Giving Away Your Cake (and eating it too), AKA Charitable Remainder Trusts

ImageOne of the first recorded instances of the age old phrase “a man can not have his cake and eat it too” was written from Thomas, Duke of Norfolk to Thomas Cromwell, speaking about how the construction of Kenninghall had cut deeply into his finances. Today, we use this phrase when considering saving something of value, or giving it up for consumption. When thinking about our own personal assets, we have many choices. We have the opportunity to hold on to them (having our cake), swap them out (trading for a different cake), or selling them and buying a consumable asset (eating the cake).

With responsible planning for the future, the size of your portfolio should grow through the years. At the point of retirement for someone, a combination of pension, social security, and portfolio income may be able to provide for all of their expenses. This is a fantastic place to be in as a retiree. A dependable cash flow can empower gifting to the extent that the cash flow remains intact.

A few months ago, I wrote about Charitable Remainder Trusts here. For a retiree that has an excess income stream from investments, a Charitable Remainder Trust (CRT) can provide a certain and continued stream of income from donated property.  As the name suggests, a charity will inherit the property held in the trust when the beneficiaries pass away, just as it would if you left the property to a charity in your will. However, the additional benefit of a CRT is the income tax deduction received for giving the property occurs immediately. As a beneficiary you retain an income interest.

Give thought to the idea of giving some of your cake away now. There are many great non-profits and charities that will thank you. Now, I know all this talk of cake has really gotten that sweet tooth going, so feel free to eat some cake now too!

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Portfolio Construction: The Way We See It – Part 1

In this ever changing world we live in, there are “advisors” everywhere. Flip on the TV, pull up a news app on your mobile device, or even the national paper. I came across a gem a few weeks ago from the NY Times archives.

SUNDAY, June 5, 1994; Picking Stocks by the Stars

Published: June 5, 1994

For those who missed the recent conference on “Astrology and the Stock Market” in Manhattan (about 40 people attended), here are some tips from several of the hot sessions:

The Art of Timing: Combining Astrological Indicators — Graham Bates, London financial astrologer. “I’m worried and confused about the eclipses in November. I don’t know what they’re going to do, but I know they’ll be important.”

Stocks, Planets and Solar Cycles — Richard Mogey, executive director of the Foundation for the Study of Cycles. “There’s a 23 percent gain the fifth year of every decade because of the Jupiter-Saturn cycle. I’d expect the same in 1995.”

The Cosmic ‘Inner Winner!’ — Paul Farrell, author of “Think Astrology and Grow Rich.” “When Uranus and Neptune go into Aquarius, I look toward information and technology.”

Beyond Cycles: Using Interpretive Astrology to Identify Key Turning Points in Markets — Charles Harvey, president of the Astrological Association of Great Britain. “When there is a new moon in the eighth house, Placidus system, in New York, there is always a major change in interest rates. That happens July 8.”

Want something more specific? Henry Weingarten, who heads the Astrologers Fund (the conference sponsor), predicts, “Novell will be at 30 next May.” But, “If it hits 35 before then, I’m out.”

There will always be very smart individuals that develop complex theories of why and how the markets work. This is part of human nature and our innate desire to understand how our world works. This is why we have departments in government and universities dedicated to studying human behavior. Our investment approach at Parsec is incredibly simple. We accept that markets behave irrationally in the short term. We feel that it would be a breach of our fiduciary duty to attempt to predict short term market movements.

Fiduciary duty is extremely important to us. This duty is a very old idea, which was defined here in America with Harvard College v. Amory in 1830. The decision of this case scolded the trustees and instructed them of their duty to manage the trust as they would manage their own affairs. This is known as the “Prudent Person Rule.” Here at Parsec, when evaluating an investment, we ask ourselves first is this in the best interest of our client and secondly would we invest in this particular security.

Be on the lookout for further posts on this topic.

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Taxable Income Reduction Strategies

As a trusted financial advisors for our clients, our priority is to stay apprised on current tax laws, as well as provide planning opportunities to reduce future tax liabilities. For many of our clients, their Traditional IRAs are also their largest tax liability. When an IRA is responsibly managed, the hope is that the account will continue growing until the owner’s late 70s. At that point in time, the mandatory withdrawals from the account may offset any capital appreciation and earnings on the account. When taking into account these growth expectations, as well as the client’s necessary cash flow, many clients find that the RMDs in their 80s will far exceed their necessary cash flow. These factors contribute to an increasing likelihood of the client having a higher tax rate later in life. Higher Modified Adjusted Gross Income(MAGI) is one concern that has a trickle down effect. When MAGI gets high enough, it can result in an income based adjustment for Medicare Part B and D. It should be clear by now that a healthy retirement can actually increase tax concerns.

So, by now you may be saying, “Thanks for the depressing news Daniel, I don’t think I want to read any further. ” I encourage you to keep reading.
 
Controlling Income

The first step in keeping MAGI low is controlling income. For retired individuals, there are two main sources of cash flow. The first being social security and pensions. These are fixed amounts that cannot be changed. The second source is income from personal assets. This includes brokerage accounts, Traditional IRAs, and Roth IRAs. A brokerage account is not a tax-deferred account. Therefore any income produced by the account will contribute to MAGI. It is possible to manipulate a brokerage account’s holdings to reduce taxable income. The second source of cash flow is withdrawals made from Traditional IRAs to supplement income or fulfill an RMD. These withdrawals are fully taxable to the individual. In addition to Traditional IRA withdrawals, Roth IRA withdrawals can be made, however, these withdrawals are not taxable to the individual if made after 59 ½. The IRS gives us tax tables, from these, we are able to determine the maximum amount of taxable income we want to produce for clients. As I said before, it may become impossible to keep income below this desired threshold when RMDs get larger and larger. If this is the case, we move on to advanced planning techniques.

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Roth Conversions and Charitable Remainder Trusts 
One of our favorite techniques to reduce the impact of RMDs is to combine the benefits of a Roth IRA with a charitable gift. The establishment of a Charitable Remainder Trust may allow someone with charitable intentions for their estate to realize the benefit now. The Charitable Remainder Trust can provide a lifetime income stream for the donor, as well as provide a large charitable deduction. In this tandem planning technique, the charitable deduction can offset the income incurred from a Traditional to Roth conversion. The reduction in the size of the Traditional IRA will also truncate the amount of the RMD going forward.
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This particular technique is just an example of some of the advanced planning options we evaluate with our clients. Every situation is different with special circumstances to consider. If you have any questions about these strategies, contact one of our advisors.
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Retirement Plan Savings 101

This time of year there are many employee benefit emails being churned through inboxes. Some of these benefits are time sensitive and can only be changed during qualifying events. Many times these benefits include health insurance coverage, group life and disability insurance coverage, and Health Savings or Health Reimbursement account withholdings. One benefit that is available to many employees, and can be changed at any time, is a retirement savings account. The maximization of these account benefits can result in a large reduction of your year-end tax bill. Let’s take a look at a few of the major plans approved for use by the IRS.

The 401(k):

The 401(k) is the most popular defined contribution plan available. The plan sponsor (the company) sets up the rules for employer contributions, which is approved by the IRS. Participants (employees) also have some decisions to make in regards to contributing to the account. For employees younger than 50, the 2014 maximum funding is $17,500 and for those older than 50 the maximum is $23,000. This employee contribution is subtracted from the employee’s taxable income for the year. This can lead to significant tax savings, but will also reduce the amount of take home pay for the employee. Similarly, some plans allow for a Roth 401(k). This plan functions the same way as the traditional 401(k), except employees do not get to exclude contributions from taxable income. However, once the employee reaches retirement age, all withdrawals from the Roth 401(k) are tax free, unlike a traditional 401(k).

The 403(b):

The 403(b) functions very similarly to the 401(k) but is only offered in certain types of organizations. Primarily, the 403(b) is offered to employees in public education and most non-profit organizations. The contribution limits are the same as the 401(k), with a slight advantage with the “catch up” rules.

SEP/SIMPLE Plans:

SEP IRAs and SIMPLE IRAs are two savings vehicles available to small business owners. These accounts give small business owners and their employees access to tax-deferred savings vehicles with lower administrative costs. The SEP IRA’s contribution limit is similar to the 401(k) and 403(b), but based on the discretion of the business owner. This is different from a 401(k), for which an employer is required to contribute a certain amount. The SIMPLE IRA has a maximum salary deferral of $12,000 for 2014, with a $2,500 catch-up for employees older than 50.

This just scratches the surface of the details involved with employer sponsored savings plans. If you have questions about whether you are making an appropriate deferral, contact your advisor for a review of your situation. If you own a business and are interested in establishing a company plan, contact Neal Nolan, our Director of ERISA for a comprehensive consultation.

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