Trying to recover from the damage the recession inflicted on your wealth? Consider these 10 steps back to financial health.
1. Hedge Against Higher Taxes. When it comes to reducing your taxes, the standard advice is to defer income into future years and accelerate expenses. But this logic only applies when tax rates are stable or falling. Even if Congress does nothing to impose new taxes, the Bush administration tax cuts will expire at the end of this year, pushing the income tax bracket and the top rate on dividends to 39.6 percent, up from 35 percent and 15 percent respectively. The top capital gains rate will climb from 15 percent to 20 percent.
Advice: Accelerate any additional income from bonuses, incentive pay, stock options or consulting work into this tax year, since the tax bite is likely to be bigger in future years. Business owners who can control the timing of dividend income should consider accelerating payments into this year, while it’s taxed at 15 percent.
2. Consider a Roth Conversion. This year, the IRS has eliminated the adjusted gross income cap of $100,000 that prevents many high-income investors from converting a Traditional IRA to a Roth IRA. Converting seems like a no-brainer since Roth IRAs enable you to withdraw assets tax-free and do not mandate any minimum distributions, thus enabling you to preserve tax-free growth for retirement assets that you don’t currently need. Still, Roth conversions require careful analysis. Most important, you must have funds available outside of your retirement accounts to pay the tax or the economics won’t make sense.
Under IRS rules, if you convert in 2010, you can spread the tax burden over the 2011 and 2012 tax years.
3. Protect Your Assets From Creditors. Here’s a scenario that will keep any parent awake at night: Junior borrows your sports car, collides with another vehicle and gravely injures its driver, a surgeon, who can no longer perform in the operating room. Robbed of his income, he sues you and your son – and wins a multimillion-dollar jury verdict. your savings, future earnings and even your homes are at risk.
One way to protect yourself is to buy an umbrella insurance policy, which can add millions of dollars in liability protection to the policies that you already carry on your home, car or boat. The coverage isn’t expensive. You can purchase a policy offering $1 million in protection for around $228 a year.
If you work in law, medicine or another litigation-prone field, consider going one step further by setting up an asset protection trust to shield your wealth from plaintiffs and creditors.
4. Insure Your Portfolio. If your family depends on your income for living expenses, you need life insurance to replace that money if something were to happen to you. But after 2008′s market rout, you just might need the same kind of replacement insurance for your portfolio. Heavily tilting your investments toward high-risk assets isn’t a viable strategy.
If your portfolio has shrunk in size, and you are concerned about the diminished value of the assets available to your spouse and children if you were to die before the investments recovered, purchase a 10-year term life insurance policy for an amount equal to your losses.
5. Transfer Your Wealth Tax-Efficiently. One of the few silver linings to the lingering financial crisis is an obscure interest rate set by the IRS, called the Applicable Federal Rate. The AFT is a hurdle rate of sorts for individuals looking to transfer assets to beneficiaries during their lifetimes while retaining an income stream during the trust term. If the return on the trust assets beats the AFR, all the appreciation above that rate passes to beneficiaries free of gift tax. Rates have been rising from historic lows. The current AFR is at 4.02 percent, so if you want to set up a grantor retained annuity trust, or GRAT, you should do it now.
6. Protect Your Heirs (From Themselves). If you’re a parent, you want the wealth that you leave to your children to be a positive force in their lives. But if you gift assets directly to them, you surrender the certainty that the money remains in their possession. Some children, regardless of age, just aren’t equipped to manage large sums of money. Others may enter high-risk professions like medicine and expose themselves to litigation. And if there’s a messy divorce, all bets are off: The estate you intended to leave to your children and grandchildren could end up lining the pockets of an ex-spouse.
The solution is to set up an irrevocable “family protection” trust, which can be created during your lifetime or spelled out in your will and funded when you die. By leaving assets to the trust, rather than making direct gifts to beneficiaries, the money will be shielded from lawsuits, creditors and ex-spouses alike.
7. Restructure Your Balance Sheet. According to the National Bankruptcy Research Center, Chapter 11 bankruptcy filings by wealthy individuals jumped 73 percent in the second quarter of last year compared to the same period in 2008. Anyone who borrowed heavily against stock or real estate that has declined substantially in value is at risk.
Credit problems can be paralyzing. But if you are facing a crunch, negotiating a workout plan should be at the top of your to-do list. Lenders are under pressure to clean up their balance sheets and may be willing to cut a deal.
8. Consider Liquid Alternative Investments. If you’re not enamored with pricey and opaque alternative investments like hedge funds, consider low-volatility hedging strategies that are a fraction of the price.
Using mutual funds, you can get hedge fund strategies in a vehicle that is regulated, liquid, transparent and has lower costs. The strategies can be divided into four main categories: hedged equity funds; long/short funds; long/short bond funds; futures, commodities and foreign exchange funds; and multistrategy funds.
9. Consider a “Do It Yourself” Structured Note. If you’ve been looking for a way to gently wade back into the market without risking the kinds of losses that ravaged portfolios in 2008, you might be tempted to invest in a structured product – prepackaged investments that combine a standard investment in stock, commodity or index with options or derivatives, a combination that is usually designed to provide a degree of principal protection.
10. Go Commercial. Renowned money manager Sir John Templeton famously urged investors to “buy at the point of maximum pessimism.” In today’s market environment, nothing fits the bill better than commercial real estate, where pessimism has tipped into despair – and created opportunities for patient investors with capital to deploy. There is going to be a large transfer of wealth between people who own and have overleveraged commercial real estate but can’t refinance, and the people who have liquidity.
In this challenging environment, managing wealth isn’t easy. Discussing these 10 planning ideas with your financial advisor should help you prepare for the rest of the year.$
Author-Bio: Ray Buckner (Chicago, Illinois) provides personal financial planning and wealth management services for professionals in the greater Chicago metropolitan area. His primary focus is serving pre-retirees who are preparing for a successful retirement as well as those who have already retired and want to develop a 100% retirement income personal paycheck. His pre-retiree clients want to focus on replacing 100% of their last year s income and keep their current standard of living through out their retirement adjusted each year for inflation.
Ray Buckner
630-890-1458
www.primerica.com/rbuckner
