Kevin T. Smith, CFP®, CTFA, RICP®, CDFA™
Discussing the generational transfer of your wealth with your adult children may feel as uncomfortable as talking politics at a dinner party. There is no question that the Greatest Generation — and those that came before — kept their financial information much closer to the vest, while Boomers have been more apt to discuss these affairs with their children. It is obviously a personal decision if you want this discussion to take place.
Here are some considerations when deciding whether or not, or how to broach this sensitive topic with your children:
- Will the relationship change dramatically if beneficiaries are made aware of their future inheritance or lack thereof? Of course, this can be difficult to predict.
- Will it be advantageous to begin gifting assets during your lifetime?
- Are you anticipating that your children will be involved in your finances as, for example, a trustee or POA (Power of Attorney) while you are alive?
- Is there family pressure to disclose your financial affairs? If so, this can be a sign to proceed with caution.
- Is your next generation financially sound enough not to need or want the inheritance? If the answer is yes, you may be able to do multi-generation planning such as college funding, generation-skipping trusts, or “stretching” IRAs.
Provide a Roadmap
If the decision is made not to include the next generation in your planning, it is still wise to provide your spouse and/or children with the names and contact information of your professional advisors in case of an emergency. These commonly include:
- Attorney (legal and estate planning documents)
- Accountant (copies of previous years’ tax returns which can identify where accounts are held)
- Financial Advisors (statements on investment accounts, IRAs)
I recommend that you review the list annually with those who would be involved so that when the time comes, your family knows who to alert. Some honest, and admittedly morbid, questions to ask yourself are: How will my affairs be handled if I don’t wake up tomorrow? Will my spouse/children know who to contact? Will they have access to cash immediately from non-probate assets to cover short-term expenses?
It’s Your Decision and Yours Alone
As a client advisor, I advocate for the discussion among family on the transfer of assets whenever possible and encourage clients to include the second and, when appropriate, even third generations in our meetings. This approach can help provide for a smoother, more tax-efficient transfer of wealth to your loved ones. It can also create opportunities to educate about the successful moves or missteps that you made with your finances. Remember — you are the one who worked and saved for your assets and no one will appreciate the hard work and effort as much as you!
“The university’s storied history centers around coaching legend John Wooden who won 10 championships, including a remarkable seven in a row. Mr. Wooden has a library of timeless quotes. One quote epitomizes the extensive research we conduct on your behalf, ‘You can’t have confidence unless you are prepared. Failure to prepare is preparing to fail.’ Our fieldwork equips us to make purchases even during times of adversity.” Letter from Cobleskill Spring 2019
Human nature leads investors to strive for maximum returns and our industry may further condition them to always seek more, often in comparison to others. Investors feel compelled to chase performance – to sell funds (fire managers) that are underperforming and buy those funds (hire managers) that are outperforming. After all, how can one be maximizing returns if someone else is doing better? For financial advisors the temptation to chase performance may be amplified when a client asks the seemingly fair question, “Why are we keeping this underperforming fund?”
In a July 2014 Vanguard research study titled “Quantifying the Impact of Chasing Fund Performance,” the mutual fund firm found that performance-chasing strategies often diminish returns. The study used actively-managed, U.S. equity mutual funds available in Morningstar’s database that had been in existence for at least three of the 10 years ending 12/31/2013 (3,568 funds). With respect to this universe of funds, Vanguard took Morningstar’s nine style categories based on blend, growth, and value subsets of large-, mid-, and small-cap funds, and looked at hypothetical results for each based on buy-and-hold and performance-chasing approaches.
The buy-and-hold strategy was simple: invest in any fund, sell only if the fund was discontinued, and replace a discontinued fund with one of the median-performing equity funds within the style box.
The performance-chasing strategy invested in any fund that had above median 3-year returns for the period 2004 to 2013. Funds that achieved below median returns for a rolling 3-year period were sold and replaced with a fund that achieved an average annual return within the top 20 performing funds over the prior 3-year period. The results, detailed in the chart below, were conclusive: a performance-chasing approach may, in practice, be a hindrance to building wealth. *
* Source: Vanguard, “Quantifying the Impact of Chasing Fund Performance.” July 2014
We know the symptoms, but what’s the cure for short-termism? How should investors steel themselves against behavioral and external factors that may lead them to attempt to time the market or chase performance?
As advisors well know, the key is to have a comprehensive, understandable, long-term investment plan that can serve as a foundation. It is hard to stay the course if you do not know the course. In my view, performance against that plan should be the primary yardstick – not what others’ returns are or whether all your money managers are number one across multiple time periods.
When investors adopt long-term perspectives, the businesses in which they invest may very well do the same over time with their internal investments. I believe this prescription could be healthy for our economy and, by association, for investors’ long-term returns.
In the Financial Services field we love to use acronyms. RMD (Required Minimum Distribution), YTM (Yield to Maturity), and AGI (Adjusted Gross Income) are common ones that you may have heard. However, if you are older than age 70 ½, have a Traditional IRA, and make charitable gifts annually, a QCD (Qualified Charitable Distribution) is a good acronym to know.
QCDs – A Brief Background
Individuals with monies in a Traditional IRA, who are older than 70 ½, draw their Required Minimum Distribution each year. These distributions are treated as taxable income and included in your AGI. However, since 2006, individuals have had the ability to direct these required distributions (up to $100,000) to a qualified charity of their choice and exclude the amount from their taxable income each year. This strategy is referred to as a Qualified Charitable Distribution.
However, even though you are making a charitable gift, you may not include this amount in your itemized deductions. In other words, you cannot “double dip.”
Why the Popularity Now?
With Congress passing the Tax Cuts and Jobs Act in late 2017, it doubled the standard deduction for individuals and joint filers ($12,000 in 2018 for individuals and $24,000 for married filing jointly). This significantly reduces the number of individuals who will be itemizing their deductions. For those taxpayers who were itemizing their charitable gifts and are now taking the standard deduction, the tax benefit of the charitable gift is lost.
This has created more popularity for the QCD from IRAs and may provide the following benefits:
- Satisfy some, or all, of your Required Minimum Distribution
- Reduce your taxable income which can potentially:
- Reduce the amount of tax on your Social Security benefits
- Reduce the costs of Medicare Part B and Part D premiums
- Help you avoid exposure to the 3.8% net investment income tax
- Allow you to qualify for certain tax credits that have income caps
Please note these additional QCD strategy items:
- The charity must be a qualified charity per IRS standards (it cannot be a private foundation or donor advised fund)
- The distribution must be made directly from your IRA trustee to the charity (check payable to the charity)
- The QCD can be accomplished with Inherited IRAs where the beneficiary receiving the distribution is older than 70 ½
If you have already satisfied your RMD for 2018, you can look to the 2019 tax year and beyond as Congress has made the ability to do a QCD permanent. If you have questions on whether the QCD from your IRA is a strategy that may benefit you, we recommend that you speak with your tax professional.
This is the third in a series of posts about short-termism from FAM Value Fund Co-Manager Drew Wilson.
There are any number of reasons investors may find it difficult to achieve their financial goals. In some cases, unexpected and uncontrollable events can wreak havoc on a financial plan. But it is often an investor’s own actions that lead to the failure of meeting their objectives. There is a branch of science called Behavioral Finance dedicated to exploring how an individual’s propensities and predilections can short circuit rational investment decisions.
Unfortunately, in my opinion, there is a powerful gravitational pull that has fostered a short-term mindset with many investors. This force comes from academicians, practitioners, pundits, and the financial press who promote – wittingly or unwittingly – return-diminishing behaviors such as market-timing and performance-chasing.
How well does a short-term investment approach work? In my next post I’ll highlight a compelling research study that compares performance-chasing versus buy-and-hold behaviors. At FAM, we have a long-term approach; however, despite consistent results for buy-and-hold strategies, this research study exposes a challenge the investment industry faces. Stay tuned.
The event was held on October 9, 2018.
- Look at the past 10 years and discover how time in the market, not market timing, can make a big difference
- See how our funds performed
- Watch an insightful Q&A session with our Investment Research Team