It’s an unsettling time right now. There is uncertainty, angst, frustration, and isolation. As humans, we are experiencing fear of contracting (or passing) COVID-19; stress of seeing friends and family members suffer from overnight economic contraction; strain from working in noisy homes with a dependency on oftentimes unreliable technology; and panic in global financial markets. In the midst of all this, it’s challenging to think past the next few hours. However, my training as a financial planner has me thinking about opportunities.
What can investors do to take advantage of the crisis? Are there any silver linings to be found amid the chaos?
As Head of Financial Planning, I help clients organize, prioritize, and strategize. We assess problems and work together to find reasonable solutions.
A silver lining of the coronavirus is that some financial planning problems, ever-present for many clients, have new opportunities for resolution.
Problem: You need access to cash.
While Balentine maintains a cash management policy that dictates two years’ worth of annual spending be held in cash and bonds for portfolios from which distributions occur, many business owners and professionals are finding their income restricted as sales grind to a halt and billable hours diminish. Ensuring adequate lines of credit are open and available is a natural next step. Since interest rates are typically based on the federal funds rate or LIBOR, debt is suddenly cheap. Investment accounts can serve as collateral for margin loans or investment credit lines, though borrowers must be prudent in tapping these sources for cash and leave a margin of safety should asset prices fall further.
Homeowners can access the equity in their homes with home equity lines of credit (HELOC) and home equity installment loans (HEIL). Cash can be withdrawn and repaid with a line of credit, while installment loans operate like other traditional loans with a set amount borrowed up front and regular payments made for a specific time period. Home prices don’t experience the same minute-to-minute volatility as stock and bond prices, yet they can certainly fall, as the Great Financial Crisis taught us. Some lenders offer interest-only HELOCs, which can be particularly attractive if this is simply a bridge until some stability develops. For some homeowners, a cash-out refinance could be compelling with rates generationally low if you have not refinanced recently and you’ve built up equity in your home.
Securities-based lending is typically quicker and easier to set up, while it can take up to a month to finalize HELOCs and HEILs or 60 days for mortgage refinances.
“Liquidity is only there when you don’t need it.” -Old Proverb
Problem: You expect a large tax bill for 2020.
Identifying positions in your portfolio that are now trading below where you bought them (unrealized losses) should not be hard. By realizing these losses (what’s known as “tax-loss harvesting”), you receive a deduction on your tax returns and can offset income or gains realized elsewhere. Furthermore, you can reinvest the proceeds into a similar, yet different, security to maintain your desired exposure without running afoul of what’s known as the wash-sale rule. Losses will carry forward into future tax years if you don’t have significant capital gains from the sale of stock or a business in 2020.
If you’ve maintained significant exposure to individual stocks given a desire to not deal with capital gains taxes, now is a great opportunity to trim these positions and reinvest in a manner that aligns with your risk tolerance. Done in conjunction with losses harvested elsewhere, you can limit or even avoid paying any capital gains tax.
Problem: You expect your estate will owe a large tax bill at your death.
Many families are in survival mode, as parents battle school-aged children for Wi-Fi bandwidth, all while juggling the balancing act of working, homeschooling, and running a household. For those able to look further in time and who expect to have an estate tax bill, the recent volatility offers several opportunities to play offense.
- Take advantage of the sharp drop in stock prices:
- Gift large number of shares at temporarily depressed prices, especially in hard-hit sectors. This is especially relevant for anyone holding concentrated positions. The annual gift-tax exclusion stands at $15,000 for individuals and $30,000 for married couples, allowing a couple the ability to make $30,000 gifts of stock to children, grandchildren, or anyone else. For a couple with three children (plus spouses) and eight grandchildren, they can pass up to $420,000 to their heirs each year free of gift tax. If they use a stock whose price has fallen by 50%, the couple would be able to gift twice as many shares as they would have at the start of the year (what was previously worth $840,000), permanently removing these shares from their estate and potentially leading to a significant increase in value within their heirs’ accounts when markets recover.
- Larger gifts can be made to individuals or through trusts by taking advantage of the lifetime gift-tax exemption, which is almost $11.6 million in 2020 (or almost $23.2 million for a couple). Again, a couple whose concentrated holdings in a stock previously worth $40 million yet now down 50% to $20 million can fully remove the stock from their estate free of any tax and allow their children to benefit from any recovery.
- Take advantage of the sharp drop in wealth-transfer rates:
- Mortgage rates and Treasury yields are not the only rates to have fallen over the past month. Rates set by the IRS to establish the lowest allowable rate to be not considered a gift, the Applicable Federal Rate (AFR) and Section 7520 rate, have reached historic lows and make several strategies for transferring wealth more attractive. As of April 2020, the AFR ranges from 0.91% for short-term loans to 1.44% for loans greater than nine years. These contrast with December 2019 rates that were 1.61% and 2.09%, respectively.
- Grantor retained annuity trusts (GRATs) are irrevocable trusts in which the person making the irrevocable gift (grantor) receives income over a set period of years and the remainder beneficiary (children, grandchildren, and/or others) receives the balance at the end of the term. The amount of income is calculated using the Section 7520 rate and the lower the rate, the more ultimately goes to your heirs with little or no gift tax.
- Installment sales are structured via a promissory note with entities outside the estate. Typically, real estate or a business interest is sold to a trust, limited liability company (LLC), or other entity in exchange for a promissory note. The highly appreciating asset is immediately removed from your estate, and you receive payments based on the terms of the note. With the AFR at historical lows, interest costs are now lower for your heirs.
- Intra-family loans are a common strategy for wealthy families to support their children by serving as the “bank” as they purchase their first home or start a business. Typically pegged to the AFR, these loans are much more attractive than what one could receive from a traditional financial institution.
- Charitable Lead Trusts (CLTs) are particularly advantageous for charitably minded individuals who want to support a charity over multiple years, after which the remaining balance passes to heirs or non-charitable beneficiaries, potentially estate and gift tax-free. This is a great tool to fund a capital campaign pledge for your alma mater or place of worship. The AFR is used to calculate the present value of the payment stream to the charity for the term of the trust.
There are myriad planning opportunities which suddenly became more attractive with the dislocation in the financial markets. Given the numerous tax and legal nuances with the various opportunities, you’ll want to assemble your advisory team, including tax and legal expertise, to determine if any might fit with your broader goals and your complete financial picture.
For those looking for opportunities to help family, friends, and strangers during this difficult time, consider the following:
- Do you know someone hospitalized for COVID-19? Paying for medical expenses does not use any annual exclusion or lifetime gift-tax exemption if it is paid directly to a hospital or medical provider. Do not write a check to an individual for them to pay the bill. You can do the same for anyone’s educational expenses, too, if you’d like to help a friend or family member who may struggle with their child’s college tuition after losing their job.
- Are you looking for ways to increase support to charities this year? The recently passed economic relief “CARES Act” removed a limitation on charitable contributions of cash during 2020 for taxpayers who itemize deductions. Donors can now deduct 100% of their cash gift to a public charity (unfortunately, your donor-advised fund or private foundation don’t count) against their 2020 adjusted gross income (AGI). Previously, this was limited to 60% of AGI. You’ll need to weigh whether donating appreciated securities of low-basis stock could still be in your favor.
Much uncertainty exists around the coronavirus and the ripple effects of this pandemic. Balentine will continue to assess new data and provide timely information and insight around current market volatility and economic impact. Visit the dedicated resource page on our website, “Latest Market Updates Amid the Coronavirus,” for a consolidation of the insights and resources we encourage investors to read.