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A Super Genius Weighs In On Inflation

by M. Burke Koonce, III

I have a friend, a hedge fund manager of course, who was filling out a job application years ago at a major Wall Street asset manager. In the section asking about special skills and abilities, he wrote “Super Genius.” I can’t remember if he got this particular job—it’s possible that he did—but I have often giggled about the look on the human resource manager’s face upon reading his application.
Now, this fellow is extremely smart, and he is also clearly not lacking in the chutzpah department. I’m not sure I would categorize him as Super Genius though. Seems a bit inflated, which brings us to a topic on the minds of not just many investors but also business owners and grocery shoppers. Inflation. Is. Here.

I’m old enough, just barely, to remember the inflation of the 1970s and the terrible impact it had on this country. Rooted at least in part in America’s departure from the gold standard and exacerbated by energy crises, inflation reached 14.5 percent by 1980, helped chase a U.S. president out of office and came to symbolize a general sense of economic malaise and even societal decay that persisted until the Volcker Fed brought it under control with higher interest rates and slower reserve growth.

According to the Labor Department, consumer prices rose 5 percent last month, the largest increase since August 2008. The 3.8 percent increase in the core number, which excludes the volatile categories of food and energy, was the largest increase since June 1992. That’s when I graduated from college. For perspective, I have a child who graduated from high school last month.

There’s no disputing these are historic increases. But before we race to the gas station and get in line, let’s take a deep breath. One reason these increases are so large is that last year prices were so depressed. Governments around the world were doing everything they could to keep prices from collapsing. So the denominator (pandemic-pressured prices last year) is juicing these price increases.

Even so, it seems fairly obvious that the economy is far, far healthier than anyone could have believed just a few months ago. Pent-up demand is meeting supply that has been constrained by supply chain problems and labor shortages, so it’s only natural that prices are rising, and it is possible, depending on what happens with consumer expectations, that some inflation continues. As Nobel laureate Gene Fama recently pointed out, the longer inflation or deflation persists, the more likely it is to persist.

Still, there is a component to these price increases that seems decidedly short-term. Generous unemployment benefits are keeping some service workers on the sidelines, but those benefits will run out by the end of the summer and in many states well before, and this ought to ease the labor crunch in the service sector. The microchip shortages that have created a frenzy in the used car market, driving prices up more than 7 percent last month and accounting for about a third of the entire increase in overall prices, will eventually be met with new supply. Globalization has been a crushing weight on inflation for decades, and the base case is that this will continue to suppress price increases.

That’s the company line at the Federal Reserve anyhow, and it’s important to remember that this is actually what Fed Chairman Jay Powell explicitly predicted last September. At that point, the central bank was still so concerned about falling prices that it indicated it would allow the economy to run a little hot instead of pre-emptively raising interest rates. Of course, at that point, there was no such thing as a COVID-19 vaccine. Fast forward to today and we have a $1.9 trillion stimulus package coursing through our veins, potentially another $2 trillion in infrastructure spending on the way, and COVID-19 is on the run. (I actually went to a party last weekend! With people!) Also, I think it’s worth noting that the globalization bandwagon has gotten a little less crowded in recent years as populist and trade protectionist forces have gathered momentum. Combined with an aging population in rich countries and in China, the relative strength of deflationary forces is strong, but not as strong as it was just a few years ago.

So far, the financial markets have taken the whiff of inflation in stride. The threat of higher rates has taken some steam out of the more speculative sectors of the market such as growth stocks and long-dated fixed income, but other areas, such as financials, commodities, and value stocks, have done extraordinarily well. Inflation is a serious threat, but it is only one factor of many that the markets are always in the process of discounting. That’s why good old-fashioned diversification is so important.

My friend might think he is a super genius, but for the rest of us mere mortals, diversification and commitment to a plan still seem to work well. How long will inflation last? No one knows for certain, and there are reasons to be watchful, but diversification and a tilt toward value has historically served investors well over time. The real genius is in mastering one’s emotions, not mastering the market.

Burke Koonce recently joined Trust Company as the firm’s Investment Strategist, working out of our Raleigh office. 

Rising Rates and Your Bond Portfolio

by Dan Tolomay, CFA

Recently, our son lost his first tooth. (Actually, it was his third lost tooth. We suspect he swallowed the other two. But this was the first instance where he would interact with the Tooth Fairy.) After we explained the mechanics of the tooth-for-treasure trade, he drifted off to sleep. My wife and I then debated the going rate for a tooth. What did we receive as children? Did those amounts still apply? Or did we need to adjust for decades of inflation?

The two of us were not the only ones thinking about rising prices. Optimism about a post-COVID recovery pushed up inflation expectations in the first quarter of 2021. Bond investors, who receive fixed coupon payments, began requiring higher yields to account for the anticipated loss of purchasing power. Higher expected demand for money in a normalizing economy also helped to nudge rates upward.

The change in interest rates was not uniform, however. Most of the action was in intermediate- and long-term yields. As short-term rates were stable, the yield curve “steepened”. It is not uncommon for different maturities to behave differently. Not long ago, there was fear that the yield curve would “invert” where short rates would exceed long rates. Normally longer bonds yield more than shorter bonds as an investors’ capital is at risk for a longer amount of time. This is known as the term premium.

It is difficult to consistently predict what rates will do, at what magnitude, and when they will do it. Making such guesses can damage your portfolio. Some investors, convinced that rates would rise, concentrated their holdings into short-term debt. This debt, which is less sensitive to rate increases, should offer protection, they reason. As noted above, though, short bonds normally yield less than their longer counterparts. So, there is a cost to this perceived safety. Additionally, the curve could “flatten” where short rates rise or long rates fall. Being concentrated in near term bonds could mean a principal loss or missed gain, respectively.

Alternatively, low interest rate environments may tempt an investor to reach for yield and hold more long-term debt as longer maturities usually mean juicier payouts. But maturities that are further away are more sensitive to rate moves (the bonds fall more in price when rates go up), and an investor could get burned by rising long-term yields.

Rather than guess what rates will do or make yield-driven bets, diversification can increase return and lower risk. Owning bonds of various maturities means exposure is spread across time and lessens the impact of rate moves in specific segments of the yield curve. Expanding holdings to various sectors of the bond market adds securities that behave differently to a portfolio. Higher coupon corporate bonds, for example, may increase credit exposure but reduce interest rate risk. Similarly, government-backed mortgage bonds comprised of adjustable-rate loans can lessen sensitivity to yield changes. Lastly, adding foreign bonds means less money is exposed to the US interest rate environment and American inflation expectations.

Periodically assessing market conditions can improve risk management without having to outsmart the market. For example, if longer-term bonds yield the same or less than short-term bonds, it may not make sense to bear the risk of a later maturity. Likewise, if less credit worthy bonds are not offering a sufficient premium to hold them versus safer alternatives, an investor can abstain until the reward becomes commensurate with the risk level.

The recent uptick in interest rates has caused some bonds to decline in value. It is important to remember that this is only one piece of the return. The coupon payments from the securities must be considered, too. This income lessens the impact of value dips due to rate increases. And, like stocks, when bond prices fall, their expected return goes up. These are silver linings to remember as bond markets adjust to new expectations. Diversifying across countries, maturities, and creditworthiness helps a portfolio reduce bumps in the road and capture return opportunities without having to know the future.

As Chief Investment Officer, Dan is responsible for developing Trust Company’s investment strategy and managing client portfolios.

A Strategy to Offset Higher Taxes

by Jonathan S. Henry, CPA, CFP®

President Biden will soon turn his attention to comprehensive income tax reform which is expected to result in higher taxes for wealthy individuals.  For taxpayers who routinely give to charity, a donor-advised fund might be a useful tool to offset the anticipated increases in tax liabilities.

The Biden Administration campaigned with a promise to increase income taxes for wealthy individuals, defined by the campaign as those earning greater than $400,000 a year.  With the recent passage of the American Rescue Plan Act, President Biden and Congress seem poised to now focus on comprehensive changes to current income tax law.  The White House is concurrently rolling out a plan, coined “Build Back Better,” to gather support and consensus for the next phase of its economic agenda – a variety of programs that would invest in infrastructure, education, carbon-reduction, and working mothers.  Build Back Better could cost an estimated two to four trillion dollars.  Biden and his team believe the proposal to increase spending requires an agenda with a two-pronged approach, with the second being an increase in tax revenue to fund the desired infrastructure spending and protect the nation’s long-term financial stability.  A sample of some of the income tax increases proposed by the Biden campaign are listed below:

·         Decrease the top tax bracket from $622,000 to $400,000 and increase the top tax rate from 37% to 39.6%.

·         Tax long-term capital gains and qualified dividends at the ordinary income tax rate of 39.6% on income above $1,000,000.

·         Eliminate the step-up in basis for capital gains taxation.

·         Cap the tax benefit of itemized deductions to 28% of value for those earning more than $400,000.

·         Phase out the qualified business income deduction (Section 199A) for filers with taxable income above $400,000.

·         Increase the corporate income tax rate from 21% to 28%.

For those individual taxpayers who are charitably inclined, the utilization of a donor-advised fund is an excellent strategy to offset income.  A donor-advised fund acts as a charitable investment account used over time to support the charitable organizations you care about.   You can establish a donor-advised fund by donating cash, appreciated securities, or non-publicly traded assets such as an interest in a private business.  The donation is generally eligible for an immediate tax deduction, but gifts can be made from the donor-advised fund to charities you choose over the course of many years, perhaps even your lifetime.  While you are deciding which charities to support, your donation can be invested, and the growth is tax-free.  Essentially you are taking the tax deduction when it is most valuable to you by pre-funding your charitable giving for the future.  As a bonus, all of your future giving can be organized and administered in a single place.

Funding a donor-advised fund is particularly useful during a high-income year.  Examples of financial events that would cause a high-income year include selling a business, exercising stock options, receiving a large bonus, selling real estate, and rebalancing an account with concentrated low-basis positions.  A portion of this income can be offset by funding your future charitable giving in a donor-advised fund.  Assume you plan to sell your business for $10,000,000 in 2021 and your basis is low, which means you will realize significant capital gains when you file your 2021 tax return.  You also plan to continue charitable gifting which has averaged $50,000 per year.  Rather than give $50,000 to charities each year for the next ten years, you could fund ten years of gifting in 2021 by donating $500,000 to a donor-advised fund and create a $500,000 charitable deduction on your 2021 tax return to offset proceeds from the sale of your business.   Gifts to charities can then be made in future years from your donor-advised fund.

If you find yourself in a high-income year due to a financial event, or a high tax year due to income tax reform (or both), consider discussing a donor-advised fund with your wealth advisor.   There are additional charitable planning techniques, including the use of charitable trusts, that your advisor may wish to explore given your unique situation.

Silver Linings

by Matthew Hornaday, CPA

The year 2020 was a remarkable year in many ways and forced each individual throughout the world to adapt to new norms in unimaginable ways.  As our firm responded to the COVID-19 pandemic, we made decisions guided by the original vision of our founders: to make an impactful, positive difference in the lives of our clients, their families, and our employees.  While there is much of 2020 we hope to never experience again, there were several silver linings that we celebrate:

Sticking to a Long-Term Financial Plan: We develop comprehensive long-term financial plans for our clients to first preserve then grow and transfer assets.  The importance of sticking to a long-term financial plan was highlighted in 2020.  The market downturn in March and April 2020 provided us an opportunity to ground our clients in their long-term financial plans, discuss if these goals had changed (most had not), and, if not, reinforce to our clients the importance of sticking to their long-term financial plan and remaining invested.  Sticking to a long-term financial plan won the day again, our clients let the markets work for them, and the temporary declines our clients experienced have since reversed in a significant way.

Deepening Connection: The COVID-19 pandemic has forced each of us to focus on what is most important in our lives and be present in ways not previously experienced.  It has been easier to prioritize in this context.  We have worked hard to maintain and deepen connection with each client.  Internally, we deepened connection via numerous platforms for employees to share firm-wide messages daily, ranging from sharing a meaningful life event or story to sharing each employee’s favorite charity (after which Trust Company provided a meaningful contribution to each).

Remarkable Employee Flexibility: Our employee team of 31 was resilient in adapting to a remote work environment in 2020.  Most of our team pivoted to work from home, we automated highly manual processes, became experts at screen sharing (via Microsoft Teams) and virtual meetings (via GoToMeeting), and established a virtual office setting to foster enhanced communication and connection.

Leading with Grace: Our journey through 2020 was not perfect, and we all had days when we did not feel like ourselves and felt down or depressed.  However, we continued to provide each other grace, which enabled us to emerge much stronger.  Grace soothed fears, calmed anger, and provided peace in an uncertain year.

Navigating the COVID-19 pandemic in 2020 forced us to prioritize, strengthen, and deepen.  As we turn the page to a new year, we remain committed to serving our clients as an independent and objective fiduciary – always prioritizing our clients’ interests ahead of our own.  Thank you for your continued trust in our firm.

Matthew Hornaday is Chief Operating Officer and a Principal in Trust Company’s Greensboro office.  In addition to managing client family relationships and several nonprofit client relationships, Matthew is also responsible for establishing and enhancing Trust Company’s operational controls, procedures and people systems, ensuring the continued financial strength and efficiency of the company.

Breathe Easy…You Are Not Being Squeezed

by Dan Tolomay, CFA

The broad equity market is off to a quiet start with the S&P 500 off -1% through January. The same cannot be said for a couple of stocks. GameStop and AMC Entertainment were up 1,587% and 514%, respectively. There have been many headlines about these stocks’ gains and the clashes between short sellers on Wall Street and Reddit users on Main Street. So, what’s going on and what does it mean for a portfolio?

To begin, an explanation of short selling is useful. Instead of the traditional path to profit, which entails finding an opportunity, buying low, and selling high (a.k.a. being “long”), short selling reverses the process. Rather than look for an asset that will appreciate, “shorts” seek assets that are perceived to be overvalued and will depreciate. To execute, the stock is borrowed and sold in the market. Assuming the stock depreciates, it is then bought back at a lower price and returned to the lender.

Shorting a stock is a legal way to financially express an opinion on its value. In theory, shorting helps markets. It enables those who feel that a stock is overpriced to try to push its price to fair value. Having this capability is more effective than simply abstaining from purchase. There is, admittedly, an ethical line that can be crossed when pushing a stock to fair value leads to attempts to make it worthless (which would maximize the profit for a short seller).

Shorting is not without risk, though. As a stock’s rise has no upper bound, the losses to a short seller can magnify extensively. What we see is that- when a stock rises- the short sellers unwind their positions by buying the shares back to stop losses. This phenomenon, known as a “short squeeze”, leads to further price increases. Managers know this risk and should not cry foul when markets move against them.

What’s unusual about recent market gyrations is the source of the stocks’ advances. Retail investors trying to coordinate buys via social media have driven a handful of stocks higher. Some retail investors are seeking quick profits while others have expressed a desire to inflict losses on hedge fund managers who are openly short these stocks. (Here, too, an ethical line is being crossed.) Exacerbating the issue is the expanded access to stock and option trading by retail investors homebound by the pandemic.

We’d expect markets, as they always do, to adapt. At risk of being the next target, hedge funds may close out short positions for fear of succumbing to a short squeeze. The involvement of systematic funds which use algorithmic trading to try to profit from trends, may magnify the issue in the short term. Retail investors may continue these coordinated efforts, or they may cease actions at the fear of loss or legal action. In general, though, market participants (large and small) will adjust their behavior to generate profits and avoid losses.

The situation is very fluid:

  • Trading platforms are limiting trading activity, increasing margin requirements.
  • Members of Congress are calling for investigations into why retail investors are being restricted while hedge funds are not.
  • The SEC may act if retail investors appear to be colluding or manipulating markets with false information.

The recent price swings and uptick in trading volume of these few companies have captured much attention. It does not change our advice to clients, however. Our clients are insulated from these moves by being broadly diversified. Targeting empirically-proven sources of higher return is more reliable than attempting to identify the next stocks to benefit or hedge funds to suffer from these recent actions. Having an asset mix that’s appropriate for your specific goals and executing that at a low cost are controllable factors that will lead to investment success.

As Chief Investment Officer, Dan is responsible for developing Trust Company’s investment strategy and managing client portfolios.

2020 Year-End Tax Planning

by Chris Sutherland, CPA

Year-end tax planning often comes with a bit of art sprinkled in with the science. Thanks in part to the January Senate runoffs in Georgia, this year presents even more challenges. It is not unusual to see material tax legislation in years in which the presidential party changes. We are likely to see that continue in 2021. How impactful those changes will be hinges on the two Senate races in Georgia. Democrats need to win both seats to effectively win the Senate and thus control Congress and the presidency.

Much of what has been said and written about President-elect Biden’s tax plan highlights the impact on high earners –  those making $400,000 or more. We will focus on those provisions of his plan.

  • Ordinary Tax Brackets – The top ordinary tax bracket reverts to 39.6% from the current rate of 37% and applies to those making over $400,000.
  • Capital Gains and Qualified Dividends – For those with income above $1 million, long-term capital gains and qualified dividends would be taxed at 39.6%. Combined with the 3.8% Net Investment Income Tax, the total capital gains tax would be over 43%, nearly double the current rate of 23.8% for high-income taxpayers.
  • Step-up Basis – Also of note regarding future capital gains taxes, Biden has proposed eliminating the step-up in cost basis that allows for basis to be adjusted to fair market value at the time of death. Under current basis step-up rules, heirs can effectively sell inherited assets tax-free.
  • Social Security Tax – A 12.4% Social Security payroll tax would be imposed on earned income over $400,000. Like the current Social Security tax, this would be split between employees and employers. The new tax would create a “donut hole” in which earned income between $142,800 (2021 wage base) and $400,000 is not taxed.
  • Itemized Deductions – Biden has two proposals impacting itemized deductions:
    • His plan reinstates the Pease limitation for those making over $400,000. This is a reduction of total itemized deductions by 3% for every dollar of income over $400,000.
    • The Biden plan also caps the benefit of itemized deductions at 28%. This provision has the potential to impact more taxpayers, but Biden has pledged to prevent the limitation on those making less than $400,000
  •  Qualified Business Income (QBI) Deduction – The QBI deduction would phase out for taxpayers with taxable income above $400,000. Currently, certain businesses can claim a deduction of 20% of qualified business income.
  • Corporate Tax – One of the major provisions of the 2017 Tax Cuts and Jobs Act was a reduction in the corporate tax rate from 35% to 21%. Biden’s plan would split the difference and raise the corporate rate to 28%. He has also proposed a corporate alternative minimum tax that would impose a 15% tax on book profit should ordinary corporate taxes not reach that level.

The greatest impact of President-elect Biden’s plan falls on the top 1% of taxpayers. According to the Tax Foundation, the top 1% will see a reduction of after-tax income in excess of 11% in 2021. So what can you do now to lower your tax bill?

Conventional wisdom in times like these, with expected higher tax rates on the way, is to accelerate income and defer deductions. Unfortunately, it’s not that simple. For example, with the proposed limitations on itemized deductions, you might be better off taking deductions in 2020. Another consideration for those making over $400,000 is a Roth Conversion.  Converting funds from a traditional IRA to a Roth IRA is an easy way to accelerate income that also comes with the benefit of future tax-free growth. Finally, while some tax reform is likely next year, the ability to pass all the provisions listed above comes down to control of both chambers of Congress. And that will not be decided until January.

Tax planning is never a “one-size-fits-all” approach, so contact your tax professional to better understand what actions you can take before the end of the year.

Chris Sutherland is a Principal and Wealth Advisor in Trust Company’s Charlotte office, where he works directly with clients to provide integrated wealth management solutions.

A Better Mousetrap

by Dan Tolomay, CFA

A little over a year ago, I wrote a blog post, “Value Stocks: Lessons from the Produce Aisle”. In that writing, I touched on ways to invest in an attractively-priced segment of the stock market: active management (trying to outwit the market), indexing (trying to match the market), and evidence-based (trying to outperform the market). That discussion showed that active management and indexing have resulted in lower performance. In this piece, I’d like to highlight some other pitfalls in those strategies and highlight how an evidence-based tactic avoids them.

When targeting a specific market segment, consistency is critical. In an effort to add to a fund’s return, an active manager may deviate from the mandate or let their holdings run. Such actions result in “style drift” and can cause a portfolio to behave differently than what the investor needs or wants.

The Standard & Poor’s Index Versus Active (SPIVA) report analyzes this effect via a metric known as Style Consistency. This calculation shows the percentage of funds that had the same style classification at the end of a time period as at the beginning. As the graphic below shows, many active managers are prone to this phenomenon.

Whereas a wandering focus may be the result of deliberate action on the part of an active manager, index funds are not immune. Such funds seek to track a benchmark with little variance. As a result, the fund’s holdings will mirror those of its target index. Changes are made to the benchmark index periodically in a process known as reconstitution. But what happens between reconstitutions?

Let’s say, for example, that a fund is targeting small value companies. If the market is rising (and small value firms with it), the names in the benchmark may drift from small to mid-sized firms or from value to core holdings on a valuation basis. For an investor seeking exposure to small value names, the fund may not purely provide it between reconstitutions.

An evidence-based approach corrects for these drawbacks. By following an objective, investment process rather than a subjective, manager’s directions, the portfolio stays focused on its goal and uses disciplined buying and selling to prevent drift and maintain consistent exposure. Unlike an index fund, the goal is not to track the index but to routinely position the portfolio to the pieces of the market with the highest expected returns. This may result in short-term “noise” around the benchmark return. However, as is shown below, over the long-term, the difference narrows, and value has been added by pursuing more rewarding market attributes.

The impact on an investor’s portfolio may be reduced diversification. If a fund fails to “stay in its lane”, it could lead to holdings overlap. The result is that an investor may end up overexposed to an area of the market during a selloff or underexposed to an area of the market that rallies. If a gap is left in the portfolio, it’s not just a return story but a risk one, too. By not having broad exposure, the portfolio may move together more, resulting in greater volatility.

The second limitation of active and indexed approaches has to do with rigidity. A stock picker, by definition, seeks specific names for the portfolio. He or she wants to buy those companies deemed desirable and sell those dubbed inferior. Such a manager adds and removes holdings at self-identified optimal times. Being rigid on what names to trade and when makes the manager subject to prices set by the market. An active manager may pay up for a “good” stock or accept a lower price to get out of a “bad” stock.

Now consider an index fund during reconstitution. It’s not a manager dictating the names and times but a third-party. For example, when changes to the Russell 2000 are announced, an index fund springs into action. In an effort to minimize the noise around the benchmark’s return, the manager buys and sells to match it. The amounts that are paid and the proceeds that are received are based on prices set by the market. Reconstitutions are announced to the public in advance. Not only are index providers placing the same trades, but traders on the other side know that they must make the trade to achieve their goal.

A flexible, evidence-based approach removes these impediments. By being agnostic on individual names and knowing that research shows that attributes of stocks explain returns, companies can be viewed as substitutes. If a stock picker or an index fund has to buy/sell a specific name, the flexible manager can oblige and choose to hold a different stock instead. If stocks with similar characteristics are perceived as equivalent, the one commanding the highest price can be sold while a lower priced option can be bought.

There is a price to this malleable approach. When comparing the results to a benchmark, there will likely be a difference. It may be negative in the short run. Longer-term, though, the flexible manager has added positions at more attractive levels and has a portfolio better built for the future. Over time, the noise fades and superior results emerge.

How does average ten year outperformance of 0.97% for large value and 1.52% for small value compare to the alternatives? Again, using SPIVA data, we see that over the 10 years ended June 30, 2020, 86% of active large value and 90% of active small value managers failed to perform better than their Standard and Poor’s benchmark.

An index fund would be expected to trail its benchmark by the expense ratio. This reliable result can be comforting. But a detail can be lost when returns are reported in their standard, annualized format. That aspect is the cumulative impact of relative performance and fees.

For example, consider the 10 years ended 9/30/20. DFA US Large Cap Value posted an annualized return of 10.09% vs. 9.95% for the Russell 1000 Value. If we look at this result on a cumulative (de-annualized) basis, we see that the performance was 161.50% vs. 158.20% or 3.30% greater return. An index fund charging a low expense ratio, say 0.07%, would return 9.88% (the benchmark return less the expense ratio). The cumulative return of the index fund is 156.56% vs. 158.20% or 1.64% less than the benchmark.

The SPIVA study shows that the average large value fund returned 9.08% for this 10 year period. It’s been established that this is a sub-par result. But, what’s the cumulative effect? Earning 9.08% per year versus 9.95% for the benchmark accumulates to 19.72% performance lag!

Lastly, it is difficult for a fund to outperform if it disappears before the evaluation period ends. This occurs if a fund is liquidated or merged into another fund. How common is it for a fund to not survive? SPIVA tells us this story, too. As time goes on, active funds become fewer and fewer.

The prolonged lag in the performance of value stocks relative to growth stocks has been frustrating. However, it also offers an opportunity to position a portfolio to benefit from an inevitable value rebound. In addition to what to pursue, how to seek the exposure must be considered. An evidence-based approach provides a consistent experience. Flexible implementation can cause short-term noise but has also led to long-term outperformance. These superior results compound in a favorable way, which contrasts with the impact of active underperformance or fee drag from index funds. Working with an established partner that has a disciplined approach, means the fund knows how to and will be around to deliver.

As Chief Investment Officer, Dan is responsible for developing Trust Company’s investment strategy and managing client portfolios.

Planning Before the End of 2020

by Westray Veasey, J.D.

The Tax Cuts and Jobs Act of 2017 (“TCJA”), signed into law at the end of 2017, was based on tax reform advocated by Congressional Republicans and the Trump administration and resulted in the highest federal gift and estate tax exemption ever available under the current transfer tax system, currently $11.58MM per person. A couple can leave just over $23MM to their beneficiaries before incurring a 40% tax on the excess. This high exemption is scheduled to return to pre-TCJA levels, or $5MM per person indexed for inflation back to 2010, in 2026. If Joe Biden is elected President in the November election, and the Democrats regain control of the Senate and keep control of the House, a government looking to raise revenue for stimulus spending and to address wealth inequality could seek to implement tax changes that could negatively impact estate planning. Changes anticipated include reducing exemption amounts before 2026 and possibly to amounts lower than pre-TCJA levels, raising the gift and estate tax rate above 40%, and curtailing effective estate planning techniques such as valuation discounts. Any such changes could be effective as soon as January 1, 2021 if Congress passes legislation having retroactive effect.

Bottom line: If you were considering implementing estate planning strategies before 2026 to take advantage of the high TCJA exemptions, you may want to do that now. Recall that in 2012 there was much anticipation that the exemption could drop from $5MM to $1MM. As a result, there was a flurry of activity at the end of 2012, and many who rushed to make large gifts to lock in the higher exemption were later unhappy with the plans they made when the exemption did not, in fact, go way down. The lessons to be learned from 2012 are (1) plan ahead: go ahead and contact your advisory team to run projections, discuss strategies, get appraisals and have documents prepared, and (2) whatever you decide to do, make sure you will be comfortable with your decision even if the laws do not change after the election.

It is important to keep in mind that the exemption is used from the bottom up, meaning that if you want to use the “bonus” part of the current exemption that is scheduled to sunset in 2026 (or next year, worst case), you have to make a gift in excess of what the exemption will be in the future when it is reduced. Example: You make a gift of $6MM today and the exemption is $10MM. If the exemption is reduced to $5MM on January 1, 2021, on that date you will have $0 exemption left and $4MM of the $5MM “bonus” exemption you had in 2020 will have been wasted.

What strategies might you implement to take advantage of the record high exemptions before tax mitigation techniques are curtailed, exemptions are reduced, and taxes are increased? It depends, of course. If you are wealthy enough to use your full exemption without having to access any assets you give away, you could simply make a gift outright or in trust for your beneficiaries up to the amount of the current exemption. Many wealthy people, however, do have not sufficient assets to use all of their exemptions and not be able to access those assets should they need to.

If you are in that category, a spousal lifetime access trust (or “SLAT”) is a strategy that can take advantage of high exemption amounts without eliminating access to your assets in the future. With a SLAT, one spouse makes a gift in trust for the benefit of the other spouse (and others if desired). This uses the donor spouse’s exemption, and if the spouses later need funds, the trustee can make distributions from the trust to the beneficiary spouse. If you have sufficient assets, it is possible for each spouse to set up a SLAT for the other spouse and use all $23MM of their combined exemptions. If you don’t have sufficient assets, one spouse should set up a SLAT using as much of his or her bonus exemption as possible, preserving the full base exemption of the other spouse for future planning.

There are obvious complexities to designing and implementing a SLAT. For example, what assets should fund the trust, who should serve as trustee, and how you may be able to protect against the possibility of divorce or the beneficiary spouse predeceasing. Consultation with your advisory team is critical to the viability and success of the strategy.

In addition to record high exemptions, wealthy individuals should also take advantage of the economic impact of COVID-19, namely pandemic-depressed asset values and record low interest rates. One such strategy is a Grantor Retained Annuity Trust (or “GRAT”). With a GRAT, you can transfer assets to a trust and retain an annuity interest in the trust for a term of years. At the end of your retained term, any amount remaining in the trust passes to your beneficiaries. A gift is made equal to the value of the property contributed to the trust less the present value of your retained interest. (Note that if the annuity is sizeable enough, the gift can be virtually zero, which is a way to implement additional planning to take advantage of low rates even if you have already used your exemption.) If the assets in the trust appreciate in excess of a government rate called the Section 7520 rate, that appreciation will pass to the remainder beneficiary without making any additional gift. The Section 7520 rate for October 2020 is 0.4%, so it is quite likely that a GRAT could pass significant value to the trust’s remainder beneficiaries without a gift tax cost, especially if assets contributed to the GRAT are currently at depressed values and are expected to appreciate post-pandemic.

An intra-family loan is a simple and low cost technique that works best in low interest rate environments. If the interest rate on a loan to a beneficiary is at the applicable federal rate (“AFR”), which for long-term loans made in October 2020 is 1.12%, the loan will not be treated as a gift. Assuming the beneficiary can use the loan proceeds to pay down higher rate debt or make investments that will yield more than the AFR, assets are passing to the beneficiary without any gift or estate tax.

There is a window of opportunity to take advantage of these and several other estate planning strategies before the impact of the November election hits and the economy recovers from the pandemic. Anyone with net worth in excess of the reduced exemption levels that may be in effect as early as January 2021 should engage their advisory team to explore these planning opportunities while there is still time.

Behavioral Finance: Understanding Bias

by Lindsey Stetson, CFP®

At Trust Company of the South, we believe markets are efficient. This means that all available information has been taken into account in real-time and is accurately reflected in current pricing. An individual trying to “time” the market or find hidden value is no match to the volume and speed at which trades are executed in the marketplace. However, market efficiency does not require all market participants to act rationally. Individuals often fall prey to behavioral biases that result in irrational decision-making, which may be detrimental to investment returns and ultimately in achieving financial goals.

A few of the most common biases advisors encounter with clients are discussed below. They should serve to highlight the importance of setting a target allocation for your portfolio and developing an investment plan so you can refer to it when you consider making changes during adverse market conditions.

Loss Aversion
This bias occurs when avoiding a potential loss takes precedence over achieving a potential gain. Because we tend to recall losses more vividly than gains, we focus on avoiding that pain to the detriment of potential gains. An example of this tendency is holding on to a losing investment for too long in order to avoid realizing a loss. On the flip side, investors may quickly sell securities that have appreciated to lock in profits.

Recency Bias
Most people find it easier to remember what happened yesterday compared to several years ago. This can hurt us when making investment decisions. Recency bias prompts us to place too much importance on current events, which can cause hasty decisions when markets are volatile.

Confirmation Bias
This is the tendency to seek information that supports your opinions and ignores information that contradicts them. Because the investor focuses on data that supports his or her decision, it reinforces that decision and leads to the belief that nothing can go wrong. This can lead to taking on too much risk in the portfolio.

Mental Accounting
Mental accounting occurs when you artificially compartmentalize money into different categories and apply different decision rules to each. The underlying concept is the fungibility of money, which means that, regardless of the origin or intended use, all money is the same and should be valued equally whether it is earned or received as a gift. Often mental accounting is applied to inherited assets. Diversifying out of Grandad’s stocks may make sense, but it’s often difficult for the recipient to sell due to the associated attachment.

Herd Mentality
Herd mentality is the tendency to follow what other investors are doing, rather than following the path that makes sense for your goals. This behavior has served humans well as a survival technique, but investors need to stay on their own course.

While everyone is susceptible to these pitfalls, there are ways to avoid them. The first step is to work with an advisor. We help identify biases and educate clients so the decisions they make are rational. We can also help reduce the effects of emotion on your wealth decisions. Your investment policy statement, which is developed based on your risk tolerance and goals, should serve as a roadmap for your decisions. Staying disciplined will serve you well in the long run and you will find it’s much easier with an advisor by your side.

FAQ Round Up with Dan

by Dan Tolomay, CFA

Over the last few months, the financial sector has experienced prosperity, decline and only one thing has been constant — that nothing seems to be constant. We all experience the anxiety that comes with not knowing what comes next. Our clients have been asking great questions lately, running the gamut in topics from the current geo-political climate to economic conditions to investing fundamentals. Trust Company’s CIO, Dan Tolomay, has compiled some of our most frequently asked questions and responses for you below. 

The COVID-19 cases keep rising. What does this mean for the economy and the markets?

Different states took different approaches to shutting down and re-opening. Those that rushed to re-open learned the hard way that they should have listened to the medical experts. Increasingly, the policy response has fallen on state and local leaders. Hopefully, they will learn from areas that have had success containing the virus.

There is a risk of more shutdowns, which would be effective at slowing the virus but would harm the economy. It is interesting to see capitalism at work. In a relatively short-time frame, we’ve learned to conduct virtual business and education, shop at (without entering) brick-and-mortar stores, and interact when necessary with the help of masks, shields, and sanitizer. The transition isn’t easy; but, over time, companies innovate and adapt, and conditions improve. The incentive to provide solutions and make profits drives these companies. These same reasons drive the continued search for a vaccine.

Many have been confounded by the rise in the markets at a time of increased Coronavirus cases. There are two things to remember with markets: (1) they are efficient at processing new information and adjusting prices accordingly and (2) they are forward looking. The news seems bad, yes. But, if it’s not as bad as macro expectations, that’s a positive. Also, the focus is not on the economic damage done or cases reported but future prospects and containment. The markets were blindsided with COVID but now deal with a known enemy. Each day we learn more and are closer to its exhaustion.

What’s the latest on value vs. growth stocks? Has TCTS made any changes?

A component of our investment philosophy is that we expect stocks trading at lower relative prices to have higher returns than names where valuations are higher. This is not a guarantee, though. We have been in a period of growth out-performance. While we believe in value long-term, we also have tactical reasons to be optimistic.

At the end of 2019, growth stocks were trading at 8.17x book value (vs. 5.10x average) while value traded at 2.14x book value (vs. 2.06x average). As there is a tight relationship between valuations and subsequent return, value had the better outlook.
The market sold off from 2/19/20 to 3/23/20. At the end of March, growth had fallen to 7.12x while value dropped to 1.60x. After the selloff, growth was cheaper but still expensive. Value became even more attractive. Fast forward to June 30th and growth and value were at 10.98x and 2.05x, respectively. The continued value lag has been frustrating, but we are more ardent than before.

With the headlines reminding us of value’s under-performance, it helps to put a value tilt in perspective. For example, for the 12 months ended June 30, 2020, the Russell 3000 Growth Index returned 22% while the Russell 3000 Value index delivered -9%, a variance of 31%. This gap is eye-opening but was not likely realized by many.

The market is roughly split between value and growth, so the return would have been 6.5%. An all value portfolio would have lagged by -15.5%. Not good, but not as bad as -31%. Compare that to a value tilt of say, 60% value and 40% growth. The return on that portfolio would be 3.4% and lagged the market by only 3.1%.

Why should I hold international stocks?

International stocks, represented by the MSCI All Country World Index (ACWI) ex US, have underperformed U.S. stocks in 8 of the last 10 years. But, how many of those years was the United States the top performer? Zero. Its best showing was 2013 when it placed 3rd (behind Finland and Ireland). Better returns will likely come from a country outside the U.S., but we don’t know which one(s).

So, what do we do? Own them all. As Jack Bogle, the founder of Vanguard said, “rather than look for the needle in the haystack, buy the haystack”. If we can’t identify the winners in advance, owning all the options gives us at least some exposure to the winners. Unfortunately, we also get some exposure to the losers. But research can help us optimize.
About half of the global investable stock market is international, which is a big opportunity set. Historically, investors have reduced their volatility the most by holding 30-35% of their equities abroad. Doing so ensures exposure to the best performer and should make an all domestic stock portfolio’s ride less bumpy.

Over the past 21 years, the US has won 11 times and foreign shares have been on top 10 times. At the beginning of 2008, when international triumphed six years in a row, one might have asked “why own US stocks?”. While it’s not known when the tide will turn, we know it will at some point. As valuations are more attractive beyond our shores, it’s a good time to buy low and sell high.

What moves should I be making ahead of the election?

As is the case with every election, anxiety rises. And, whether the worry is four more years or a change in control, the answer is the same – accept it is out of your control. There are reasons to feel reassured: checks and balances and mid-term elections.

In our current situation, one party controls the White House and Senate while another party controls the House. This can lead to frustrating gridlock, but it also prevents major policy changes. Should one party gain control of all three chambers, there are still items that prevent upheaval. One is the presence of the other party and moderates. The fringe elements garner the headlines, but there has to be consensus buy-in to implement changes. Lastly, even if one party begins radical changes, mid-term elections are only two years away.

It is not recommended that portfolio changes be made in anticipation of the election. First, what seems certain may not materialize (ex. 2016 presidential election, Brexit, etc.). Second, markets efficiently process new situations such that trying to outsmart global investors’ collective wisdom is futile. Lastly, much like the COVID situation, companies adapt to profit. In the face of tax changes, regulation revamps, tariffs, etc., firms modify their actions for survival and success.

If the government’s actions cause the dollar to weaken, what does that mean for my portfolio?

If government spending and monetary stimulus from the Federal Reserve increases inflation and the Fed holds down interest rates, there could be downward pressure on the U.S. dollar. There are multiple ways that this could impact one’s investments.

U.S. multinationals would benefit as American goods would become less expensive overseas. Also, when foreign sales are repatriated back to the States, there would be a benefit as the foreign currency would buy more dollars. International stocks would face the reverse situation. But, a U.S. investor would benefit as shares of foreign companies, which are denominated in other currency, could appreciate as the dollar declines.

A weak dollar is inflationary to Americans. Foreign goods become more expensive as the dollar falls. Higher inflation expectations tend to push up interest rates as bondholders seek to earn a positive return after inflation. Higher yields would push down bond prices. Inflation would force the Fed to take a more restrictive posture, which would likely mean higher short-term rates and better yields on money market vehicles.

How can the U.S. remain stable if it keeps running deficits?

The government spending more than it takes in is nothing new. However, a renewed focus has been placed on its finances in the wake of the COVID-19 response. Tax revenues are down and spending is up due to stimulus (and potentially more to come). What’s more, many states and cities are also experiencing financial strain, which has been exacerbated by the pandemic.

States are not able to routinely issue debt; so, they cannot finance ongoing deficits. If the books need to be balanced, revenues must rise and/or expenditures must fall. Such moves would be restrictive, not stimulative, at a time when economies are shaky. As such, the Federal government may have to step in.

Additional spending would need to be financed. Thankfully, rates are currently very low, which will ease the burden. Also in the government’s favor is the fact that American rates are higher than many other nations. As a result, finding buyers of our debt should be easier.

Eventually, the bill will come due. Taxes will need to rise and/or spending will need to fall. If steps are not taken, we’d expect to see buyers of Treasury debt perceive the U.S. as less creditworthy. This would take the form of a higher required return. So far, we have not seen that dynamic play out.

Why would I want to hold bonds at today’s low interest rates?

There is a great visual from Vanguard  that shows the close relationship between the current 10-year U.S. Treasury yield and the subsequent decade’s return for high quality fixed income. That number is below 0.75% today. Does it make sense to hold bonds?

The two main roles that bonds play are to generate income and dampen equity volatility. There’s not much income to speak of today. Rather than chase yield in lower quality or longer maturity bonds, more equity might be the answer. The dividend yield on stocks is close to 2% today. So, an investor could collect the higher yield, have exposure to potentially rising dividends, and have the possibility of capital appreciation as well.

This move is not without risk, though. Dividends can be cut and share prices can fall. So, increasing equity exposure should not exceed one’s ability or willingness to bear risk. If volatility reduction is sought, equities and riskier bonds are not the answer. High quality bonds provide stability and a better yield than cash (0.08% currently). Further, the Fed has been clear that short-term rates (which drive money market yields) are to remain low for some time.

Being smart about a bond allocation can improve results. For example, risk should be sought when compensation for bearing that risk is offered. For example, if bonds, which have greater risk, yielded the same as cash, why would you own bonds? Alternatively, if a lower quality bond doesn’t pay more than a high quality issue, why take the risk? Diversifying across maturities and geographies can lower volatility and improve returns by expanding the opportunity set.

We’ve had quite a run from 2009, aren’t we due for a downturn? Should I reduce risk?

Making investment decisions based on past performance or hunches is not wise. Rather, the questions to ask pertain primarily to: required return, risk tolerance, and time horizon. If your portfolio has performed better than hoped, you may be able to de-risk as you don’t need to target the same level of return. Similarly, if your personal situation has changed that you are not willing or able to tolerate as much risk, a change may be in order. Last, as the time until your goal nears, it can make sense to lower your risk and return profile as there’s less time to recover from a market dip.

If no changes are necessary, stick to the controllable and fundamental: diversify, target areas of the market where valuations are more attractive and risk is being compensated, and minimize costs.

As Chief Investment Officer, Dan is responsible for developing Trust Company’s investment strategy and managing client portfolios. 

Weather Ahead

by William Smith, CFP®

Flying blind

Inside a dense layer of clouds, I couldn’t see anything outside the plane.  The pilot tried to prepare me for this, but his coaching hadn’t helped in the moment.  It’s difficult to simulate what we were experiencing, instrument flight conditions, at least it was 30 years ago.  In a series of rapid fire instructions, air traffic control finally directed us, “Baron one seven niner romeo papa turn left heading two seven zero, descend and maintain three thousand, join the localizer, cleared for the ILS two three approach, contact Greensboro tower now on one nineteen point one.”

I watched the pilot maneuver the airplane, never once taking his eyes off the instrument panel, checking gauges, following a disciplined process — he remained calm throughout.  Despite my anxiety about this environment: the noisy clamor from the radios, constant terrifying turbulence, and falling forward 200 mph toward our destination with zero visibility — I trusted the pilot.  Scanning the gauges, I found what I thought was the altimeter.  It was spinning counter-clockwise, 3000 feet, down to 2000 feet, 1500 feet and suddenly, we broke through the clouds, several hundred feet above ground, magically aligned toward runway 23.  Once safely on the ground at Piedmont Triad International Airport – I had never felt more relieved yet inspired.

On that day in the summer of 1988, I realized I wanted to learn to fly.  The entire program appealed to me:  the challenge of planning a flight, navigating, communicating, coping with weather, responding to pressure situations – managing my and possibly my passengers’ emotions.  Little did I know that the experience of becoming a private pilot proved to be the perfect training ground for my future career as a financial advisor.


Planning your trip

Independent advisors, like my colleagues at Trust Company, serve our clients in a fiduciary capacity, meaning our interests are aligned with yours — we’re in the plane with you.

Much like a pilot, at the beginning of our journey together, we gather details and chart a course to your desired destination.  While the pilot is concerned about fuel needed for the trip, wind speeds and direction, and any restricted airspace along the route, your advisor requires details about your current assets, tax situation, spending needs, charitable and legacy goals.  Do you hold concentrated stock positions?  These are like nasty weather events we can avoid altogether by diversifying.  How have you responded to past bear markets?  They happen with unfortunate frequency (about once every five years since WWII) and best practice suggests we endure through these turbulent patches, trust our process and appreciate that eventually, all bear markets come to an end.

Weather ahead

Inevitably, circumstances may force us to change course enroute.  Sometimes we can navigate around the event, other times we must grit our teeth and fly through the turbulence.  The pilot may encounter different winds than forecast, icing at the requested altitude or even worse.  On the ground, your advisor responds to your life events as they occur: job loss, incapacity, birth of a grandchild, an unexpected inheritance – all of these may require a modification to the original plan.  In the midst of the storm, an advisor, just like the pilot, slows down, maintains a level attitude, assesses the data and focuses on the factors he or she can control:  can we rebalance the portfolio, harvest any unrealized losses, or deploy available cash at discounted prices?

Both pilots and advisors operate in a setting that’s highly volatile, and if not managed properly can have life-altering consequences.  We approach that environment by formulating a plan, avoiding unnecessary risks, and executing that plan with discipline and focus.

Handling turbulence

Regardless of how much coaching you’ve received, bear markets are scary, just like flying through the clouds on an instrument approach for the first time.  Sometimes they’re severe but brief like the market crash in October 1987 or the most recent episode in March 2020.  Other times conditions gradually erode and the environment goes from bad to worse over several years like the Dot-Com bust of the early 2000s.  In all cases however, the most prudent path forward is to remain calm, stay in your seat and trust that the markets will recover.  Every past market decline has been temporary, while the advance is permanent.

For additional valuable perspective on tuning out the noise associated with stock market events, take 2 minutes to listen to this fantastic piece from Dimensional Fund Advisors –  Tuning out the Noise.

Bill serves as President and Chief Executive Officer of the firm as well as Chairman of the Board.  Based in the Greensboro office, he oversees client relationships, assists in new business development efforts, and works directly with many of Trust Company’s not-for-profit clients.

How We Help: Putting our Family Office Services Model to Work for You

by Jay D. Eich, CFP®, CPA

The original vision of our founders was to make a positive impact in the lives of our clients and their families by continually working towards holistic financial well-being. Through our team of multi-disciplinary professionals, we’re able to develop and employ complex strategies across all areas of our client’s financial life. This “family office” approach sets us apart in our industry and allows us to add value for our clients in unique ways.

Recently, most conversations with our clients have been focused on the impact of geopolitical events on investment portfolios in the short term as well as the long run.

We’ve reassured them that while the coronavirus is an unprecedented event and market performance in the immediate is uncertain, based on the results of similar past events ( like the 1987 market crash, 2008 financial crisis, and the 2000 “dot com” crash), their performance, three, five and ten years after a market crisis will likely be very strong.

We’ve also reminded our clients that adversity often brings opportunity. In response to the recent downturn, we’ve harvested tax losses to offset future capital gains, we’ve rebalanced from bonds to stocks, and we’ve put excess cash to work at lower market prices.

While investment themes are often top of our client’s minds and are certainly very important, we’d like to highlight other examples of how our family office model has helped our clients in recent months.

Estate Planning
A depressed stock market is a great time to consider wealth transfer strategies. One such technique is a Grantor Retained Annuity Trust (called a “GRAT”) – a tax-advantaged way to transfer assets to the next generation. In addition to depressed market values, interest rates are also low, making this strategy an appealing way to transfer assets to the next generation with little, if any, gift or estate tax consequences.

A GRAT originates when a grantor contributes an asset to an irrevocable trust. The grantor retains the right to receive an annuity stream over the term of the trust. At the end of the term, the remaining assets transfer to a beneficiary, usually the grantor’s children. Depending on the terms of the trust, there may be gift tax consequences. However, by using a zeroed-out GRAT, a taxable gift can likely be avoided. Here is an example of how a zeroed-out GRAT works:

Sarah has one child, Amy. She would like to make a gift to Amy and feels the market will rise over the next few years. She contributes $1,000,000 of her diversified stock portfolio to a three year zeroed-out GRAT for Amy. In order to minimize the gift tax consequences, the trust must generally return the principal ($1,000,000 or $333,333 each year) plus an IRS prescribed rate (currently 0.60%) to Sarah. If the growth and income of the trust is greater than the IRS rate (again 0.60%), there will be remaining assets to pass to Amy. If we assume 10% growth and 2% income each year over the next three years, Sarah will have transferred approximately $270,000 to Amy with almost no use of her estate exemption.

Business Planning
Like so many Americans, many of our client’s livelihoods have been impacted by COVID-19. Our tax team has helped our clients navigate the Coronavirus Aid, Relief, and Economic Security Act (CARES Act) in order to determine the best way to access government programs, both as small business owners and as employees. While details of the programs are constantly changing, maintaining familiarity with the Paycheck Protection Program, The Economic Injury Disaster Loan Program, and state unemployment programs has allowed us to advise our clients on which program to apply to and why.

Tax Planning
The late 2019 release of the Setting Every Community Up for Retirement Enhancement Act (SECURE Act), and the recently released CARES Act have significantly impacted our clients. For 2020, July 15th is the new April 15th! In addition to the new filing deadline, first and second 2020 quarter payments (normally due in April and June of 2020) are also due on July 15th.

IRA, Roth IRA, and HSA contributions can also still be made by July 15th, while SEP contributions can still be made at the time you file your 2019 return (which can be as late as October of 2020).

New IRA distribution and contribution rules are also impactful for many of our clients. The SECURE Act allows IRA owners to make contributions beyond 70 ½ and required minimum distributions (RMDs) will now begin at age 72. While the CARES Act allows IRA owners to skip their 2020 RMD, in some cases it may still make sense to take one.

Financial Planning
The SECURE Act now requires adult children and non-spouse beneficiaries to deplete an IRA or Roth IRA within 10 years of the original owner’s death. Prior to the Act’s passing, adult children could take distributions over the course of their lifetimes. Lower stock market values combined with the SECURE act make this a great time to consider a Roth IRA conversion.

Let’s assume Bob, age 60, has a $1M IRA and a net worth of $15M. Bob does not anticipate a need for IRA funds during his lifetime. He has one child, Eric, who is 25 years old. Bob converts the IRA to a Roth IRA. This results in $1M of income to him and additional tax liability. After the conversion, Bob would not have to take distributions during his lifetime. If Bob lived until 90, there would be 40 years of tax free growth in the ROTH IRA, 30 years during Bob’s life plus an additional 10 that Eric could defer distribution. If the funds earned an average rate of return of 6%, it would more than overcome paying the tax upfront.

This technique does not just apply to the wealthy. For those who are young or in lower tax brackets this could also be a valuable technique. A Roth conversion is especially valuable when market values are down as you are converting at a much lower value, reducing tax and increasing expected future return.

Charitable Planning
As a result of the SECURE Act, the amount a taxpayer can deduct for cash contributions is limited to 60% of adjusted gross income (AGI). Cash donations over that amount can be carried over for up to five years and deducted on future tax returns. The CARES Act lifts the 60% of AGI limit to 100% for 2020 only before reverting back to the 60% limit in 2021.

The preparation of an income tax projection is critical in order to determine how best to make charitable contributions. In addition to the new 100% cash contribution limit, a few other issues to consider when making a charitable contribution include:

• Cash vs. Stock gifts: While a gift of appreciated stock is usually the best asset for a high net worth individual to give to charity, for those with portfolios who invested over the last few years, you may want to consider making a cash gift to take advantage of the increased AGI limits in 2020.

• The Medicare Surcharge: If your income exceeds certain thresholds you may pay significantly more for Medicare.

• Qualified Charitable Distributions (QCD): Distributions from an IRA are typically treated as taxable income. For those who are at least age 70 1/2, taking a QCD allows IRA owners to gift $100,000 per year from the IRA to a qualified charity. The QCD is not considered income nor do you report a deduction since the two cancel each other out.”

Risk Management Planning
At Trust Company of the South, we do not sell insurance policies. We help our clients identify areas of risk and then partner with firms who specialize in each individual area. Like most industries, the insurance industry has been impacted by COVID-19. Interest rates can have an impact on premiums and some providers have increased their premiums. If you have not recently done so, now is a great time to look at your life, medical, disability, property and casualty, and long term care coverage.

Please contact us if you have interest in discussing any of the above.