Look to Higher Ed for Higher Returns

Is your email inbox cluttered with offers to magically cure a host of problems? One popped up last weekend promising to fix my slice in 15 swings. I simply needed to mimic PGA TOUR pro Rory McIlroy’s swing plane. No mention of the thousands of hours Rory has invested developing his craft, nor a nod to his rare natural talent. Nope, that’s all, just 15 swings. Although skeptical about this offer, I do believe that by following the best practices of high achievers in any field, we can improve our performance.

For struggling investors, is there a model to emulate? One that would increase their chances of keeping it in the fairway? Turns out there is.

Many of the investment industry’s leading professionals, our Rory McIlroys, manage the endowment assets of our nation’s top colleges and universities. Endowments of all sizes share a common goal: to provide a current income to support today’s priorities and invest for growth to fund tomorrow’s initiatives. They do this by establishing a “spending policy”, a percentage of the portfolio that’s available to be distributed currently, and positioning their investments to achieve a return that offsets the effects of inflation, “preserving purchasing power.” Yale University’s Nobel Prize-winning professor James Tobin eloquently described this challenge, “the trustees of endowed institutions are the guardians of the future against the claims of the present. Their task is to preserve equity among generations.”

Professor Tobin’s job description for university trustees would well suit investors wishing to draw from their portfolios to support their current lifestyles while hoping to leave a legacy for their children, grandchildren, or a favorite charity.

Were we able to study how endowments allocate their investments and set spending percentages, that might offer valuable perspective. Thanks to the folks at TIAA and NACUBO (the National Association of College and University Business Officers) who publish an annual survey, we have that information readily available.

The 2020 NACUBO-TIAA Study of Endowments covering the year ending June 30, 2020 had 705 of the nation’s top endowed institutions participate. Representing more than $600 billion in assets, managers from the likes of Harvard, Princeton and Yale, along with those closer to home from UNC Chapel Hill, Duke and Elon, all reported how their investments were allocated, how much they withdrew from their portfolios, what rate of return they achieved, along with a multitude of other data.

The portfolios of the smaller funds ($100 million and below) typically allocated their assets roughly 70% to global equities and 30% to fixed income, a shift from 60% / 40% years ago due to a decade’s long stretch of low interest rates. This cohort of endowments realized net average annual returns of 7.5% over the past 25 years. Further, they spent roughly 4.5% of their portfolios annually over that timeframe, leaving 3% net growth, enough to outpace inflation – their primary goal. These results would likely garner a passing grade in Professor Tobin’s book.

With this reference, we can model these university endowments to improve outcomes in our personal portfolios. If you’re uncertain whether you have the proper asset allocation or if you’re spending more than your portfolio can support, we would recommend an in-depth consultation with your advisor. However, a CliffsNotes summary plan might read:

1. Set a broadly diversified asset allocation you can tolerate and maintain, especially through market corrections.
2. Consider spending no more than 4.5% of your portfolio each year.
3. Rebalance when market forces cause your allocation to drift from target.

Following these 3 steps will most certainly increase the likelihood of your having a successful investment experience.

If only fixing your slice was that easy.

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.

A Strategy to Offset Higher Taxes

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.

Behavioral Finance: Understanding Bias

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

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

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

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.

Weathering the Storm: Opportunities in Adversity

A philosophy can be defined as “an attitude held by an individual or organization that defines its behavior.” This, in essence, is how we view our investment philosophy at Trust Company of the South. It is not a theoretical concept. Rather, it is a concrete belief that drives our daily behavior as advisors. Consistency of investor behavior ultimately determines one’s investment success. Our philosophy has four core tenets. These foundational statements underpin our response to the current crisis:

Current Events

The most commonly used word we are hearing these days is “unprecedented”. Certainly what is happening today is unprecedented. There is no doubt. Without minimizing that fact, most crises are unprecedented.

September 11th is a relevant example. We had never had an attack on US soil (Hawaii was a territory during the attack on Pearl Harbor). We did not know what normal life would look like or how we would ever get back to it. The 2008-2009 Global Financial Crisis offers another comparison. For the first time ever, the “safest” asset on any household’s balance sheet, their home, began losing value. People were underwater in a matter of weeks as the number of foreclosures grew exponentially. The economic toll weighed on the economy for years.

Every crisis has a unique story, and each story in most people’s eyes is unprecedented. But if you listen closely, each story rhymes. First, an unprecedented event occurs, then markets enter a free fall. When the last drops of hope are gone, markets begin rising, and disciplined investors reap the reward.

Markets are efficient.

Beyond the research and data that support this statement, consider the conundrum of believing that markets are inefficient. The problem with this view is that you must now guess what the market has and has not priced in yet. How much worse will things become? What will be the ultimate economic cost? When will stocks fully recover? What will perform best going forward? These are questions no one can answer.

In our view, markets are extremely efficient. The recent volatility in prices proves this point. Early in this crisis, the market traded wildly up or down each day. The financial media likes to add a narrative to each trading day, but ultimately, each day prices are being moved to fair value based on any new information. We are receiving a lot of new information every day – every hour in fact. The market is excellent at processing new information. It leaves no opportunity to benefit from new information.

So why are prices falling so much and so quickly? Investors are recognizing that uncertainty (i.e. risk) has increased, and they are rightly demanding higher returns in the future in order to buy stocks today. It really is that simple.

What are we doing?

At this point, you may be wondering if our sage advice, honed over almost three decades, is to do nothing. Absolutely not!

Market downturns, painful as they may be, present a plethora of prudent planning opportunities. Every day our team is actively engaging with clients to improve their financial lives and advance the financial well-being of their children and future generations. Some of these opportunities include:

Investment Opportunities:

• Harvest tax losses to offset future gains
• Rebalance stock to bond allocations
• Sell risky concentrated stock positions with lower tax burdens
• Put excess cash to work in the market at lower prices

Financial Planning Strategy

• Refinance home mortgage to take advantage of low rates
• Convert a traditional IRA to a Roth IRA while account values are down and in light of SECURE Act changes

Estate Planning Suggestions

• Low AFR rates present planning opportunities
  • Enter into or refinance an intra-family loan
  • Enter into a sale of assets at depressed values with intentionally defective grantor trust for a note with a low interest rate
  • Charitable lead trusts and GRATs work best in a low interest rate environment
• Front load up to five years of annual exclusion gifts into a 529 plan to potentially capitalize on a market rebound
• For taxable estates, use historically high exemptions before they are taken away (by sunset or a new administration) to make gifts at depressed values
  • Gift to a spousal lifetime access trust (“SLAT”) preserves access to the gifted assets via the spouse

History is on our side. 

Trust Company is no stranger to market downturns. We have walked alongside our clients through the savings and loan crisis of the early 1990s, the 1997 Asian financial crisis, the Tech Wreck of the early 2000s, September 11th, the Great Financial Crisis of 2008-2009, the 2011 European debt crisis, and countless other impactful events. Every market downturn is unique or unprecedented in cause yet similar in resolution. Stocks rise again. The economy resumes. Disciplined investors are made whole and continue growing their wealth. In fact, those who stick to plan and remain steadfast do not just endure – they stand to benefit.

All this to say: our seasoned team stands ready to serve you in good times and bad.

The Best Assets to Donate to Charitable Organizations

When donating to a charity, you may ask yourself: should I give cash, appreciated securities or make a Qualified Charitable Distribution (“QCD”). The ideal assets to donate to charity are the ones that best fit your individual situation. Writing a check is certainly the easiest way to make a charitable contribution, but it isn’t the most tax-efficient since you are gifting after-tax dollars. However, gifts of cash can be deducted up to 60% of your Adjusted Gross Income (“AGI”).

Let’s explore three alternative assets to donate to charity that are more efficient than donating cash.

Appreciated Securities

If you have owned appreciated securities for a year or more, you can deduct the full market value of the securities on the day you make the charitable contribution. For example, if you bought stock ten years ago for $5,000, and now, when it’s worth $25,000, you donate it to a charitable organization, you are allowed to deduct the full $25,000 and avoid the long-term capital gains tax on the $20,000 profit. The $20,000 is a pre-tax deduction while the $5,000 of basis is an after-tax deduction.

The tax liability that you are giving away is based on your long-term capital gains rate. Your rate can be as low as 0%, or could be either 15% or 20%. The rates are dependent on your marital status and your taxable income. You may also be subject to the 3.8% net investment income tax.

A deduction for gifts of appreciated securities is generally limited to 30% of AGI when the gift is made to qualified charitable organizations. As an example, if your AGI is $100,000, a gift of securities with a fair market value of $30,000 or less is deductible. If you make a gift to a private foundation, the deduction is limited to 20% of AGI.

Qualified Charitable Distributions from Your IRA

If you are charitably inclined, a Qualified Charitable Distribution is another tax-efficient way to make charitable gifts provided you are age 70 ½ or older. A QCD allows you to transfer up to $100,000 per year from your IRA directly to a charitable organization while also satisfying your Required Minimum Distribution (“RMD”).

With a QCD, you don’t have to itemize income tax deductions to receive a tax benefit for your charitable contribution. The amount of your QCD is excluded from your gross income, meaning you will pay less tax. You end up with a 100% pre-tax charitable deduction with a tax savings between 10% and 37%, depending on your filing status and your top marginal rate. An added feature of QCDs is that they aren’t subject to the AGI limitations nor are they counted for purposes of the 60%, 30%, or 20% AGI limitations mentioned above.

The SECURE Act (see our January 2020 blog) states that if you turn 70 ½ in 2020, your RMDs will not be required until you turn 72. However, you can still make a QCD at 70 ½ even though you aren’t required to take RMDs. Taxpayers who turned 70 ½ prior to January 1, 2020 must continue to take distributions under the previous law.

The QCD is popular with retirees who plan to make charitable donations and don’t need the money from their RMDs. There are several benefits of excluding the QCD amount from your income.

First, given the recent tax legislation, 70% of taxpayers don’t itemize deductions by virtue of an increased standard deduction and the $10,000 limitation on deductible taxes (e.g. state and local income taxes and real estate and personal property taxes). When your gross income decreases by a QCD, you end up getting the tax benefit of a charitable deduction whether or not you itemize deductions.

Second, as a result of the QCD, your Adjusted Gross Income decreases. A lower AGI can result in less Social Security Income being taxed. You’ll also have less income to trigger the 3.8% surtax on net investment income. In contrast, a higher AGI can lead to higher Medicare premiums or lower the itemized deductions that are tied to AGI. For example, medical expenses are deductible to the extent they exceed 10% of AGI in 2020. Also higher income may reduce your eligibility for certain tax credits.

Maximizing Your Tax Savings with Charitable Gifts

The best way to limit the income taxes you pay while keeping 100% of your IRA money in your pocket on an after-tax basis is to take a taxable IRA distribution and make an offsetting charitable donation of appreciated securities. In general, this strategy works for anyone age 59 ½ and older. The best results occur when AGI limitations on the charitable deduction are not a factor, and your itemized deductions exceed your standard deduction.

As an example, assume your RMD is $50,000 and you donate $50,000 of low basis securities. From a tax standpoint, the deduction for the $50,000 stock donation negates the tax on the $50,000 IRA distribution. You are left with the $50,000 IRA distribution on which you didn’t have to pay income taxes, plus you gave away your capital gains tax on the appreciated securities. In essence, you have neutralized the income tax impact of taking an IRA distribution while also eliminating potential capital gains tax.

If you’re charitably inclined, there may be a way to maximize tax benefits through various gifting strategies. Our Wealth and Tax Advisors can navigate the complexities of your unique circumstances and help determine which type of charitable donation will result in the largest overall savings to you.

Kara works closely with other team members to provide seamless tax and compliance services to our clients. She has extensive experience in legacy and business succession planning, qualified and non-qualified stock options, restricted stock units and qualified and non-qualified retirement plans, as well as  education and retirement planning, and income tax compliance for U.S. citizens working abroad and non-U.S. citizens living and working in the United States.

How Will the SECURE Act Impact Your Retirement Planning?

The Setting Every Community Up for Retirement Enhancement Act (the “SECURE Act”), enacted on December 20, 2019, is landmark legislation containing a number of provisions that will affect most clients’ retirement planning. Here is a look at some of the more important elements of the Act that impact individuals.

With Congress concerned that we are not saving enough for retirement and recognizing that people are working later in life, the SECURE Act lifts the prohibition on contributing to a traditional IRA after the year an individual reaches age 70 ½. (There are no age limits on contributions to 401(k) plans or ROTH IRAs.) Beginning in 2020, individuals of any age can contribute earned income to a traditional IRA. This change allows people working past age 70 ½ an additional way to save for retirement and to potentially further reduce their taxable income, Medicare premiums, and taxation of their social security.

In addition, the Act pushed back the starting age for required minimum distributions (“RMDs”) from age 70 ½ to age 72. For individuals who turn age 70 ½ in or after 2020, their required beginning date for RMDs is April 1 of the year following the year they turn age 72. (If you turned age 70 ½ in 2019, you are under the old rules and must take an RMD by April 1, 2020.) Be aware, as under the prior law, if you push your first RMD to April 1 of the following year, you will have two RMDs for that year, as the following year’s RMD will also be due by year end. Clients who are not relying on their IRAs for living expenses can take advantage of the tax deferral offered by IRAs for another 18 months, but should they? Waiting longer to begin taking RMDs could push you into a higher tax bracket during retirement, and potentially increase the amount of taxable social security or generate additional income-related Medicare premium surcharges.

To counterbalance the tax deferral from the extension of contribution and RMD ages past 70 ½, the SECURE Act largely eliminated the “stretch IRA” strategy. Under the prior law, designated beneficiaries (humans and certain qualifying trusts) of inherited IRAs could take RMDs over their life expectancy. The younger the beneficiary, the greater the remaining life expectancy and the smaller percentage of the account withdrawn and taxed each year. Now, for IRA owners who die after December 31, 2019, beneficiaries other than “eligible designated beneficiaries” must empty the account by the end of the 10th year after the death of the IRA owner. Eligible designated beneficiaries are spouses, disabled or chronically ill persons, and individuals who are not more than 10 years younger than the deceased IRA owner. Those beneficiaries may generally still take their distributions over their life expectancy as under the pre-SECURE Act rules. Minor children of the account owner are also eligible designated beneficiaries, but they can only take age-based RMDs under the old rules until the age of majority, and then the 10 year rule kicks in.

Clients should reevaluate their IRA beneficiary choices and revisit how their IRA dollars fit into their overall estate planning strategy. For some, this could be as simple as making sure your beneficiary is an eligible designated beneficiary, or if that is not possible, increasing the number of beneficiaries to spread out the tax hit. Some clients might want to consider more complex strategies. Certain trust strategies could allow them to pass their accumulated retirement funds to their heirs on a tax-preferred basis, such as contributing their RMDs to a trust that can purchase tax-free wealth replacement life insurance or using a charitable remainder trust as the beneficiary of their account. In situations where the client has designated as their IRA beneficiary a trust that was designed to use the beneficiary’s life expectancy to stretch out RMDs under the prior law, the application of the SECURE Act rules could produce unintended adverse effects.

There were also a few notable non-retirement provisions in the SECURE Act. Tax-free distributions up to $10,000 (lifetime) from a 529 plan are allowed to pay principal or interest on a qualified education loan of a designated beneficiary and each of their siblings. Under the 2017 Tax Cuts and Jobs Act, for tax years 2018 and after, tax on the unearned income of children (the “kiddie tax”) was based on rates applicable to trusts, which are very compressed. The SECURE Act repealed these new rules so that starting in 2020, and with the option to start retroactively in 2018 and 2019, the kiddie tax rate returns to the marginal tax rate of the child’s parents. Potential tax savings could be achieved by filing amended returns to apply the new-old rates to unearned income in 2018 and/or 2019. Lastly, certain tax breaks were extended through 2020, including the exclusion from gross income for the discharge of certain qualified principal residence indebtedness, the mortgage insurance premium deduction and the deduction for qualified tuition and related expenses.

Like most tax laws, the SECURE Act presents both opportunities and challenges. Because most of its provisions go into effect in 2020, clients should talk with their advisor about whether and how the SECURE Act impacts them.

As Fiduciary Counsel, Westray oversees the firm’s legal matters, including its trust activities. Westray also serves as a resource to the firm’s individual clients with regard to their estate planning matters and to our nonprofit clients with regard to compliance issues.

The Importance of Women Joining the Wealth Conversation

More than 80% of women will be a primary financial decision maker for themselves or for someone else at some point in their lives. Therefore, financial engagement should be a priority, yet it’s all too common to see women bow out of the financial conversation or, worse, never show up in the first place.

Women have a life expectancy that is five years longer than men. This, combined with the rapidly increasing rate of divorce among those over 50 years of age, means that 80% of women will be solely responsible for their financial well-being at some point in their lives. Additionally, there are currently 34.2 million Americans providing unpaid care to an adult over the age of 50 and approximately 75% of those caregivers are female. For many caregivers, making sure bills are paid, insurance claims are filed correctly, and legal documents are up-to-date and in order also falls upon them.

A recent study by UBS found that 56% of married women leave investment and long-term financial planning to their husbands. Financial advisors experience such scenarios frequently – the couple who both show up to initial meetings, but then the wife stops attending, or the recently divorced woman with too much cash in her bank account, unsure if she will outlive her money.

Even more surprisingly, millennial women are more likely than any other age group to leave investment decisions to their husbands. While this may be a function of their current life stage, i.e. balancing work, children and household duties, it may indicate a trend in the wrong direction.

Financial planning is essentially creating a roadmap to reach your goals. It’s similar to setting a goal of running a marathon – while you may be able to finish the marathon without adhering to a training plan, creating and following a plan will create clarity and confidence that your goals are achievable. Planning is a form of dreaming and serves as a chance for individuals and couples to explore their financial priorities and to be mindful of their wealth today, in the future and as a legacy.

Joining the wealth conversation can feel overwhelming, but it doesn’t have to be. While it can be complex and technical, teaming up with an advisor who can break down the financial planning process into manageable pieces is an empowering experience. When questions arise, your financial plan will serve as a roadmap and your trusted advisor will be there to help you make informed decisions.

If you haven’t done so already, make financial engagement a priority in your life. There are many resources available, from books to blogs to in-person seminars to assist you in preparing for your financial future.  At Trust Company of the South, our advisors will partner with you in creating a plan for financial security and success, and walk with you along the journey, providing counsel and guidance every step of the way.

Charitable Giving in 2019

As individual taxpayers begin to plan their charitable gifts in 2019, below are some planning points for your consideration that could help you maximize the tax deductibility of your gifts.

Taxpayers should consider “bunching” multiple years of desired annual charitable gifts into one year.  Recall that the Tax Cuts and Jobs Act (TCJA) increased the basic standard deduction to $24,000 for married couples ($12,000 for single filers) and capped the deduction for state and local taxes at $10,000.  This means that many taxpayers who have previously itemized deductions may now take the standard deduction.  Essentially, joint taxpayers will only be itemizing if their $10,000 of state and local taxes, mortgage interest, and charitable deductions collectively exceed $24,000.  For example, a married couple that typically makes $12,000 of annual charitable gifts and will hit the $10,000 cap for state and local taxes could bunch together two years for gifts for a total of $24,000 in year 1.  Their total deductions in year 1 would be $34,000 and in year 2 they would simply take the $24,000 standard deduction.  The bunching strategy would allow the couple to total $58,000 of deductions over the two year period compared to $48,000 if they simply continued with $12,000 of annual gifts.

Alternatively a donor advised fund could be utilized by “front-loading” charitable gifts now.  A donor advised fund is an investment account held for charitable purposes.  Donors receive a charitable tax deduction when the account is funded and then are able to make gifts from the account over time.  Continuing the example from above, the married couple could make their $24,000 of gifts in year 1 to a donor advised fund rather than to charitable organizations directly.  They would benefit from the deduction in year 1 but could wait until future years to decide which charities will ultimately benefit from their fund.

Taxpayers who withdraw funds from their IRA account simply because they are subject to the required minimum distribution (RMD) rules could create significant tax savings by making a qualified charitable distribution (QCD) from their IRA.  All or a portion of a taxpayer’s  RMD (up to $100,000) can be sent directly to a charitable organization thereby excluding that amount from the taxpayer’s gross income but counting it against the RMD requirement.  A QCD could be a particularly useful strategy for taxpayers who will not receive a tax deduction for their charitable gifts because of the current increased standard deduction.  This strategy could fulfil a taxpayers desire to be charitable and receive a tax benefit for their donations.  The lower adjusted gross income resulting from a QCD may also lessen the effects of phase-outs and limitations on other tax deductions.

Rather than giving a charity a cash gift, taxpayers should consider making an in-kind gift of appreciated securities.  Suppose you own a mutual fund with a basis of $20,000 and a current value $100,000.  If you sold the fund and gifted the cash to a charity, after paying taxes, the net gift would be approximately $77,000.   If the mutual fund was instead gifted directly to the charity, which the charity can sell tax-free as a tax exempt entity, the value of your gift would be $100,000.  This strategy is especially useful for securities with a very low, or perhaps unknown, basis.

As a reminder, the TCJA states that no charitable deduction is allowed for any payment to an institution of higher learning in exchange for which the taxpayer receives the right to purchase tickets or seating at an athletic event.

If you would like to discuss tax planning specific to you and your family in greater detail, please contact your Wealth Advisor.

What Is Comprehensive Financial Planning?

In most of our client and prospective client meetings, we reference the term “comprehensive financial planning” as a process that distinguishes us from many of our competitors. Our comprehensive planning approach, the cornerstone of our client relationships, is an ongoing process; it evolves and changes over time as our clients’ goals and needs change over time.

“Comprehensive financial planning” encompasses a review and analysis of financial and non-financial aspects of a client’s affairs including investment/asset management, insurance and risk management, income tax, retirement, and estate planning. While our initial client conversations generally focus on investment/asset management topics, our goal is to understand other areas of the client’s life as well, in an effort to add maximum value to the client relationship. Our discussions with clients, therefore, cover a broad range of topics including:

• Investment/asset management planning discussions include understanding a client’s risk profile and cash needs, which facilitates establishing an investment objective and asset allocation strategy for underlying assets by account and on a consolidated basis.
• Insurance and risk management planning discussions include reviewing current life, disability, long-term care, health, and property & casualty insurance policies as well as discerning and analyzing client needs.
• Income tax planning discussions include reviewing income tax returns, how to best utilize loss carryforwards, and tax planning strategies based on specific client needs.
• Retirement planning discussions include reviewing the client’s income sources and cash flow, future cash flow scenarios via Monte Carlo simulations, and IRAs including Roth conversions, and the most efficient way to distribute (monthly, annually, or other) based on the client’s unique needs.
• Estate planning discussions include reviewing estate planning basics, the client’s estate balance sheet, the client’s current estate planning documents including family goals and an estate flowchart, and considerations based on our review of current documents.

The key benefits of comprehensive financial planning are peace of mind, focus to achieve clearly defined financial and non-financial goals, and increased trust between client and advisor. Some individuals, however, may choose not to provide the information necessary for comprehensive financial planning services because either they perceive the information gathering process to be too time consuming or difficult, or they may not want to focus on uncomfortable topics such as death or disability. While these reasons are certainly understandable, we believe the benefits of comprehensive financial planning far outweigh the costs.

At Trust Company of the South, we truly believe the philosophy: wealth management is more than managing money. Providing comprehensive financial planning services is one way we live out this mission on a daily basis.

Matthew 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.