The spread of the coronavirus has been a traumatic event across the globe. In addition to health and safety concerns, we’ve seen the rapid and severe dislocation of financial markets. For investors, this has been a particularly difficult time, and we urge calm and careful assessment of asset allocations, with emphasis where possible on a long-term investment horizon. Beyond those ideas, we believe it is important to consider capitalizing on planning opportunities as they present themselves. In this article, we provide a number of ideas that we believe are particularly well suited to an environment where asset valuations have been reduced and interest rates are low.
Convert to a Roth. Now may be a time to consider converting your traditional IRA to a Roth IRA. Conversions are taxed in the year they take place, so converting when asset levels are lower can help reduce the current tax cost. Moreover, due to the SECURE Act of 2019, non-spouse beneficiaries (with certain exceptions1) are now required to withdraw 100% of inherited IRA assets within 10 years of the death of the original owner. Conversion allows beneficiaries who may be in their peak earning years to receive those assets income tax-free—making for especially tax-efficient transfer. (See “Estate Planning Under the SECURE Act,” below.)
Reassess Your Portfolio. In times of market turbulence, it may be appropriate to take stock of your investment portfolio to help ensure that your risk profile is aligned with your asset allocations. Take this opportunity to assess what you own and consider adjusting your portfolio with investments that make sense from a risk/return standpoint, and, for those at or nearing retirement, which may emphasize income generation.
Accelerate Equity Compensation Exercises. If you are paid with incentive stock options and nonqualified stock option grants, it may make sense to exercise shares in light of recent market declines. Income is recognized at the time of exercise, so such an acceleration could potentially reduce the overall tax consequences. In addition, you can start the clock for the required holding period (12 months) prior to sale in which any capital gains can be treated at the preferential long-term tax rate.
Consider Dollar-Cost Averaging. Regularly contributing to your portfolio can help take the emotion out of investing in volatile markets. Through dollar-cost averaging, investors can acquire more shares with the same fixed dollar amount as markets decline (and fewer shares as markets advance). Over time, this could reduce average cost per share and hopefully lessen anxiety levels.
Watch Mortgage Rates. A “flight to safety” in bonds and aggressive easing by the Federal Reserve have helped move Treasury yields to near historic lows. Mortgage rates, which are often heavily influenced by 10-year Treasuries, may move lower in the coming months, providing an opportunity to refinance and reduce the carrying cost of your home. Remember to consider closing expenses and the period you plan to stay in the home (and benefit from lower rates) in assessing whether the transaction is worthwhile.
Gift Depreciated Stocks. Many stocks have declined significantly in the current bear market. For those who are willing to part with some assets, this may be an opportunity to gift them away at lower valuations and move their future appreciation out of your estate. Such gifts can be made directly to individuals or to trusts to leverage additional planning advantages. Note that for older individuals who have low-basis securities with sizable gains, it may be better to hold onto them even if they have recently declined. State estate tax survivorship rules should also be considered.2
Create a SLAT to Transfer Assets. For those not as comfortable making gifts exclusively for heirs at this time, spousal limited access trusts, or SLATs, may be particularly useful. This type of trust may be attractive in light of its flexibility and the recent decline in asset values. A SLAT is a variation of a credit shelter trust or a generation-skipping tax (GST)-exempt trust or dynasty trust. Using his or her federal estate and gift tax exemption (and GST exemption), an individual creates and funds the trust to benefit a spouse and descendants. Upon the spouse’s death, the remainder passes to the descendants outright or in continuing trusts free of gift, estate and GST tax, no matter the value of the trust at that time.
Capitalize on Low Rates Through Trusts. A number of trusts have become more attractive with the sharp decline of interest rates. Grantor retained annuity trusts and charitable lead annuity trusts are among the vehicles where it is possible to transfer appreciation on assets beyond the assumed growth rate free of gift tax. This growth rate is determined based on a government interest rate, published monthly, of just 1.2% for April—its lowest level since 2013—providing a low hurdle rate to achieve excess growth for heirs.
Make Loans to Family Members. With lower interest rates, making or refinancing loans to family members or trusts for their benefit has also become a more attractive way to transfer assets. In making such a loan, you must charge a minimum interest rate—the “applicable federal rates” of 0.91% (short-term), 0.99% (mid-term) and 1.44% for (long-term) in April—to assure that there is an “arm’s length” transaction and the loan is not considered a disguised gift. Any appreciation on the amounts loaned is not a gift, and escapes gift and estate tax, and lower rates create a greater opportunity for the borrower to grow additional capital. This type of transaction can be done with certain types of trusts so that the interest payment is not subject to income tax for the lender. However, given current low rates, this may not be a concern.
We are all living in anxious and logistically challenging times, and given current market volatility, you may be unsure about how to proceed with regard to planning strategies. Fortunately, financial, tax and estate planning advisors can help you explore these ideas in greater detail; legal and accounting consultation is particularly important. We would encourage you to have those conversations, and take preparatory steps if interested. Finally, please do not hesitate to reach out to your Neuberger Berman team if you have any questions about the ideas we have discussed.