Our Blog

DWM is committed to learning for its team, clients and friends. In this changing world, it’s extremely important to stay current in all areas impacting your financial future.

We encourage all of team members to “drill down” on current topics important to you and contribute to our weekly blogs.  Questions from our clients and their families are often featured in our blogs.  

Financial literacy for clients and their families is very important to us.  We generally hold an annual wealth management seminar for all of our clients.  We encourage regular, at least semi-annual, meetings in person with our clients to review family updates, progress on financial goals, asset allocation and performance of investments.  We’re happy to assist younger members of the family as part of our total wealth management program.

Here’s our latest blog:

 

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The Beauty in Roth Accounts

Written by GRANT MADDOX.

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The most common type of retirement accounts are traditional Individual Retirement Accounts (IRAs) and company sponsored traditional 401(k) plans, both of which are funded using pre-taxed dollars. The goal of these accounts is to accumulate retirement assets by deferring current year taxes and reducing your taxable income. Later, when funds are withdrawn, either voluntary or as part of a required minimum distribution upon reaching age 70.5, the accumulated earnings and contributions are subject to ordinary income tax. In addition to this, if you are below age 59.5 and you withdraw funds you could be subject to an additional 10% tax penalty.

“Cue the Roth IRA.” One alternative to popular IRAs and traditional 401(k) plans is the Roth IRA and Roth 401(k) (“Roths”). Contributions to both consist of after-tax funds. The accumulated earnings and contributions are not subject to income tax upon withdrawal. In addition to this, there are no required minimum distributions for Roths until the account has reached a non-spouse beneficiary. Although no current tax break is received, there are several arguments as to why Roth accounts can be a significant attribute to your portfolio and to your estate planning. As we will discuss below, the Roth has the ability to grow income tax-free for future generations.

 Contributions:

Funding a Roth account can occur in one of two ways; either through yearly contributions, currently limited to $6,000 per year if below age 50 and $7,000 if above age 50 for 2019 Roth IRA accounts. In addition to this, contributions may be limited for Roth IRAs if your income is between $193,000 and $203,000, for married filing jointly, and you are ineligible to contribute if your income is higher than the latter figure. Roth 401(k) contributions limitations are currently set at $19,000 per year per employee, with an available catch-up contribution of up to an additional $6,000 if age 50 or older. Contributions to Roths are typically more beneficial for young people because these funds will likely grow tax-free for a longer period of time and they generally have a lower current income tax bracket.

Conversions:

The IRS allows you to convert traditional IRAs to Roth IRAs without limitation. You simply have to include the converted amount as ordinary income and pay the tax. Converting traditional IRA funds to Roth is certainly not for everyone. Generally speaking, conversions may only be considered beneficial if you are currently in a lower tax bracket now, than when the funds will be distributed in the future. If you are in the highest tax bracket, it may not make sense to execute a Roth conversion. If you do not have available taxable funds, non-IRA funds, to pay applicable taxes, then a conversion may not be the best strategy for you. Lastly, conversion strategies are not usually recommended if you will have a need for your traditional IRA or Roth funds during the course of your lifetime(s).

Example:

In the right circumstances, a Roth conversion strategy may hold great potential to transfer large sums of after-tax wealth to future generations of your family. For example, let's assume a conversion of an $800,000 traditional IRA. Of course, this would typically be done over the course of several years to limit the amount of taxes paid on the conversion. However, following the completion of the conversion, these funds will continue to grow tax-free over the course of the converters’ lifetime (and spouse's lifetime). Assuming a 30 year lifespan, at an average rate of 5% per year, this would amount to close to $3,500,000 at the end of 30 years; a $2.7 million tax-free gain. For the purpose of this example, let's also assume these Roth funds skip over the converters’ children to a future generation of four potential grandchildren. Split evenly, each grandchild would hypothetically receive $875,000. At this point, the grandchildren generally would be required to take a small required distribution, however, the bulk of these Roth funds would grow-tax free until the grandchild reaches 85 years of age.  Assuming they receive these Roth funds at age 30, it's possible each grandchild could receive $5,600,000 of tax-free growth, assuming a 6% average yearly returns. For this example, the estimated federal tax cost of converting $800,000 in IRA funds may be close to $180,000, assuming conversions remain within the 24% tax bracket year-over-year. An estimated state tax cost may vary by state, however, some states such as IL, TN and FL do not tax IRA conversions. Now, if we multiply the $5.6 million times 4 (for each hypothetical grandchild) and add the $2.7 million of appreciation during the first 30 years, this is a total of $25.1 million of potential tax-free growth over 85 years. This obviously has the potential to be a truly amazing strategy. Note that because of the rules that enable people to stretch out distributions of an inherited Roth, the people who benefit the most are young.

To review if Roth strategies may be a good addition to your overall planning, please contact DWM and allow us to assist you in this process.

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Memorial Day 2019

Written by Ginny Wilson.

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In the spring of 1915, shortly after losing a friend in Ypres, a Canadian doctor, Lieutenant Colonel John McCrae was inspired by the sight of poppies growing in battle-scarred fields to write a now famous poem called 'In Flanders Fields'. After the First World War, the poppy was adopted as an international symbol of remembrance.

       

In Flanders Fields
John McCrae, 1915.

In Flanders fields the poppies blow
Between the crosses, row on row
That mark our place; and in the sky
The larks, still bravely singing, fly
Scarce heard amid the guns below.
We are the Dead. Short days ago
We lived, felt dawn, saw sunset glow,
Loved and were loved, and now we lie
In Flanders fields.

Take up our quarrel with the foe:
To you from failing hands we throw
The torch; be yours to hold it high.
If ye break faith with us who die
We shall not sleep, though poppies grow
In Flanders fields. 

 

On this Memorial Day, our DWM team would like to thank and honor all those who have served our country and for those who have paid the ultimate sacrifice for our freedom.

May you and your families have a safe and enjoyable holiday weekend!

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Your Money and Your Estate Taxes-Impacted Greatly by Your Withdrawal Rate

Written by Lester Detterbeck.

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Historically, retirement worries have centered around two major questions: 1) Will I run out of money and 2) Will my heirs owe estate taxes? Withdrawal rates in retirement certainly have a huge impact on your money and, in the future, perhaps your estate taxes as well.

Let’s first look at a hypothetical couple, age 65, just starting retirement with $3,000,000 of liquid investments and assume:

  • They spend $12,500 per month on basic retirement spending, health care, travel and gifts.
  • Their social security, net of Medicare premiums and taxes is $2,500 per month.
  • So, they need $10,000 monthly ($120,000 annually) from their portfolio.
  • Their annual investment return is 6%.
  • The tax rate on investment income is 20%
  • Inflation is 3%.
  • Their “real return” is 3% (6% gross less 3% inflation).
  • They live 30 years.

Their withdrawal rate is 4% ($120,000 divided by $3,000,000 in year one). And, since this withdrawal rate exceeds their real return of 3%, over time their portfolio starts to decline. In their 95th year, they spend their last dollar.

It’s not surprising that if this couple’s withdrawal rate was greater than 4%, e.g., they take out $150,000 per year (5%), they would likely run out of money (in 23 years). If their withdrawal rate is less, e.g. they take out $90,000 per year (3%), their portfolio stays almost perfectly level over this 30 year at $3 million.

So, now let’s turn to couple #2 with twice as much money and a similar withdrawal amount initially of $120,000 per year. Their $6,000,000 portfolio starts with an annual withdrawal rate of 2%. In 30 years, their portfolio would be $13 million. This hypothetical couple doesn’t need to worry about running out of money, but they do need to worry about estate taxes.

The lifetime estate tax exemption is currently $11.4 million ($22.8 million per couple). The estate tax exemption has changed dramatically over the years. As recently as 1997, the exemption was only $600,000 per person.  In 2007, it had risen to $2,000,000. In 2011 it jumped to $5,000,000 (plus annual inflation) where it stayed until the Tax Cuts and Jobs Act (TCJA) brought it to its current level.

If the so-called Blue Wave continues from the 2018 midterms into the 2020 general election, a Democratic majority in Washington could significantly change estate planning. Senator Bernie Sanders has suggested a reduction of the estate exemption to $3.5 million. Others have suggested a reduction to $2 million per person. Even assuming an inflation increase in the exemption, our second couple upon death could owe millions in estate taxes. Though taxpayers may be well under the exemption limits today, if their withdrawal rate is lower than their real return, their portfolio will increase and there might be a taxable estate in future years. Exemption amounts and tax rates are always subject to change.

One of the key tax strategies that will likely be employed to eliminate the estate tax for couples similar to couple #2 and others will be to use an irrevocable trust to freeze estate values. An irrevocable trust is a trust that cannot be changed or amended by its maker after it is signed. Irrevocable trusts are used to make gifts (often to children) “with strings attached.” Once the trust is funded, it is no longer part of the maker’s estate and appreciates for the benefit of the beneficiaries.

This effectively “freezes” the value of the gifted assets, since only the value when gifted may be added back to the maker’s estate, not the future value. Furthermore, while we are not attorneys, it is our understanding that certain gifts made while the lifetime exemption was $11.4 million may not be required to be added back at all.

A quick example. For simplicity, let’s assume couple #2 split their $6 million into two buckets, $3 million each. The first bucket is theirs to use for lifetime expense withdrawals. The second is in an irrevocable trust, gifted to their children. The first bucket is likely to be depleted in their lifetime (as we saw with couple #1). The second bucket grows to $13 million, as it has no withdrawals, other than taxes. Upon death, their estate would potentially only include the $3 million in gifts to the irrevocable trust 30 years earlier. Hence, no estate tax even with a future lifetime exemption of only $2 million.

Conclusions: Your withdrawal rate is a key metric. It requires a budget, financial plan and forecast. It will help you determine if you have enough money for your live(s) and if estate tax strategies may be needed in the future and how they might be designed. Please give us a call if you would like to discuss this very important topic in more detail.               

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