Build Back Better Act + Impact on High Net-Worth Family Estate Planning

Build Back Better Act + Impact on High Net-Worth Family Estate Planning

 

LUTZ BUSINESS INSIGHTS

 

build back better act + impact on high net-worth family estate planning

joe hefflinger, director & investment adviser

 

Last week, the House Ways and Means Committee released its proposal to pay for the $3.5 trillion Build Back Better Act. While the potential legislation contains a wide array of adjustments to the tax code, this post will focus more directly on the proposed changes that could impact your estate planning. For further context on these issues and a general overview of how our estate laws work, see my previous post here:  https://www.lutz.us/high-net-worth-families-review-estate-plans-pre-election/).

It’s important to note that if a bill ultimately gets passed, it may look materially different from the provisions I will highlight below. Also, it’s essential to understand that time could be of the essence. While some of the changes wouldn’t go into effect until January 1, 2022, certain crucial planning tools that your estate attorney would likely want to implement before year-end could be rendered ineffective as of the date of the bill’s passage (which could technically happen at any time now). The outcome is uncertain at this point; those with a high net-worth (in this case, I’m referring to couples with a net worth approaching $20 million or greater or individuals approaching $10 million) should be reviewing options with their estate attorney now.

 

Key Estate Changes Proposed by the House Ways and Means Committee

Decrease in the Estate/GST and Gift Tax Exemption

The current transfer tax exemptions are $11.7 million per person in 2021 ($23.4 million per couple). Under current law, those exemptions are scheduled to “sunset” and decrease to $5 million each adjusted for inflation on January 1, 2026. The recent proposal accelerates this to January 1, 2022, meaning they will roughly be cut in half next year to approximately $6 million per person (or $12 million per couple) adjusted for inflation.

 

Valuation of “Non-Business Assets”

It’s currently common when transferring an interest in a closely held business for estate purposes to discount the value based on a lack of control and a lack of marketability. This approach will still be available for interests in operating (active) businesses but not for family entities funded with marketable securities (passive assets). This change would apply to transfers made on or after the date the new law is passed.

 

Income Taxation of Grantor Trusts

Much of the sophisticated planning done by estate attorneys to help clients minimize estate taxes has centered around the use of grantor trusts. These trusts allow you (the grantor) to transfer assets that are removed from your estate while also allowing you to continue to pay the income taxes associated with the trust’s assets on behalf of the trust beneficiaries (without counting as a gift). Because the grantor is still treated as the owner of the trust for income tax purposes (but not for estate tax purposes), transactions between the trust and the grantor are “disregarded.” This means assets can be sold or exchanged with the trust, and the trust can pay interest on low-interest notes owed to the grantor without triggering any income tax consequences.

The recent proposal would cause any gain inherent in an asset sold to a grantor trust to be recognized and thus create taxation (where under current law, there would be none). In addition, it’s common for a grantor to “swap” assets of equal value with other trust assets in a transaction that is typically disregarded for income tax purposes. The recent proposal would seem to create a taxable event in this scenario. These changes would apply to grantor trusts created on or after the date the new act is passed.  Existing grantor trusts would be “grandfathered,” but future contributions to existing trusts would not be.

 

Estate Taxation of Grantor Trusts

Under the proposal, any portion of a grantor trust’s assets that a person is the “deemed owner” will be included as a part of their taxable estate. Any distribution from a grantor trust will be treated as a taxable gift (with limited exceptions). Lastly, if a trust’s grantor status is terminated during the grantor’s lifetime, the assets will be treated as being gifted at that time by the grantor.

These three provisions effectively render most grantor trusts useless for estate planning purposes. This potentially impacts (subject to future clarification) some of the most useful estate planning techniques commonly employed by estate planners, namely intentionally defective grantor trusts (IDGTs), grantor retained annuity trusts (GRATs) and spousal lifetime access trusts (SLATs), each of which is discussed in more detail below. As outlined above, the effective date for these changes to grantor trusts would be the date of bill passage, and grandfather status would be allowed for existing trusts.

 

Irrevocable Life Insurance Trusts (ILITs)

ILITs are designed to ensure that a life insurance death benefit is not subject to estate tax and are typically structured as grantor trusts. Existing ILITs would be grandfathered, but it would appear that future contributions to ILITs for purposes of paying insurance premiums could cause some of the death benefit to be included in the estate. This would be a major limitation on the usefulness of ILITs going forward if not carved out from the final bill.

 

Relief for Farmers

One of the positive changes in the proposal is a welcome change for those in the farming community. Current law allows property used in farming to be valued based on “use” (typically a lower value) and not its true market value, but the downward adjustment is limited to $750,000. The proposal would allow a downward adjustment of up to $11.7 million.

 

Notable Changes Not Included in the Recent Proposal (but still could be)

Increase in the Estate and Gift Tax Rates

The current proposal leaves the estate and gift tax rates at 40%. It had been speculated that a return to the 45-55% range we’ve seen in the past 10-20 years was possible.

 

Change in the Basis Rules at Death

Under current law, your heirs will typically receive any assets you leave them upon your death with a “stepped-up basis,” meaning they get to hold those assets with a basis equal to their fair market value on the date of your death. At various times, factions in DC have floated the idea of eliminating the basis step-up at death (meaning heirs would take a lower carryover basis instead) or alternatively the realization of capital gains at death (meaning the deceased individual’s estate would owe capital gains tax on appreciated assets at death). This could obviously be a major complication for your heirs if you hold assets with a large amount of appreciation. As of now, these changes are not included in the proposal.

 

Estate Moves High Net-Worth Families Should be Considering Right Now

Given the potential estate law changes that could be made effective as soon as a bill passes, what estate updates should high net-worth families be evaluating now? Here are a few to consider:

 

Outright Gifts

If the estate and gift exemptions are reduced next year, you could miss out on a great opportunity to pass a large amount of wealth free of tax. To lock in the use of the current larger exemption this year, you’d need to be in a position to have at least one spouse transfer upwards of $11.7 million out of their estate. Even if you’re not comfortable gifting that full amount, gifting a lower amount would still be effective in removing that reduced amount and any future appreciation out of your estate.  These types of outright gifts are commonly made to irrevocable trusts (often grantor trusts) for the future benefit of your children and/or grandchildren. Treasury Regulations from 2019 indicate that transfers covered under an individual’s exemption in the year of transfer can’t be “clawed back” later at their death if the exemption has subsequently been reduced.

 

SLATs

If the thought of transferring that amount of wealth outright this year makes you uneasy, talk to your estate attorney about a spousal limited access trust (SLAT). If structured correctly, SLATs can potentially allow for trust distributions of the transferred assets back to the transferor’s spouse during their lifetime. You wouldn’t go down this route if you expected to need the funds in the future. However, if there is some type of unexpected financial hardship down the road, it can be comforting to know that you have the ability to access the funds again (indirectly through your spouse) if needed. Obviously, the possibility of a future divorce or the premature death of the spouse beneficiary needs to be considered.  SLATs are typically grantor trusts and will be impacted under the current proposal.

 

Estate “Freeze” Techniques

If you aren’t comfortable making a large outright gift, an estate freeze may be a better fit for you. A freeze transaction has the net effect of removing the future appreciation of an asset (above a predefined “hurdle” rate established by the IRS) from your estate. There are several different structures to accomplish this. Some of which involve transferring assets to a trust in exchange for a promissory note equal to the fair market value of the assets sold. The transfer to the trust can be structured as either a sale or a gift (or some of each), depending on whether you want to use up some exemption (and if so, how much).

Two of the more common freeze structures are IDGTs and GRATs (referenced above). Your estate attorney can highlight the key differences between each and examine the appropriate fit for your situation. Both IDGTs and GRATs are typically grantor trusts and can be powerful tools under current law, especially in a low-interest-rate environment where the hurdle rate that the transferred asset has to beat is so low. These tools can also be leveraged even further if you have an asset to transfer whose value can be discounted when transferring for estate purposes (as discussed above).

Keep in mind, however, that the ability to use SLATs, GRATs, IDGTs and some discounts could be rendered ineffective as of the date a new bill is passed (which could come at any time now).

 

Call Your Estate Attorney Today

So, what does all of this mean to you? If your personal balance sheet is approaching the $20 million range or greater for couples ($10 million for individuals), it means you should at least be reaching out to your estate attorney and other advisors now to discuss what impact these potential changes could have on your personal planning. If you are uncertain about what amount of assets you can transfer and still have enough left over to comfortably live on, we at Lutz Financial can do a cash flow analysis to help you better answer that question. From a timing perspective, keep in mind that high-level estate planning of this nature usually takes some time to complete (and your attorney will likely already be busy due to high demand). Whether you ultimately decide to make any estate updates now or not, it’s essential that you at least talk to your advisors and understand your options. If you have any questions, please feel free to contact us.

Important Disclosure Information

Please remember that past performance may not be indicative of future results.  Different types of investments involve varying degrees of risk, and there can be no assurance that the future performance of any specific investment, investment strategy, or product (including the investments and/or investment strategies recommended or undertaken by Lutz Financial), or any non-investment related content, made reference to directly or indirectly in this newsletter will be profitable, equal any corresponding indicated historical performance level(s), be suitable for your portfolio or individual situation, or prove successful.  Due to various factors, including changing market conditions and/or applicable laws, the content may no longer be reflective of current opinions or positions.  Moreover, you should not assume that any discussion or information contained in this newsletter serves as the receipt of, or as a substitute for, personalized investment advice from Lutz Financial.  To the extent that a reader has any questions regarding the applicability of any specific issue discussed above to his/her individual situation, he/she is encouraged to consult with the professional advisor of his/her choosing.  Lutz Financial is neither a law firm nor a certified public accounting firm and no portion of the newsletter content should be construed as legal or accounting advice.  A copy of the Lutz Financial’s current written disclosure statement discussing our advisory services and fees is available upon request.

ABOUT THE AUTHOR

402.827.2300

jhefflinger@lutzfinancial.com

LINKEDIN

JOE HEFFLINGER, JD, CFP®, CAP® + DIRECTOR & INVESTMENT ADVISER

Joe Hefflinger is an Investment Adviser and Director at Lutz Financial. With 15+ years of relevant experience, he specializes in comprehensive financial planning and investment advisory services for professionals, business owners, and retirees. He lives in Omaha, NE, with his wife Kim, and daughters Lily and Jolie.

AREAS OF FOCUS
  • Retirement Cash Flow Planning
  • Insurance Planning
  • Estate Planning
  • Business Owner Exit Planning
  • Charitable Planning
  • Tax Planning
AFFILIATIONS AND CREDENTIALS
  • National Association of Personal  Financial Advisors, Member
  • Financial Planning Association, Member
  • Nebraska State Bar Association, Member
  • Omaha Estate Planning Council, Member
  • CERTIFIED FINANCIAL PLANNER™
  • Chartered Advisor in Philanthropy®
EDUCATIONAL BACKGROUND
  • JD, Creighton University School of Law, Omaha, NE
  • BS in Economics, Santa Clara University, Santa Clara, CA
COMMUNITY SERVICE
  • Partnership 4 Kids - Past Board Member
  • Omaha Venture Group, Member
  • Christ the King Sports Club, Member

SIGN UP FOR OUR NEWSLETTERS!

We tap into the vast knowledge and experience within our organization to provide you with monthly content on topics and ideas that drive and challenge your company every day.

About UsOur Team | Events | Careers | Locations

Toll-Free: 866.577.0780Privacy Policy | All Content © Lutz & Company, PC 2021

Long-Term Care Planning 101

Long-Term Care Planning 101

 

LUTZ BUSINESS INSIGHTS

 

LONG-TERM CARE PLANNING 101

long-term care planning 101

joe hefflingeR, Director & investment adviser
PUBLISHED: JUNE 28, 2021

One of the most difficult decisions clients will make in the financial planning process is planning for long-term care (LTC). With LTC, I’m referring to the possibility that at some point, you or a family member will require some form of care to help with your daily life for an extended period of time, whether due to physical or mental limitations (or both).

The economics of LTC can be difficult to factor into a financial plan because the range of outcomes is vast. With LTC, you are also dealing with what can be an emotionally and physically draining experience for the whole family. But some of that potential family stress can be reduced, at least in part, with the proper planning.

 

What is Long Term Care?

When most people think of LTC, they typically picture a nursing home. It can also mean receiving care in an assisted living facility or a memory loss center. But increasingly, LTC also means getting the care you need while remaining in the comfort of your own home, and people are typically more open to this idea.

A need for care is usually evaluated by a doctor on your inability to perform at least two of the following six activities of daily living (ADLs) on your own:

  • bathing
  • dressing
  • eating
  • transferring (being able to walk or move yourself from a bed)
  • toileting
  • continence

Separate from ADLs, severe cognitive impairment (e.g., Alzheimer’s or other forms of dementia) can also be the triggering event for an LTC need. Other conditions that may require LTC include a head injury, stroke, cancer, Parkinson’s, heart disease and Multiple Sclerosis.

 

Will You Need It?

Unless someone has had first-hand experience with LTC, it may be difficult to assess another’s needs or understand its value. That being said, here are some credible stats on long-term care:

  • 70% of Americans over 65 will need some type of LTC during their lives[i]
  • 1 out of 7 people ages 65+ will need LTC for more than 5 years[ii]
  • 1 in 9 people in the US age 65+ have Alzheimer’s dementia and 1 in 3 people age 85+ have it.
    • People age 65+ survive an average of 4 to 8 years after diagnosis, yet some live as long as 20 years with it.
    • At age 80, 75% of people w/ Alzheimer’s live in a nursing home.
    • 1 in 3 seniors die with Alzheimer’s or another dementia, it is the 6th leading cause of death in the US.[iii]

With those types of odds, it is fairly risky to formulate your retirement plan while operating under the assumption that neither you nor your spouse will ever require any LTC. It can be insured against, self-funded or not funded, but that is a choice you will make during the planning process.

 

What Does It Cost?

If you need LTC, the cost can vary based on care setting, geographic location and the level of care required. The most widely quoted cost comparison tool in the industry is Genworth’s Annual Cost of Care Survey, which has been conducted for the past 17 years.

For the most recent survey done in 2020, Genworth contacted 57,981 providers by phone to complete 14,326 surveys of nursing homes, assisted living facilities, adult day health facilities and home care providers in all 50 states. Here is a summary of costs in 2020[iv]:

National (U.S.) Median Annual Costs

  • In-Home Care (Home Health Aide): $54,912 (up 4.35% from 2019)
  • Assisted Living Facility: $51,600 (up 6.15% from 2019)
  • Nursing Home Private Room: $105,850 (up 3.57% from 2019)

Omaha, Nebraska Median Annual Costs

  • In-Home Care (Home Health Aide): $59,488 (up 0.97% from 2019)
  • Assisted Living Facility: $54,279 (up 13.08% from 2019)
  • Nursing Home Private Room: $110,960 (up 19.69% from 2019)

It’s likely that Covid had some impact on the jump in costs over the past year. However, even just using a 3% rate of inflation going forward, the costs can quickly mount up.  Running a projection for a 65-year-old, assuming $100,000 annual costs (in today’s dollars) for five years beginning at age 85 in 2041, the 1st year annual cost was $184,151, and the 5-year total cost was $979,637.

 

What about Medicare? Medicaid?

Medicare is the federal health insurance program designed mainly for people aged 65 and up. Generally, Medicare will only provide limited LTC support and only if you are receiving physical therapy or skilled nursing services in a “Medicare-certified nursing facility” after you had a hospital stay of at least three days.

If ALL of those conditions are met, Medicare will pay your costs for up to 20 days. After that, it will pay a portion of your costs for days 21-100, and then it pays nothing from day 101 and on. Medicare will pay nothing for assisted living or adult day services, and its benefits for in-home care are limited.

Medicaid is a joint federal and state public assistance program for financing health care for those with low incomes. Medicaid is the largest public payer of LTC services in the US. It will pay for certain health services and nursing home care for people with low incomes and limited assets.

To qualify for Medicaid, you may have to spend down your assets. Eligibility can vary by state. If you do qualify, there are restrictions on the type of care you can receive and where you can receive it. Whether the government will ultimately step in at some point to provide a greater amount of LTC benefit is an unknown but relying on that possibility is a risky approach.

 

Can You Self-Insure Against this Risk?

A big part of any financial plan is a retirement cash flow analysis. This is where I load up my client’s entire financial picture into our planning software and model out a projection of where their assets are headed over time. It’s trying to answer the questions, “when can I retire?” and “how much can I comfortably spend each year in retirement?”

Perhaps the biggest wildcard in this analysis is how to factor in potential LTC costs. If the client doesn’t have LTC insurance, I model out potential LTC costs being incurred down the road to see if the client has enough assets to withstand that type of additional expense. There have been times when I’ve run this analysis for a client and adding in LTC expenses turned what was a good-looking projection into a much riskier-looking picture. So, if you are planning on self-insuring for LTC, be sure to consult with your financial advisor.

 

The Checkered Past of LTC Insurance

Any comprehensive discussion on how to properly plan for LTC expenses should include a discussion of LTC insurance. And when discussing LTC insurance, there must be an acknowledgment that things haven’t always been great.

LTC insurance has been around since the late 1970s, though it didn’t really catch on until the late 1980s. The problem was that the insurance carriers didn’t really know what they were doing at the time with respect to LTC. Unlike life insurance and long-term disability insurance, which have long track records and actuaries that have a good understanding of claim experience and probability, with LTC, they were somewhat flying blind for a period of time. They made the mistake of treating LTC similar to life insurance. They assumed a larger number of people would let their policies lapse and that fewer people would actually go on claim.

It turned out over time the opposite was true (fewer lapses and more claims), which in turn meant that the insurance carriers drastically underpriced LTC policies from the start as their claim experience and exposure were much greater than they initially projected. LTC policies did not have guaranteed premiums. This meant the insurance carriers could go to each state’s insurance commissions and request rate increases, which were often granted based on their negative claims experiences. Many people who have older LTC policies have had to deal with multiple rate increases over the years.

 

What Insurance Products are Available Today?

LTC Insurance provides a pool of benefit dollars for LTC to be used when and where it may be needed. Important terms to consider are:

  • the amount of inflation protection they provide,
  • how many years of benefit and how much benefit are provided,
  • your options on how to pay premiums (annually for life, over a set period of years, or lump sum), and
  • whether you can share your benefits with a spouse.

Also, pay particular attention to whether the policy is a reimbursement or indemnity contract. With reimbursement, you only get paid a benefit if you qualify for a claim and prove you had a related LTC expense. With indemnity, once you qualify for a claim, you get paid your benefit regardless of what expenses are incurred, and you can use the funds however you want (although you will typically pay a higher premium for this right).

Keep in mind, if you have an existing cash value life insurance policy or annuity, you could potentially do a 1035 tax-free exchange to move those funds over to an LTC policy. For those with old life policies or annuities that are unsure what to do with them, this could be a great option.

Today, the available products fall into four general categories:

1. Traditional (Stand-Alone) LTC Policies

These are the original LTC policies previously discussed. You pay in a premium, and if you need LTC, it provides a tax-free benefit. It’s “use it or lose it,” meaning if you don’t need LTC, then you are out the premiums you paid in.

The premiums typically are not guaranteed, meaning the carrier can raise your rates in the future if it can justify that to the state insurance commissions. Carriers now have a better idea of how to price these policies from the start, so they would argue that it’s less likely for a newer policy to have increased rates in the future.

On the plus side, these policies are often cheaper on a relative basis compared to some of the other options below. So, it may be a better choice for those with smaller balance sheets or less disposable income.

These policies can often qualify for the Long-Term Care Partnership Program, which is a joint federal-state policy to promote the purchase of private LTC insurance. This program allows you to disregard any LTC insurance benefits you receive from the dollar amount of assets you would otherwise have to spend down to qualify for Medicaid.

2. Asset-Based Hybrid Life/LTC Policies

These are relatively newer products that have quickly gained in popularity and have become the top-selling LTC product in the market today. These often have a fixed one-time lump-sum premium payment. However, there are now options to pay in a fixed amount over a set number of years instead. Either way, the carrier can’t increase your rates. It’s also not use it or lose it. You will use the policy in one of three ways:

  • Return of premium: If you decide in the future you want your money back, you just take back the cash you put in, usually as a tax-free return of premium; though there may be an initial period (e.g., 6 years) where you get something less than 100% of your money back (e.g., only 80%).
  • Death benefit: If you die without needing the LTC benefits, your beneficiaries get a tax-free benefit that is typically equal to or even a little greater than the premium you paid in.
  • LTC benefit: If you need LTC, the policy leverages up your premiums to provide a healthy amount of tax-free LTC benefit. For example, based on a recent illustration for a 70-year-old female, if they put in a one-time premium of $125,000, their day one LTC benefit was $305,000, but by age 85, that grows to $500,000. Down the road, the LTC benefit is over $600,000.

These asset-based policies can be a great option, particularly for someone who may otherwise already be sitting on a healthy amount of cash. In that case, it becomes an asset repositioning play. Meaning move cash from one pocket (your bank) where it’s earning low-interest today over to another pocket (the hybrid LTC policy) where it’s earning nothing but still available to you via return of premium and also providing a ton of leverage if needed for LTC. But know that you are typically paying a bit more for all that flexibility.

3. Life Insurance Policies w/ LTC Riders

These permanent life policies attach an LTC benefit to them but haven’t been as popular as the asset-based policies described above. They typically provide a higher death benefit and less LTC coverage. So, if the focus is on LTC, they may not provide as much bang for your buck. I also hear these policies pay the agent higher commissions relative to the other options, so be mindful of that as well.

4. Annuities w/ LTC Riders

These are annuities that attach an LTC benefit to it. These could be an option if medical underwriting is otherwise an issue. It could also be an avenue to use an older existing annuity with tax-deferred growth and 1035 for tax-free LTC benefits. However, I would have similar questions about whether you are getting your bang for your buck if the primary concern is LTC.

 

The Hidden Risks of Self Insuring

Even if you are fortunate enough to self-insure against the risk of LTC, that isn’t necessarily always the optimal approach. Some people may end up being very reluctant to spend down their assets later in life for LTC. While they may have ample assets to use for their own LTC, it can be human nature to want to preserve those assets for a spouse or leave for their kids’ inheritance.

This can create a lot of tension within a family as the spouse or kids may need to provide the care for the other spouse who doesn’t want to spend down their assets on help. If they had LTC insurance, on the other hand, those conversations get a lot easier if it becomes “hey, we paid into this policy, let’s collect some tax-free dollars that we are entitled to and get you a little help.”

 

Consult with Your Advisors

As you can see, evaluating how to handle LTC within a financial plan presents many challenges. There is no one size fits all answer here, so you need to think through your particular family situation and analyze all the options.

I would strongly encourage you to do so with a financial advisor and insurance agent knowledgeable on the subject to help you make an informed decision on what’s best for your family. If you have any questions, please contact us.

 

[i] U.S. Department of Health and Human Services, National Clearinghouse for Long-Term Care Information, August 2016.

[ii] Long-Term Services and Supports for Older Americans: Risks and Financing Research Brief, Judith Dey, February 2016.

[iii] 2021 Alzheimer’s Disease Facts and Figures, Alzheimer’s Association, https://www.alz.org/alzheimers-dementia/facts-figures

[iv] 2020 Genworth Cost of Care Survey, https://www.genworth.com/aging-and-you/finances/cost-of-care.html

Important Disclosure Information

Please remember that past performance may not be indicative of future results.  Different types of investments involve varying degrees of risk, and there can be no assurance that the future performance of any specific investment, investment strategy, or product (including the investments and/or investment strategies recommended or undertaken by Lutz Financial), or any non-investment related content, made reference to directly or indirectly in this newsletter will be profitable, equal any corresponding indicated historical performance level(s), be suitable for your portfolio or individual situation, or prove successful.  Due to various factors, including changing market conditions and/or applicable laws, the content may no longer be reflective of current opinions or positions.  Moreover, you should not assume that any discussion or information contained in this newsletter serves as the receipt of, or as a substitute for, personalized investment advice from Lutz Financial.  To the extent that a reader has any questions regarding the applicability of any specific issue discussed above to his/her individual situation, he/she is encouraged to consult with the professional advisor of his/her choosing.  Lutz Financial is neither a law firm nor a certified public accounting firm and no portion of the newsletter content should be construed as legal or accounting advice.  A copy of the Lutz Financial’s current written disclosure statement discussing our advisory services and fees is available upon request.

ABOUT THE AUTHOR

402.827.2300

jhefflinger@lutzfinancial.com

LINKEDIN

JOE HEFFLINGER, JD, CFP®, CAP® + DIRECTOR & INVESTMENT ADVISER

Joe Hefflinger is an Investment Adviser and Director at Lutz Financial. With 15+ years of relevant experience, he specializes in comprehensive financial planning and investment advisory services for professionals, business owners, and retirees. He lives in Omaha, NE, with his wife Kim, and daughters Lily and Jolie.

AREAS OF FOCUS
  • Retirement Cash Flow Planning
  • Insurance Planning
  • Estate Planning
  • Business Owner Exit Planning
  • Charitable Planning
  • Tax Planning
AFFILIATIONS AND CREDENTIALS
  • National Association of Personal  Financial Advisors, Member
  • Financial Planning Association, Member
  • Nebraska State Bar Association, Member
  • Omaha Estate Planning Council, Member
  • CERTIFIED FINANCIAL PLANNER™
  • Chartered Advisor in Philanthropy®
EDUCATIONAL BACKGROUND
  • JD, Creighton University School of Law, Omaha, NE
  • BS in Economics, Santa Clara University, Santa Clara, CA
COMMUNITY SERVICE
  • Partnership 4 Kids - Past Board Member
  • Omaha Venture Group, Member
  • Christ the King Sports Club, Member

SIGN UP FOR OUR NEWSLETTERS!

We tap into the vast knowledge and experience within our organization to provide you with monthly content on topics and ideas that drive and challenge your company every day.

About UsOur Team | Events | Careers | Locations

Toll-Free: 866.577.0780Privacy Policy | All Content © Lutz & Company, PC 2021

Why High Net-Worth Families Should Review Their Estate Plans Pre-Election

Why High Net-Worth Families Should Review Their Estate Plans Pre-Election

 

LUTZ BUSINESS INSIGHTS

 

Why High Net-Worth Families Should Review Their Estate Plans Pre-Election

why high net-worth families should review their estate plans pre-election

joe hefflinger, DIRECTOR & INVESTMENT adviser

PUBLISHED: SEPTEMBER 15, 2020

Election day is fast approaching, and with it comes the potential for sweeping changes in our political landscape. While nobody can predict the outcome, those with a high net-worth (in this case, I’m referring to a net worth approaching $20 million) would be wise to start evaluating their current estate plans now.

2020 could be looked at in hindsight as the end of a golden era in estate planning. We have witnessed asset values depressed due to the impact of COVID, historically low interest rates, historically high estate and gift exemptions, and certain key estate planning techniques that are still viable. These all combine to create an ideal environment for the transfer of wealth to future generations in an extremely tax-favorable manner.

A change in our political climate, coupled with our country’s deteriorating fiscal position, could potentially change the estate tax laws. So, there is no time like the present to be considering all your options. And for those of you who may be hesitant about gifting assets now, know that some of these options may allow you to preserve some level of access to the assets you would be gifting.

 

The Estate & Gift Tax Laws – a Refresher on Where we are Now and Where We’ve Been

Currently, the federal estate and gift tax laws in our country work in tandem, which means you have a certain dollar amount which you can transfer to your heirs either while alive or at your passing, tax-free. The exemption amount in 2020 is $11.58 million per individual. This is effectively $23.16 million for married couples as portability allows a surviving spouse to use a deceased spouse’s unused exemption.

You are free to gift away assets up to the exemption amount during your lifetime with no gift tax owed. Still, every dollar you gift away during life has the corresponding effect of decreasing the amount of assets you can leave to your heirs at death estate-tax free, dollar for dollar. An important caveat to this is any gifts you make pursuant to the annual gift exclusion amount (currently $15,000 per individual, or $30,000 per couple, to any number of different beneficiaries per year) doesn’t count towards your lifetime gift exemption.

For any assets that become subject to federal gift or estate tax, the current tax rate is 40%.  This is down from 55% as recently as 2001. Without getting too deep, in addition to the estate and gift tax there is also a generation-skipping transfer (GST) tax that is levied when transfers are made to someone two or more generations below (e.g., to grandkids or below). Right now, the GST exemption levels and tax rate mirror those already discussed for the estate and gift tax.

You may be saying to yourself, “that seems like a really big exemption amount,” and you’d be right! To put how favorable the current exemption levels are in historical context, check out the following chart.

As you can see, going back to 2001, exemption amounts used to be substantially smaller, and the tax rates used to be higher. Note that the exemption levels doubled in 2018 pursuant to the Tax Cuts and Jobs Act of 2017, but also understand that these higher levels are scheduled to “sunset” in 2026. At this time, they will automatically revert back to their prior levels (adjusted for inflation; this is estimated to be around $6.5 million). However, if Congress and the President agree to change them, these exemption reductions could be much larger and could happen much sooner.

 

What a Biden Presidency / Democratic Controlled Congress Could Mean

It’s not my place to speak to the merits or validity of either political party’s policies, whether that’s in regard to tax rates, estate laws, or anything else. You don’t come to your financial advisor for political commentary, and I have no desire to provide any. That being said, as an advisor, it is my job to help clients understand what changes may be coming if the political climate turns and how they could be impacted personally. Note that it’s possible the following changes (if they occur) could be made retroactive to January 1, 2021.

Decrease in the Estate/GST and Gift Tax Exemption

Joe Biden has previously indicated that the exemption for estate and GST could be lowered to pre-Obama levels, which could be as low as $3.5 million per individual, with a gift exemption as low as $1 million (see 2009 in the chart above).

Increase in the Estate and Gift (and Capital gains) Tax Rates

It’s also possible we could see an increase in the estate and gift tax rates, which currently sit at 40%. It’s unclear at this point what that means, but a return to the 45-55% range we’ve seen in the past 10-20 years is possible. While we’re talking about tax rates, Biden has also suggested raising the rate on long-term capital gains to the rate imposed on ordinary income (at least for those with higher incomes, e.g., $1 million or more).

Change in the Basis Rules at Death

Under current law, your heirs will typically receive any assets you leave them upon your death with a “stepped-up basis,” meaning they get to hold those assets with a basis equal to their fair market value on the date of your death. At various times, Biden has floated the idea of eliminating the basis step up at death (meaning heirs would take a lower carryover basis instead) or alternatively the realization of capital gains at death (meaning the deceased individual’s estate would owe capital gains tax on appreciated assets at death). This could obviously be a big deal for your heirs if you hold assets with a large amount of appreciation.

Restrictions on Favorable Estate Planning Techniques

Based on recent Democratic proposals over the past few years, there is also speculation that they could seek to limit the use of valuation discounts and grantor retained annuity trusts (GRATs). It’s currently common when transferring an interest in a closely held business for estate purposes to discount the value based on a lack of control and a lack of marketability (which has the potential effect of increasing the amount of assets you can transfer estate and gift tax free). Similarly, GRATs are currently a popular estate tool and are used to potentially transfer the future appreciation of an asset free of estate and gift tax.

Note that regardless of the outcome of the upcoming election, the fiscal strain caused by COVID could itself be the catalyst for our elected officials to revisit the estate landscape as a source of additional revenue in a time when it may be sorely needed.

 

Estate Moves High Net-Worth Families Could Consider Before Year-End

Given the potential estate law changes that could be made effective as soon as the start of 2021, what estate updates should high net-worth families be considering now? Here are a few to consider:

Outright Gifts

If the estate and gift exemptions are reduced next year, you could miss out on a great opportunity to pass a large amount of wealth free of tax. To lock in the use of the current larger exemption this year, you’d need to be in a position to have at least one spouse transfer upwards of $11 million out of their estate. These types of outright gifts are commonly made to irrevocable trusts for the future benefit of your children and/or grandchildren. Treasury Regulations from 2019 indicate that transfers covered under an individual’s exemption in the year of transfer can’t be “clawed back” later at their death if the exemption has subsequently been reduced.

SLATs

If the thought of transferring that amount of wealth outright this year makes you uneasy (and it probably does), talk to your estate attorney about a spousal limited access trust (SLAT). If structured correctly, SLATs can potentially allow for trust distributions of the transferred assets back to the transferor’s spouse during their lifetime. You wouldn’t go down this route if you expected to need the funds again in the future. But if there is some type of unexpected financial hardship down the road, it can be comforting to know that you have the ability to access the funds again (indirectly through your spouse) if needed.  Obviously, the possibility of a future divorce or the premature death of the spouse beneficiary needs to be considered.

Estate “Freeze” Techniques

If you aren’t comfortable making a large outright gift, an estate freeze may be a better fit for you. A freeze transaction has the net effect of removing the future appreciation of an asset (above a predefined “hurdle” rate established by the government) from your estate. There are several different structures to accomplish this, some of which involve transferring assets to a trust in exchange for a promissory note equal to the fair market value of the assets sold. The transfer to the trust can be structured as either a sale or a gift, depending on whether you want to use up some exemption (and if so, how much).

The use of a promissory note can provide added flexibility. If the potential estate law changes discussed above seem more certain at a later date, it may be possible to “forgive” the note, which would then be treated as a completed gift that would use up some exemption. On the other hand, if you later decide you don’t want to part with the asset, the trust may be able to pay back the note “in kind” by transferring the asset back to you.

Two of the more common freeze structures are intentionally defective grantor trusts (IDGTs) and GRATs (referenced above). Your estate attorney can highlight the key differences between each and which might be a better fit for your situation. Both IDGTs and GRATs can be powerful tools under current law, especially in our low interest rate environment, when the hurdle rate that the transferred asset has to beat is so low. These tools can also be leveraged even further if you have an asset to transfer whose value can be discounted when transferring for estate purposes (as discussed above). However, keep in mind that future estate law changes could impact the ability to use both discounts and GRATs.

 

Start the Planning Process Now

So, what does all of this mean to you? If your personal balance sheet is approaching the $20 million range, it means you should at least be reaching out to your estate attorney and other advisors now to discuss what impact these potential changes could have on your personal planning. If you are uncertain about what amount of assets you can transfer and still have enough left over to live on comfortably, we at Lutz Financial can do a cash flow analysis to help you better answer that question.

From a timing perspective, keep in mind that high-level estate planning of this nature usually takes some time to complete (and your attorney will likely get harder to book as year-end approaches). If appraisals may be needed, those take time as well, as can applying for a federal tax identification number for a newly formed trust. Also, consider that it’s entirely possible that we may not know the results of the presidential election (and other key congressional races) for some period of time after election night. So, waiting to start this discussion until after the election may not allow enough time to get it done before year-end. Whether you ultimately decide to make any estate updates before year-end or not, it’s essential that you at least talk to your advisors and understand your options.

Important Disclosure Information

Please remember that past performance may not be indicative of future results.  Different types of investments involve varying degrees of risk, and there can be no assurance that the future performance of any specific investment, investment strategy, or product (including the investments and/or investment strategies recommended or undertaken by Lutz Financial), or any non-investment related content, made reference to directly or indirectly in this newsletter will be profitable, equal any corresponding indicated historical performance level(s), be suitable for your portfolio or individual situation, or prove successful.  Due to various factors, including changing market conditions and/or applicable laws, the content may no longer be reflective of current opinions or positions.  Moreover, you should not assume that any discussion or information contained in this newsletter serves as the receipt of, or as a substitute for, personalized investment advice from Lutz Financial.  To the extent that a reader has any questions regarding the applicability of any specific issue discussed above to his/her individual situation, he/she is encouraged to consult with the professional advisor of his/her choosing.  Lutz Financial is neither a law firm nor a certified public accounting firm and no portion of the newsletter content should be construed as legal or accounting advice.  A copy of the Lutz Financial’s current written disclosure statement discussing our advisory services and fees is available upon request.

ABOUT THE AUTHOR

402.827.2300

jhefflinger@lutzfinancial.com

LINKEDIN

JOE HEFFLINGER, JD, CFP®, CAP® + DIRECTOR & INVESTMENT ADVISER

Joe Hefflinger is an Investment Adviser and Director at Lutz Financial. With 15+ years of relevant experience, he specializes in comprehensive financial planning and investment advisory services for professionals, business owners, and retirees. He lives in Omaha, NE, with his wife Kim, and daughters Lily and Jolie.

AREAS OF FOCUS
  • Retirement Cash Flow Planning
  • Insurance Planning
  • Estate Planning
  • Business Owner Exit Planning
  • Charitable Planning
  • Tax Planning
AFFILIATIONS AND CREDENTIALS
  • National Association of Personal  Financial Advisors, Member
  • Financial Planning Association, Member
  • Nebraska State Bar Association, Member
  • Omaha Estate Planning Council, Member
  • CERTIFIED FINANCIAL PLANNER™
  • Chartered Advisor in Philanthropy®
EDUCATIONAL BACKGROUND
  • JD, Creighton University School of Law, Omaha, NE
  • BS in Economics, Santa Clara University, Santa Clara, CA
COMMUNITY SERVICE
  • Partnership 4 Kids - Past Board Member
  • Omaha Venture Group, Member
  • Christ the King Sports Club, Member

SIGN UP FOR OUR NEWSLETTERS!

We tap into the vast knowledge and experience within our organization to provide you with monthly content on topics and ideas that drive and challenge your company every day.

About UsOur Team | Events | Careers | Locations

Toll-Free: 866.577.0780Privacy Policy | All Content © Lutz & Company, PC 2021

Portfolio Management for Retirees During a Financial Crisis

Portfolio Management for Retirees During a Financial Crisis

 

LUTZ BUSINESS INSIGHTS

 

portfolio management for retirees during a financial crisis

joe hefflinger, director and investment adviser
PUBLISHED: APRIL 16, 2020

The impact of COVID-19 on the financial markets has been nothing short of dramatic. From its all-time high on February 19th, the S&P 500 fell 34% over just a few weeks before rallying off those lows recently. While the impact of the current crisis on our everyday lives is certainly unprecedented in many ways, market drops of this size and speed are not. Bear markets (drops of 20% or more from a recent peak) happen frequently enough (on average, once every six years) that their possibility should be considered in every financial plan.

Obviously, nobody enjoys seeing their net worth take such a hit in such a short period of time. However, for those with many years to go before retirement, they can generally keep adding to their retirement accounts (at discounted share prices) and remain aggressive with their investment allocation as they won’t be tapping into these funds for a long time. On the other hand, for those already in or approaching retirement, managing their portfolio during a financial crisis is far more complex. Times like these demonstrate the vital importance of having a comprehensive financial plan in place that is tailored to your personal needs. Part of any good plan is constructing your portfolio in a manner that takes into account that the markets can and will pull back materially at different points over any sizable period of time.

Keep in mind, however, that retirees could have two to three decades in retirement to invest their money. So there needs to be the appropriate balance between the need for current cash flow and the need for additional growth to protect against outliving your assets.  One way to accomplish this is to hold some of your assets in conservative bonds and cash, which provide some cushion against the risk of falling stock prices.

For those approaching or in retirement, we advise following the three-bucket approach in constructing your portfolio. Figure out what you’d like to spend each year. Say this number is $150,000 a year all-in (including taxes, out-of-pocket healthcare costs, etc.). Now figure out what amount of non-portfolio income you have coming in each year (e.g., social security, any pension or deferred compensation, etc.). Say that totals $50,000. That tells us your annual need from the portfolio (your shortfall) is $100,000 a year.

Let’s further say your total portfolio (401k, IRAs, taxable accounts, etc.) is $3,000,000. We advise putting one year of your shortfall needs in cash at the bank ($100k here). We typically like to see another ten years or so of your shortfall needs ($1M here) outside of the stock market, with a large portion of that in a diversified bond portfolio.

The remainder of the portfolio ($1.9M here) could be allocated to equities or some mix of equities and bonds depending on your ultimate goals, objectives and comfort level. The resulting overall allocation, in this case, would land somewhere between 63-37 (stocks to bonds/cash) and say 50-50, again depending on the amount of cushion the client is most comfortable with.

An illustrative example of this three-bucket approach is set forth below.

 

 

In a sense, this model takes asset allocation from the theoretical to the practical. Refilling each bucket over time can be adjusted as necessary as conditions warrant. For example, as markets fluctuate, you can evaluate options to potentially re-balance the portfolio as needed to get back to your desired targets.

It’s important to analyze your specific situation within the confines of a comprehensive financial plan. If you run your numbers and you aren’t comfortable with the result, you may be faced with some of the following questions:

  • If I’m still working, do I need to push back the age I plan to retire or increase my savings rate?
  • Do I need to find ways to reduce the amount I plan on spending annually in retirement (at least until the markets have recovered)?
  • If you’re already retired and had planned on delaying social security benefits to age 70, should you consider starting benefits earlier to avoid having to sell stocks at depressed prices to fund your living expenses?
  • Do I need to accept more risk (meaning own more stocks) in order to achieve my financial goals?

Some of these adjustments could make sense for you, but it depends on your facts and circumstances. It’s advisable to work with an experienced financial planner to help you analyze the specifics of your situation.

The benefit of the three-bucket model is that you wouldn’t need to touch the funds you have in stocks for over ten years. It’s easier to emotionally handle market pullbacks like we’ve seen when you can look at your portfolio through this lens, making it far more likely that you will stay the course. The key to all of this is not having to sell your stocks at an inopportune time. Currently, for clients that need funds from their portfolio, we will typically be selling their bonds and holding onto their stocks so they can participate in the ultimate recovery. And while it’s true that bonds can be volatile at times as well, historically they have been much less so than stocks. In times like these, having a solid financial plan in place (and sticking to it) is essential to maintaining a successful portfolio over the entirety of your retirement years.

Important Disclosure Information

Please remember that past performance may not be indicative of future results.  Different types of investments involve varying degrees of risk, and there can be no assurance that the future performance of any specific investment, investment strategy, or product (including the investments and/or investment strategies recommended or undertaken by Lutz Financial), or any non-investment related content, made reference to directly or indirectly in this newsletter will be profitable, equal any corresponding indicated historical performance level(s), be suitable for your portfolio or individual situation, or prove successful.  Due to various factors, including changing market conditions and/or applicable laws, the content may no longer be reflective of current opinions or positions.  Moreover, you should not assume that any discussion or information contained in this newsletter serves as the receipt of, or as a substitute for, personalized investment advice from Lutz Financial.  To the extent that a reader has any questions regarding the applicability of any specific issue discussed above to his/her individual situation, he/she is encouraged to consult with the professional advisor of his/her choosing.  Lutz Financial is neither a law firm nor a certified public accounting firm and no portion of the newsletter content should be construed as legal or accounting advice.  A copy of the Lutz Financial’s current written disclosure statement discussing our advisory services and fees is available upon request.

ABOUT THE AUTHOR

402.827.2300

jhefflinger@lutzfinancial.com

LINKEDIN

JOE HEFFLINGER, JD, CFP®, CAP® + DIRECTOR & INVESTMENT ADVISER

Joe Hefflinger is an Investment Adviser and Director at Lutz Financial. With 15+ years of relevant experience, he specializes in comprehensive financial planning and investment advisory services for professionals, business owners, and retirees. He lives in Omaha, NE, with his wife Kim, and daughters Lily and Jolie.

AREAS OF FOCUS
  • Retirement Cash Flow Planning
  • Insurance Planning
  • Estate Planning
  • Business Owner Exit Planning
  • Charitable Planning
  • Tax Planning
AFFILIATIONS AND CREDENTIALS
  • National Association of Personal  Financial Advisors, Member
  • Financial Planning Association, Member
  • Nebraska State Bar Association, Member
  • Omaha Estate Planning Council, Member
  • CERTIFIED FINANCIAL PLANNER™
  • Chartered Advisor in Philanthropy®
EDUCATIONAL BACKGROUND
  • JD, Creighton University School of Law, Omaha, NE
  • BS in Economics, Santa Clara University, Santa Clara, CA
COMMUNITY SERVICE
  • Partnership 4 Kids - Past Board Member
  • Omaha Venture Group, Member
  • Christ the King Sports Club, Member

SIGN UP FOR OUR NEWSLETTERS!

We tap into the vast knowledge and experience within our organization to provide you with monthly content on topics and ideas that drive and challenge your company every day.

About UsOur Team | Events | Careers | Locations

Toll-Free: 866.577.0780Privacy Policy | All Content © Lutz & Company, PC 2021

Personal Finances: Focusing on What You Can Control

Personal Finances: Focusing on What You Can Control

 

LUTZ BUSINESS INSIGHTS

 

personal finances: focusing on what you can control

justin vossen, cfp®, napfa, investment adviser & principal
PUBLISHED: MARCH 31, 2020

Like many of us, you may feel a bit disoriented, fearful, and anxious. Not only has your life been dramatically altered in the past few weeks, but the market continues to drastically swing every day. The uncertainty of it all is perhaps the most difficult thing to comprehend. While nobody has answers, we can be sure of one thing; mankind has focused all of its resources on one problem. One can hope that with a dedicated effort, positive change is on the horizon.

The disruption to the financial markets and economy is a difficult thing to gauge. Globally, many governmental programs are focused on mitigating the damage in the near term by stimulating their economy in various ways. This stimulus will provide a lubricant for the financial system in order to continue to function as normally as it can.

There is little question that there will be a recession. We have already dipped into a bear market as fast as we have seen in history. Since 1926, the average bear market lasted 22 months, while the longest bull market lasted 9 years.  Bull markets follow bear markets, and much of the recovery typically comes in the front end of the bull market.

One could argue that the markets are like a rubber band, the further you pull it back the quicker and harder it snaps back. As a result, in this particular environment, we recommend that we hold steady and make sure we have enough cash to get us through the coming quarters. That way we can effectively tune out the noise, focus on long-term goals, and let the benefits of diversification play out.

To conclude, if the best advice we can provide is to hold steady and ride through these coming weeks/months, what can we be doing proactively to help our mental and financial state?

We will be contacting Lutz Financial clients to discuss a variety of the following topics:

  • Gather tax filing items. This will help provide some level of certainty on payments/estimates and wrap up last year. In addition, it will allow you to plan for this coming year, as well to get closure.
  • Review your home budget. Are there things you don’t need immediately? Do you have unnecessary subscriptions or payments that don’t need to be made?
  • Look at tax-loss harvesting and asset location. Are there any tax plays now when the market has pulled back that you couldn’t do when greater gains were built-in?
  • Should you consider a Roth IRA conversion?
  • Should you reconsider you required minimum distributions for this year?
  • Revisit healthcare proxies, living wills and other advanced directives.
  • Make 2020 Roth/IRA contributions.

If you have immediate questions or concerns, please contact Lutz Financial today at 402.827.2300.

Important Disclosure Information

Please remember that past performance may not be indicative of future results.  Different types of investments involve varying degrees of risk, and there can be no assurance that the future performance of any specific investment, investment strategy, or product (including the investments and/or investment strategies recommended or undertaken by Lutz Financial), or any non-investment related content, made reference to directly or indirectly in this newsletter will be profitable, equal any corresponding indicated historical performance level(s), be suitable for your portfolio or individual situation, or prove successful.  Due to various factors, including changing market conditions and/or applicable laws, the content may no longer be reflective of current opinions or positions.  Moreover, you should not assume that any discussion or information contained in this newsletter serves as the receipt of, or as a substitute for, personalized investment advice from Lutz Financial.  To the extent that a reader has any questions regarding the applicability of any specific issue discussed above to his/her individual situation, he/she is encouraged to consult with the professional advisor of his/her choosing.  Lutz Financial is neither a law firm nor a certified public accounting firm and no portion of the newsletter content should be construed as legal or accounting advice.  A copy of the Lutz Financial’s current written disclosure statement discussing our advisory services and fees is available upon request.

ABOUT THE AUTHOR

402.827.2300

jvossen@lutzfinancial.com

LINKEDIN

JUSTIN VOSSEN, CFP®, NAPFA + INVESTMENT ADVISER, PRINCIPAL

 Justin Vossen is an Investment Adviser and Principal at Lutz Financial. With 21+ years of relevant experience, he specializes in providing wealth management and financial planning services for high net-worth families, business owners in transition, endowments and foundations. He lives in Omaha, NE, with his wife Nicole, and children Max and Kate.

AREAS OF FOCUS
AFFILIATIONS AND CREDENTIALS
  • CERTIFIED FINANCIAL PLANNER™
  • National Association of Personal Financial Advisors, Member
  • Financial Planning Association, Member
EDUCATIONAL BACKGROUND
  • BSBA in Economics and Finance, Creighton University, Omaha, NE
COMMUNITY SERVICE
  • St. Augustine Indian Mission, Board Member
  • Nebraska Elementary and Secondary School Finance Authority, Board Member
  • St. Patrick's Church, Trustee
  • Mount Michael Booster Club Board
  • Lutz Gives Back, Committee Chair
  • March of Dimes Nebraska, Past Board Member

SIGN UP FOR OUR NEWSLETTERS!

We tap into the vast knowledge and experience within our organization to provide you with monthly content on topics and ideas that drive and challenge your company every day.

About UsOur Team | Events | Careers | Locations

Toll-Free: 866.577.0780Privacy Policy | All Content © Lutz & Company, PC 2021

Planning For College Pragmatically

Planning For College Pragmatically

 

LUTZ BUSINESS INSIGHTS

 

planning for college pragmatically

justin vossen, cfp®, napfa + Investment adviser, principal
PUBLISHED: MARCH 16, 2020

Many parents have a goal of encouraging their kids to go to college. The dream of higher education is often a large driver in most parental decisions for their children. Financially it makes sense; the average college graduate with a bachelor’s degree makes $71,155, according to the U.S. Census Bureau for workers 18- and older in 2018. This is 83% higher than a high school graduate’s average annual earnings¹.

If you annualize the difference in earnings, the investment in college is clearly worth it monetarily over someone’s lifetime.  Thus, it makes sense that the demand for college continues to increase.  With that, the competition has increased as applications are up by more than 95% in 2018-19 compared to just 15 years ago².

This has obviously had an impact on the cost of education.  Since 1983, the cost of tuition has risen at a rate of 6.3% per year.  To put that in cumulative terms, the cost of tuition has almost risen eight-fold (798%) over the last 35 years.  Compare that to housing, where costs have only risen about 169% over that same period of time³.

The meteoric rise of college costs scares most and confounds parents when they are trying to think about the future — so what is the best way to plan for college?

Acknowledge the Uncertainty

The problem with planning for college when children are young is that there is so much uncertainty surrounding it. Will your child go to college? Where will they go? How many years will they attend? How much will it cost? How much of tuition am I willing to pay? Will they get a scholarship? What will financials look like at the time they enroll?

You can be paralyzed by variables to place into the equation.  This generally causes willy-nilly decision making and even causes some to ignore the situation completely.  Admit you don’t know exactly what is going to happen but try to apply some current reality to the situation by establishing a concrete starting point.

Pick a school and a number to quantify your goal

It’s probably best to begin by quantifying the situation from the beginning. Generally, when we advise folks, we take a specific approach to their location. For example, since we are located in Nebraska, we use the cost of its largest University, The University of Nebraska. The cost of tuition, fees, housing and meal plans in 2019-20 is $21,286.

Obviously, this tuition amount is in today’s dollars.  Based on your child’s age and an assumed tuition inflation rate, you can come up with a four-year undergrad cost need in the future (going for more than four years is a behavioral event which we will not solve for).  Then you can begin to do the math around how much is needed to fund college depending on the time horizon of your child.

When you have the numbers, you can solve for age. Below is an example of what an estimated cost of tuition will be (assuming 5% tuition inflation each year) for the University of Nebraska Lincoln. (Note: This does not include the effect of tax on any earnings/growth)

1. S. Census Bureau – Current Population Survey 2018; 2. National Center for Education Statistics; 3. BLS, Consumer Price Index, J.P. Morgan Asset Management. Data represent cumulative percentage price change from 12/31/82 to 12/31/2018

How much of college tuition are you willing to help pay for your child?

The right columns show how much you would need to save per month in order to pay for those future amounts assuming a 6% return on the assets invested monthly over the time from the beginning age.  With this information, we can estimate the cost of paying for 75% of University Nebraska tuition for a current newborn would require an estimated monthly savings of $425.

To make a plan, one needs to quantify how much they would like to pay for their children’s college and then acknowledge their ability to do so. The ability to contribute to their children’s future education must be contemplated concurrently with other income, savings, liquidity and planning for retirement. We always solve for retirement first because college is easier to fund, and frankly, it is not a necessity but a desire.

The combination of the ability to pay and the amount parents are willing to pay is what still needs to be solved for. Parents need to ask themselves if they want their children to have “skin-in-the-game” and what sacrifices they will need to make to go to college. What, then, are the parents willing to sacrifice to get them there?

The shortfall amounts can be filled with scholarships, grants and loans.  Financing college and paying back debt is another topic we will write about as a follow-up, but we want to give you some context.  According to Savingforcollege.com, the class of 2019 will have debt totaling roughly $29,900 when they graduate.  Their parents will acquire more than $37,200 in debt in addition to the children.  Whatever shortfall people haven’t saved for or haven’t paid for will generally get borrowed in some fashion.

Okay, I get it, I need to start saving now.  But to what vehicle?

Deciding what vehicle to use to save is determinant on the ability to have assets grow, tax efficiency, control and time. In our opinion, 529 plans offer the best way to plan for college.  While there are multiple 529 options out there sponsored by each state, the one that is best for you comes down to three things.

  1. Do I get a tax deduction for contributions?
  2. Is this plan low-cost?
  3. Does it have low-cost and diversified investment options?

All 529 plans have the ability to defer taxes on growth and potentially have the ability to shield growth from all taxes if used for a qualified educational expense. However, each plan has a different tax treatment on contributions determined by state laws. For example, Nebraska allows for a state income tax deduction on contributions up to $10,000 annually in totality. This could save someone up to $650 annually, depending on your income tax rate. However, it is important to note that some states offer no state tax breaks on contributions such as Minnesota.

You also have the ability to maintain control of the funds and distributions that occur throughout the lifetime of your child/beneficiary.  These are considered the assets of the owner (parent), not the beneficiary (student).  However, these accounts can be opened up by grandparents or others on behalf of a student.  These are subject to gifting limits, so please consult your tax advisor prior to opening one up.

After you decide what tax treatment you get in your state, you can narrow down the plan offerings based on cost and investment options.  The types of costs you need to look at within the 529 plan are the following:

  1. Program manager fee (what financial institution sponsors the plan)
  2. Investment advisor fee (what your financial advisor collects, if anything)
  3. Mutual Fund expenses (underlying costs of the investments)
  4. State administration fees (what the state charges to sponsor the plan)

Other options are Coverdell ESAs, which are limited to $2,000 a year in contributions and are phased out based on your income levels. These are tax-deferred and tax-free if used for education. They do offer a wider array of investment options since it is a personal account. However, you also are required to move the assets to another beneficiary by age 30, or take out the assets and pay the taxes.

UTMA (Uniform Transfers to Minors Act) and UGMA (Uniform Gifts to Minors Act) accounts for minors have a few pitfalls. The first of which is children can have full control of the assets at the age of majority in the state in which they live. In Nebraska, children have sole control at age 21.  These assets are also subject to income taxes and capital gains annually. Who is responsible for those taxes is based on the income level of the minor and in some cases their parents.

What if my kid gets a full ride scholarship?

Congratulations, you just won the lottery! You may have several options for their savings, depending on the account type. If it is a UTMA, it’s their money for good. If it is a 529 you can switch it to another beneficiary, do nothing and see if grad school funds are needed, take the money out (pay income tax on the growth), or distribute it to the beneficiary for other non-qualified educational needs (they pay income tax on the growth).

Just do it!

Planning for college is just that: planning. Like all plans, sometimes they will change. However, we believe it is important to at least quantify and begin saving as early as possible. You will have peace of mind and, more importantly, assets you can use to help aid in one of the most important decisions you and your child will ever make.

Important Disclosure Information

Please remember that past performance may not be indicative of future results.  Different types of investments involve varying degrees of risk, and there can be no assurance that the future performance of any specific investment, investment strategy, or product (including the investments and/or investment strategies recommended or undertaken by Lutz Financial), or any non-investment related content, made reference to directly or indirectly in this newsletter will be profitable, equal any corresponding indicated historical performance level(s), be suitable for your portfolio or individual situation, or prove successful.  Due to various factors, including changing market conditions and/or applicable laws, the content may no longer be reflective of current opinions or positions.  Moreover, you should not assume that any discussion or information contained in this newsletter serves as the receipt of, or as a substitute for, personalized investment advice from Lutz Financial.  To the extent that a reader has any questions regarding the applicability of any specific issue discussed above to his/her individual situation, he/she is encouraged to consult with the professional advisor of his/her choosing.  Lutz Financial is neither a law firm nor a certified public accounting firm and no portion of the newsletter content should be construed as legal or accounting advice.  A copy of the Lutz Financial’s current written disclosure statement discussing our advisory services and fees is available upon request.

ABOUT THE AUTHOR

402.827.2300

jvossen@lutzfinancial.com

LINKEDIN

JUSTIN VOSSEN, CFP®, NAPFA + INVESTMENT ADVISER, PRINCIPAL

 Justin Vossen is an Investment Adviser and Principal at Lutz Financial. With 21+ years of relevant experience, he specializes in providing wealth management and financial planning services for high net-worth families, business owners in transition, endowments and foundations. He lives in Omaha, NE, with his wife Nicole, and children Max and Kate.

AREAS OF FOCUS
AFFILIATIONS AND CREDENTIALS
  • CERTIFIED FINANCIAL PLANNER™
  • National Association of Personal Financial Advisors, Member
  • Financial Planning Association, Member
EDUCATIONAL BACKGROUND
  • BSBA in Economics and Finance, Creighton University, Omaha, NE
COMMUNITY SERVICE
  • St. Augustine Indian Mission, Board Member
  • Nebraska Elementary and Secondary School Finance Authority, Board Member
  • St. Patrick's Church, Trustee
  • Mount Michael Booster Club Board
  • Lutz Gives Back, Committee Chair
  • March of Dimes Nebraska, Past Board Member

SIGN UP FOR OUR NEWSLETTERS!

We tap into the vast knowledge and experience within our organization to provide you with monthly content on topics and ideas that drive and challenge your company every day.

About UsOur Team | Events | Careers | Locations

Toll-Free: 866.577.0780Privacy Policy | All Content © Lutz & Company, PC 2021