December Newsletter
30-Nov-2015 Greetings Clients!
We hope that you all had a wonderful Thanksgiving and that you enjoy the rest of the holiday season.
Our December newsletter provides information on long term investing and QTIP Trusts.
Please call our office to schedule an appointment with Mike if you would like to discuss strategies to reduce your 2015 tax liability before the year is over.
Have a great week!
Hanson & Co Staff
Investing for the Long Term
August 2015 was a brutal month for stocks. There were constant reports that the Dow Jones Industrial Average (DJIA) was down hundreds of points for the day, even down by 1000 points during one daily trading session. Ultimately, where do you think August 2015 wound up as far as historical comparisons? As bad as the crash of late 2008? Or even the subsequent bottom of early 2009?
Not exactly. August 2015 was the worst month for the DJIA since May 2010; it was the worst month for the S&P 500 index since May 2012. Thus, in the middle of a bull market that has lasted since 2009, there have been some severe ups and downs.
By the numbers
With that perspective, there are some points to keep in mind. For instance, don’t panic over what seem to be huge losses. Hearing that “the Dow is down by 1,000 points today” can be scary. However, when the Dow is over 18,000, as it was as recently as July 2015, a 1,000-point drop is less than a 6% loss. Indeed, the DJIA was down by 6.6% in August, while the S&P 500 lost 6.3%.
Now, losing 6% or 7% of your investment portfolio is hard to shrug off. It could be a precursor to a time like late 2008, when stocks continued to sink into the following year, and major U.S. indexes lost nearly 50% of their value.
On the other hand, the DJIA lost almost 8% in May 2010, and the S&P 500 fell by 6.3% in May 2012. Investors who sold during those pullbacks watched while stocks rebounded and continued to rise for years afterwards, reaching a succession of new highs.
The bottom line is that stocks can be volatile, on the way up or the way down. By the time you read this article, those indexes may have regained lost ground or dropped even lower.
Staying the course
Looking at the historical record, broad U.S. market indexes have always recovered from bear markets. That’s been true after the 1929 crash and the subsequent Great Depression; the stagnant stock market of the 1970s, stunted by inflation and unemployment, turned into a bull market lasting through the following two decades.
There’s no reason to suspect the current market weakness will be any different and probably no reason to alter your investment plan. Timing the stock market is notoriously difficult.
Basic strategies, such as building a diversified portfolio and investing regularly, are likely to prove profitable for investors with a long time horizon. However, if you are at a stage in your life where conservative investing is more appropriate—getting ready for retirement or building a college fund for your kids—you might want to talk with your investment advisor about the possibility of trimming stock market exposure now.
Opportunities abound
The worst recent stock market crashes (2000-02, 2008-09) have proven to be buying opportunities, as the market ascended to new highs both times. This might be the case again, especially if you’re periodically acquiring shares of stock funds in your 401(k) or a similar employer retirement plan.
Ironically, the August 2015 stock market stumble could also turn out to be a selling opportunity. If you are holding stocks or stock funds in a taxable account, consider selling any issues that now trade significantly below the price you’ve paid for them. In case of multiple purchases of the same security, specifically identify for sale the shares with the highest cost, which will generate the largest loss.
Once you’ve made the sales, you can deduct your net capital losses for the year 2015, up to $3,000. Excess losses can be carried forward and used to offset capital gains taken in the future. Therefore, harvesting losses can deliver tax savings in 2015 and the opportunity to take tax-free gains in future years.
QTIP Trusts Still Offer Advantages
For many people, trusts can play a role in estate planning. Indeed, a qualified terminable interest property (QTIP) trust may offer benefits to married couples. That’s especially true for people who are in a second (or even a third) marriage, because a QTIP trust can prevent a second spouse from disinheriting children from a first marriage.
Extending control
A QTIP trust allows the creator (grantor) to provide funds for a surviving spouse and also name the final beneficiaries.
Example 1: Dwight Emerson’s will calls for the establishment of a QTIP trust, to be funded with most of his assets. His second wife, Flo, will be entitled to all of the income from the QTIP trust, for as long as she lives. At Flo’s death, the assets remaining in the trust will go to Gregg Emerson and Helen Jenkins, Dwight’s children from a prior marriage.
Thus, Flo will be assured of cash flow for the rest of her life. However, she won’t be able to direct the QTIP trust assets to her own children, also from a prior marriage. Dwight can be sure that his children will receive whatever is left in the trust after Flo’s death.
This process can go both ways. Flo’s will also can create a QTIP trust for her assets, so that Dwight would receive lifetime income if he is the surviving spouse, yet Flo’s children would ultimately get the trust assets.
Asset protection
What’s more, a QTIP trust can provide asset protection.
Example 2: Kirk and Laurie Miller are married with grown children. Both Millers have wills calling for all of their assets to go into QTIP trusts. The surviving spouse will get all the trust income; in addition, the local bank named as trustee will be instructed to provide the survivor with additional funds from the trust, if necessary for ordinary living expenses, such as health care. Then, the remainder ultimately will go to their children.
With this arrangement, a remarriage after the death of the first spouse won’t lead to their children being disinherited. Control of the assets by a trustee will reduce the chance of depletion through squandering or unwise investments by the surviving spouse.
Tax benefits
Historically, QTIP trusts were used to defer estate tax to the death of the second spouse. With the federal estate tax exemption now at $5.43 million per person, scheduled to rise with inflation, federal estate tax is not a concern for many people.
Nevertheless, many states have their own estate tax or inheritance tax, with lower exemption levels. A couple with combined net worth of $3 million or $4 million might wind up owing substantial amounts of state tax at death, so tax deferral through a QTIP trust could be valuable. State rules regarding QTIP trusts vary greatly, however, so the applicable state’s rules must be reviewed carefully when determining whether to use a QTIP trust. In addition, couples with combined net worth well in excess of $10 million may have federal estate tax exposure, so a QTIP trust could be worthwhile for them.
Addressing concerns
Just as any well-drafted trust may offer advantages, trusts also require time and expense to create and maintain. Moreover, a QTIP trust poses specific issues in addition to the usual cautions about using a knowledgeable attorney to set it up.
With a QTIP trust, the executor will have to make a required election after the grantor’s death. A separate state election also may be required to get QTIP tax treatment. Thus, if you create a QTIP trust, the trustee you name should be prepared to make a well-considered election.
You also should prepare your heirs for QTIP consequences. Your spouse, for example, should know that income will flow life-long, but access to the trust principal will be limited. If your children will be the ultimate beneficiaries, they should understand they’ll have to wait for their inheritance, perhaps for many years. You might want to provide a more immediate source of funds to your children through insurance on your life or through a bequest outside of the trust.
In addition, you should discuss ongoing investment of trust assets with your chosen trustee. A QTIP trust must be invested to generate income to the surviving spouse, yet the trustee should attempt to provide a substantial amount to the ultimate beneficiaries as well.
Did You Know?
Among parents who are saving for their kids’ college education, 45% are using a regular savings account to do so. Including multiple responses, 31% of parents are using a 529 account, designed to fund higher education, and 30% are using their own 401(k) accounts, which are meant to be retirement plans.
Source: T. Rowe Price
