Protecting and Enhancing Your Plan

This is part of an ongoing series of articles about estate planning and succession planning, written by Joe Maier, JD, CPA, Senior Vice President, Director of Wealth Strategy

The investment markets are a collection of millions of individual and institutional investors, each with a particular set of goals and objectives. Each investor has different goals, dreams, knowledge and fears, and as a consequence, reacts differently to market volatility. So while history shows that markets rise in the long term, we also know that many people react irrationally during periods of uncertainty in the short term. This is especially true during unprecedented situations, like the coronavirus (COVID-19).

In times of uncertainty, it is critical to understand what we can control and what we cannot. We can control whether we invest in the stock market. We cannot control how those investments perform. We can also control how we react to underperformance. What can we do in times of market decline to protect, and perhaps even enhance, our goals?

Let’s explore three areas where you can have some control:

• steps you can take to protect your plan in times of market downturn
• options for liquidity, other than selling investments
• unique planning opportunities when stock prices are at historical lows

PROTECTING YOUR PLAN

Your plan is designed to provide for your needs, wants and wishes for the rest of your life, and perhaps beyond. It is critical in times like these to avoid short-term, fear-driven mistakes. To avoid those mistakes, your plan should incorporate the following:

Cash Reserves

You should strive to have cash reserves to cover at least six months of expenses so you don’t have to sell stocks to handle unexpected events such as losing your job or incurring a material expense. For example, an unforeseen pandemic like we are experiencing now has led to deep reductions in stock prices. If your plan has adequate cash reserves, that cash can be used to cover your needs, allowing time for stock prices to recover. Future growth can then be tapped to replenish your reserves.

Reduce spending/postpone major purchase

During periods of uncertainty, you should focus spending on your monthly recurring expenses (your needs) rather than experiences or major purchases (wants). What is somewhat unique about our current situation–being mostly confined to our homes and unable to travel or attend events-- is that our opportunities to spend are limited and, therefore, spending should fall rather significantly. Take advantage of lower spending by reducing automatic portfolio withdrawals and staying more fully invested.

ACCESSING LIQUIDITY

If your spending exceeds your cash reserves and you have to tap investments to cover your expenses, you may be forced to sell low now and later reenter the market at elevated prices. Instead, your plan will more effectively provide for your needs, wants and wishes if you can avoid selling until prices recover. Consider these options for liquidity when waiting for a recovery:

Mortgage Refinance

Mortgage rates are lower than they were at the beginning of 2020 and considerably lower than they were at this time one year ago. Depending on your rate reduction, refinancing could make a significant impact by reducing your monthly expenses.

Line of Credit

Psychologically, we feel more financially independent when we are free of debt. In fact, many people pay off low rate debt, even when more attractive investment opportunities are available, to achieve this feeling of control and peace of mind. But, the strategic use of debt can support your long-term plan and protect your goals. A line of credit against your home or your investment portfolio can provide you with a source of cash that allows you to stay invested.

PLAYING OFFENSE- OPPORTUNITIES TO ENHANCE YOUR PLAN

Until now, this article has focused on playing defense--protecting (but not improving) your plan from a market downturn that threatens it. But the downturn also provides opportunities to enhance your plan, allowing you to achieve more of your needs, wants and wishes. Here are some ideas for how to play offense:

Invest Cash

If you are currently holding excess cash, stocks are trading at roughly a 25-30% discount compared to where they were a month ago. History tells us growth following this level of a downturn may provide an opportunity to purchase stock within your risk profile and time horizon. But because trying to determine the right time to enter the market is impossible, particularly with so many unknowns related to the virus and so much volatility, a sound strategy is to dollar cost average into the market (i.e. invest an equal percent over a series of weeks or months).

Roth Conversion

The tax code allows you to convert a traditional IRA to a Roth IRA. With a traditional IRA, there is no current income tax burden. Taxes are due when distributions are made from the IRA and is paid on the total amount distributed. Traditional IRAs allow you to defer taxes until the tax law requires distributions to be made. During your lifetime, these Required Minimum Distributions start after you turn 72, and then are based upon your life expectancy. After you die, your spouse can take distributions from your IRA in a similar fashion, but those distributions must be taken by the beneficiary over no more than ten years.

A Roth IRA is funded with after tax contributions. So, when you create a Roth IRA, you have already paid the income tax associated with the contributed funds. Because of that, the tax code allows you to take distributions from a Roth IRA income tax free. Further, Roth IRAs do not have Required Minimum Distributions. This allows maximum income tax deferral during your lifetime, and, when you die with a Roth IRA, instead of having to take distributions over ten years, those required post-death distributions can be spread over the life expectancy of your beneficiary.

Because of the tax benefits of a Roth IRA compared to a traditional IRA, good planning should always explore the conversion of a traditional IRA to a Roth. A conversion requires you to incur the current value of the IRA as taxable income in the year of conversion. So, when thinking about a conversion, the lower the current value of the IRA, and the higher the potential future growth of the IRA, the more compelling.

It is hard to conceive of a better time, from a mathematical perspective, to make a Roth conversion. Values are historically low, economic fundamentals are positive, and stock prices are poised for a strong recovery.

Finally, it is important to consider political risk during election season. The stimulus bill will materially increase the national debt. Further, current tax rates are low from a historical perspective. Taking both of these factors into account, it would be logical to assume that, once the economy has recovered, there is a high probability the government could decide to increase tax rates making now a relatively attractive time to convert to a Roth.

Tax Loss Harvesting

Based on current stock prices, it seems inevitable that your portfolio will have unrealized losses. You can take advantage by selling positions with losses to realize income tax savings. To avoid violating wash sale rules and to ensure participation in the market recovery, reinvest the sales proceeds in a similar but not the same investment.

Pre-fund Retirement Accounts

You likely contribute to your 401(k) plan through bi-weekly or monthly payroll deductions. Under normal market conditions, this type of averaging strategy is wise. But the stock market currently offers a unique buying opportunity. So, if your cash flow allows for it, now could be a great time to increase your contribution percentage to take advantage of lower stock prices.

Gifting

Under current law, you can give away property worth approximately $11.5 million without the imposition of a gift tax. Any gifts (or bequests) over that amount are taxed at 40% of the value of the transferred property. So under the gift and estate tax law, legacy goals are enhanced when property is transferred that has high future appreciation potential. Based on the current state of the market (down 25-30%), this is the perfect opportunity to give away depressed but strong stocks to multi-generational trusts, materially increasing the power of your gift.

CONCLUSION

We have a lot going on right now including significant uncertainty and fear. These are the times when we need to take control, take stock and take advantage. Please contact your adviser to create a plan to help you realize your wishes, hopes, dreams and desires.

ABOUT THE AUTHOR

Joe Maier

SVP Director Wealth Strategy JD, CPA | Johnson Financial Group

Joe has extensive experience helping high‐net worth individuals, family offices, business owners and corporate executives meet their wealth and legacy goals. His areas of specific interest and skill include business succession planning, financial and estate planning, and wealth transfer strategies.