019—which seems like 10 years ago at this point for 2020—
It sure does!
There was this law change called the SECURE Act that came through. One of the really popular techniques that was formerly very effective, was passing retirement accounts to your children. If they inherited that retirement account, they are able to do what’s called a “stretch” of those distributions over the rest of their life. So it enabled them to defer the tax on these accounts for a very long period of time. Well, the idea of the Stretch IRA was eliminated in the SECURE Act. Now, whoever inherits your retirement account has to withdraw that over ten years. That changes the game in terms of how effective it is to pass that on to somebody that may be younger. It’s really important that you take that the beneficiaries into account with the overall goals of your estate plan to make sure that the right people are inheriting the right assets.
The other thing is, it’s just a good idea to check your documents. Again, we’re in a election year—we could see massive overhauls to the way the estate law and the estate tax work. There’s talk in proposals of maybe getting rid of what’s called the “step up in basis,” where at somebody’s death or their fair market value of their assets gets stepped up to its value at the date of death, which eliminates gains. That is something that could be a game changer in terms of how estate planning is done today. So you want to make sure that the documents are in line with what your goals are, but you’re also paying attention to any large or any significant changes to estate law—that you revisit those documents to make sure that they’re still in line with where you want them to be,
And then a grab-and-go envelope for your family. Just sort of a centralized place for all the documentation that people may need, should something happen. So should there be any illness or death in the family, whatever the case may be—let’s talk about that for a minute.
Yeah, I heard this from an insurance person that was on a webcast. I thought it was a fantastic idea, that you set people up for uncomplicated settlement of an estate, in the event something happens to you. It’s good for folks that are a little bit older, they want to make sure that you know, things are handled smoothly in the event that they pass away. So what we encourage people to do is a grab-and-go envelope, where you include not only your estate documents, but your address, your primary physician, any emergency contact that you want listed, medications, allergies, etc. In the event you become either incapacitated, or you pass away, the first people that get there, that envelope is in a prominent place in your your kitchen or in your living room, that somebody can grab to get all of the relevant information they need in order to take the next steps.
It’s something that I’ve encouraged people that I’ve spoken with to start thinking about putting together. One particular person that we did this for, it was just a load off their shoulders that they did this. They let their children know where it was in the house. It gave them an incredible amount of peace of mind knowing that in the event something happens, they’ve already gotten things in order for the people that they leave behind.
Yeah, that and that is, after all, the primary purpose: to alleviate stress for the folks that either may be taking care of you or taking care of your estate after you pass away.
Yeah, that’s one of the more stressful positions you can be in:not only potentially losing a loved one, or a loved one is sick or incapacitated—not only the heartache that goes with that, but also the complications of trying to gather everything and make sure things are taken care of.
Makes total sense. Well, Pat, this has been really helpful. Let us know if there’s any way that we can help you or answer any questions that you might have. Pat’s certainly available; I’m available. Pat, thanks again, and I look forward to the next time we have the opportunity to chat about these these important topics.
Thank you, Chas.
Thanks for joining Pat Runyen and me today as we discussed year-end financial planning topics. Thanks for joining us.
As a Wealth Manager, Pat Runyen works closely with clients to implement wealth management solutions. He leverages his technical financial planning and consulting experience to assist clients with investment counseling, retirement planning, estate planning, wealth enhancement, asset protection, tax planning, and other personally significant financial decisions. Pat joined Modera with the Independence Advisors team in January 2021. Prior to Independence, he worked in both the Assurance and Tax Practices at PricewaterhouseCoopers LLP in their Philadelphia and Denver offices. While in the PwC Tax practice, Pat provided financial planning guidance to executives and employees of multiple Fortune 500 companies. Pat’s experience also includes working at a fee-only wealth management firm in the Philadelphia area.
Pat is a Certified Public Accountant, holds the Personal Financial Specialist designation, and is a Certified Financial Planner. He earned a B.S. in Finance from St. Joseph’s University and an M.B.A. with an Accounting concentration from La Salle University. In his free time, Pat enjoys spending time with his family in Ocean City, NJ, visiting national parks, following all Philadelphia sports teams, exercising and fly fishing. He lives in West Chester, Pennsylvania with his wife Ann and their two sons Archie and Henry.
Original Release Date: November 4, 2020.
This podcast was originally distributed on November 4, 2020, by Independence Advisors. Independence Advisors officially merged with Modera Wealth Management on December 31, 2020. Please note that the information provided in these recorded conversations may no longer be current or may refer to events that have since passed.
Modera is an SEC registered investment adviser which does not imply any level of skill or training. For additional information see our Form ADV available at www.adviserinfo.sec.gov which contains a full description of our business, operations and service offerings including fees. Statements made in the podcast are not to be construed as personalized investment or financial planning advice, may not be suitable for everyone and should not be considered a solicitation to engage in any particular investment or planning strategy. Statements made are subject to change without notice.