Listen to Financial Planning Insights - Key Considerations for Today

First Republic Investment Management
May 13, 2020

More than ever, the fundamentals of financial planning are core to ensuring a solid financial future. Listen to a discussion regarding issues and opportunities that we believe all clients should consider in today’s volatile environment.

See below for a complete transcript of the audio recording.

Rich Scarpelli: Good afternoon everyone and thank you for joining us for a session on Financial Planning Insights, Key Considerations for Today. Just one housekeeping item, we are taking questions. They can be submitted in writing on your screen. We'll try to answer as many as we can as we go along. But we'll set aside some time at the end to address a few questions.

I'm Rich Scarpelli, Head of Financial Planning at First Republic. And I'm joined by a planning colleague of mine, Miranda Holmes. And I'll turn it over to her.

Miranda Holmes: Great. Thanks so much, Rich. I'm Miranda Holmes. I'm one of the advance planners on the financial planning team in San Francisco. And I'm also the west coast team lead for our planning group at First Republic.

So, Rich, what are we going to be covering today?

Rich Scarpelli: Miranda, there are a few things we're going to be covering today. Some will be applicable for everyone. And other items will depend on one's own personal situation. We'll be providing a high-level overview of several strategies, some are very basic, but we'll also be providing some actionable items clients can address today. 

I think we should stick to three broad categories, Miranda. Number one, around risk management and how to best manage these risks. Number two, around cash flow, income tax and retirement planning strategies. And number three, wealth transfer opportunities.

Miranda Holmes: These are great categories to cover, Rich. And I think it's really important to begin with the end in mind. So, I really, when I start talking to clients, I like to emphasize how important it is to understand first where you want to get to and what you want to accomplish. 

So, I definitely encourage everyone to start out by writing down your goals. And when you write down your goals, be specific about dollar amounts and time horizons. So, what you think that this goal is going to cost and when the goal is going to take effect and how long it's going to last. So, make note of short-term, medium-term, long-term goals. Then put your goals in priority order, from most important to least important. 
But while we work to meet our goals and plan for the future, we also really need to prepare for the worst. So, Rich, what are some of the risks that we may be facing right now, today?

Rich Scarpelli: Well, Miranda, I think there are a few risks that we should address. Let's start with one of the risks that individuals are dealing with today, which is around loss of income and the ability to meet cash flow needs.

And immediately what comes to mind is the establishment of an emergency fund. Typically an emergency fund is an easily accessible account, such as a checking account, where one sets aside a certain amount of cash flow for unforeseen circumstances in order to meet certain expenses either short-term or longer term. 

Generally speaking, generally, not for everybody, but generally speaking, the idea is to set aside three to six month's worth of living expenses. And depending on one's risk appetite, sometimes even longer. For some, it may be shorter. It may be one to three months that may be right for them. But some folks may be more comfortable with six to 12 months. The key is to find the right amount that's right for you. 

Continuing on the theme of income replacement. Another risk is one's health and ability to work. Disability insurance comes to mind and want you to make sure they have the appropriate coverage in place. 

And the last item I like to touch upon is life insurance. Once you review what life insurance they have, as well as the life insurance needs that they require. And when I think about life insurance, there are many aspects to consider, but two come to mind. Number one around income replacement and number two around estate tax liquidity. 

So, with regards to income replacement, a key question is what proceeds so I need to support spouses, partners and family members. This is a key question that should be revisited, as well as how much of the lost income do I want to replace? Miranda, maybe I want to replace 100% of the lost income. Could be 80%, could be 50%. It really depends on one's own personal situation.

But it's not just about income. You may want to cover your liabilities as well. Mortgage obligations you have. Credit cards. Debts, etc. So, those should be factored into the equation as well as you think about the right amount of proceeds to cover those.
The second aspect that I mentioned was around estate liquidity. One may very well have some taxable estates, both at the federal level and the state level, especially here on the east coast. Life insurance can provide the liquidity to meet the tax obligations without the heirs having to take it from their inheritance.

So, Miranda, these are a few things that folks should be thinking about in managing some risks, but I definitely know there are other things we can do to prepare for the unexpected. Can you share with us some of those things?

Miranda Holmes: Yeah, absolutely. So, what you mentioned is critical, having in place an emergency fund as well as disability and life insurance in the appropriate amounts and types. We also really need to make sure we have an up-to-date estate plan in place. 

So, what's estate planning? Estate planning is really the process of insuring that our assets pass to whom we want, when we want and in the way we want. And in addition, we want to insure that our affairs are going to be taken care of properly if we're incapacitated.

 So, I know a lot of people out there have not yet created an estate plan. It feels like something that doesn't need to happen for a long time. It feels like a long way off. And some people who do have estate plans in place may have put them in place a number of years ago and it's been a long time since they reviewed how their documents work.

So, now is really an excellent time to review what's in place and make sure that it still fits with your asset distribution goals, or if you don't have an estate plan, to go ahead and create one right now.

So, there are four key documents that we want to make sure we have. The first is a will. And a will is a series of instructions that tells your executor how to distribute your estate in the event you pass away, as well as naming guardians for any minor children you have. 

Unfortunately, with a will your estate may pass through the state probate system and in some states, like California, that probate process can be really lengthy. It can take up to a couple of years to get through. It's a public process, so anyone can go down to the court house and look up information about it. And it can also be expensive.

So, in many cases it also makes sense to set up what's called a revocable living trust. And that's a document that instructs your successor trustee on how to take care of your assets if you are unable to do so. And how to distribute those assets after you pass away.

So, this kind of trust, a revocable living trust, can help your estate avoid the probate process, as long as you title all of the appropriate assets in the name of the trust. So, not retirement accounts or some other accounts, but the majority of your assets should be titled in the name of that trust.

The third document we want to have in place is what's called a power of attorney. And that authorizes another person to make financial decisions on your behalf if you are unable to do so. For example, if you're unconscious. 

And the fourth and final document we want to have in place is called a healthcare directive. And that has two parts. The first part is a healthcare proxy or power of attorney. And that gives another person the ability to make medical decisions on your behalf if you cannot do that. The second part to the healthcare directive is what's called a living will. And that allows you to specify what kind of medical treatment you want or do not want, especially if you're in a terminal condition or you're unconscious and you're not expected to recover or come out of it.

So, right now it is vitally important for you to review your existing healthcare directives because there are documents out there at the moment which limit all forms of life support treatments, including ventilators. Now, imagine for a moment that you were to get very sick with COVID-19. You end up in the hospital and you need to be put on a ventilator to save your life. Most of us would not want our healthcare directive to tell the doctor not to put us on life support. So, really important to go back and look over those documents. And if you don't have the documents in place, now is a great time to get that done.

So, I know that talking about death and illness and disability and incapacity can really be difficult for a lot of people. But it is very important to have those preparations in place. 

So, Rich, once we've prepared for all the potential risks, let's get back to planning financially for the future. So, in this new environment, what are some of the planning things that we can be doing?

Rich Scarpelli: A good question, Miranda. It's definitely a nice transition to our second category around cash flow, income tax and retirement strategies. Especially, some of these strategies are appropriate for these times. 

And there are two things that come to mind, really. One is just around cash flow and savings and spending and budgeting. And it's really important for individuals to take a look at their savings and spending again, as well as develop a complete picture of all the assets that they own.

The liabilities as well. And write it down. Write it down on paper. I can't stress that enough. Because once one starts to write it down on paper, it puts it in the context and it makes it much easier to make some tough adjustments as I'm sure there are some tough adjustments out there that need to be made.

Revisit one's time horizon. You really may need to reassess your short-term goals and longer term goals such as retirement. 

And when it comes to savings and budgeting, there's a 50/30/20 rule out there. Just a concept. It's a good guardrail. And it basically says, that once you look at your after tax income, and 50% of that income should go towards the necessities. The mortgage payment, groceries, utilities, etc. 30% of that after taxing income is more discretionary, like going out to dinner. Well, I don't know how many folks are going out dinner nowadays, but hopefully that will return soon. But other monthly subscriptions such as Netflix, etc. come to mind for that 30% bucket. And 20% of after tax income should really be siphoned off and saved for a longer term goal such as retirement and college savings.

 So, that's just a general rule. Not saying or suggesting that everybody should follow that, but write your assets down on paper. Write your budget down on paper. Put it into context, see where you fall within that 50/30/20 rule. And you'll have to make some adjustments. Maybe you will, maybe you won't.

 That's the first thing. Now the second item that I want to talk about is more of a retirement income tax strategy that is extremely timely nowadays. And the concept is converting a traditional IRA to a Roth IRA. Let me just talk about what a traditional IRA is and a Roth IRA and then we'll go from there.

A traditional IRA is an account where one has contributed pre-tax dollars, dollars that have not been taxed yet. And those assets grow on a tax-deferred basis. Because when they're distributed from that account, that's when the tax event occurs. Individuals will have to pick that distribution up in income.

As opposed to a Roth IRA, where you're contributing after tax dollars, dollars that have already been taxed. And that account will grow in a tax-free manner until it's finally distributed and that distributed amount will not be subject to tax. 

So, you can see the difference there. The Roth IRA has a tremendous tax-free compounding effect where you're not hit with that tax bill at the end when it's finally distributed.

So, why is this strategy of taking a distribution from your regular traditional IRA, paying the tax now and then converting it and putting that distribution into a Roth IRA for that tax-free compounding effect? Why is it timely? Several factors that favor this strategy now. 

Number one, that account, that traditional IRA, could very well be worth less today than it was five months ago. It could be worth 10% less, 15%, 20%, 30% less depending on what those assets were invested in. That means upon conversion the tax bill is lower than it would have been and all the subsequent growth out into the future will not be taxed. That's factor number one.

 Factor number two, just the current rates, where they are. The top bracket is 37% right now. We all know the government is spending a lot of money, eventually going to have to be paid for. The likelihood of taxes going up in some way, shape or form, is probably highly likely. So, one could convert it now at a lower rate and then when if rates do go up, it doesn't matter because it's a tax-free distribution when it comes out of the Roth IRA. 

The third factor is it could very well be a low income tax year for some individuals. Their income may have gone down by 10%, 15%, 20%, 30%, 40%, their taxable income. So, they could very well be in a much lower tax bracket, number one. And number two, you could very well have clients that have a business that generated a net operating loss for the year. Which could potentially wipe out all their taxable income, or a good chunk of it, which puts them in a lower marginal rate or maybe not paying taxes at all.  So, it's a highly advantageous time to take a look at this strategy today. 

Miranda, but beyond retirement, and let's just move on to our third category wealth transfer because I think there's a tremendous opportunity here for our clients that have been contemplating a gifting program. What can our clients do today around wealth transfer? And why?

Miranda Holmes: Those are great questions. So, there are really three factors that contribute to why today is a great time for people to be considering wealth transfer opportunities. And you mentioned a little bit earlier lower asset values. You were talking about how a lot of assets may have come down in value because of the pandemic, recession, economic uncertainty. Many assets may have dropped in value. So, that's one factor.

 And in addition, the government has lowered interest rates to some of the lowest we've ever seen. On top of that, we have the highest gift and estate tax exemption in history which is $11.58 million per person right now with the possibility that that exemption may drop over the course of the next few years. 

So, if you're thinking about helping other family members or moving assets out of your estate to allow the assets to appreciate outside of your estate in order minimize future estate taxes, now is a great time to consider a few strategies. I'm going to talk about a few of those right now. 

You may be familiar with the annual gift tax exclusion which allows you to gift up to $15,000 per person per year to as many individuals as you like, each year with no gift tax consequences. So, you can use this exclusion to gift assets that have dropped in value to children, grandchildren, other family members or to trusts for their benefit and allow those assets to appreciate outside your estate over time.

So, let's say that you give some shares of a stock that's dropped in value down to $15,000 to your child. And that stock then grows to $25,000 over the next year or two. That means you've been able to transfer the entire $25,000 of value to your child gift tax-free. So, this can be a very effective way to transfer assets out of your estate over time. 

In addition to that, many of our clients are interested in helping adult children buy houses or make investments into a business. Now is a really great time to use the current low interest rates. Right now, for example, a nine year loan would be as little as 0.58% interest. And you can use those low interest rates to lend money to your family members on an interest-only basis allowing them to use that capital for investment into a house, or a business or other investments where they're going to pay only a small amount of interest to you each year on the balance that you've loan to them. And repay the original principle only at the end of the loan term. So, that's potentially many years from now.

One of the things you can do is use your $15,000 annual exclusion to forgive the loan interest on the loan that the kids or other family members would otherwise be paying you each year. And let's say the loan interest is actually less than $15,000 a year. You can use the additional amount, up to $15,000 to forgive principle on an annual basis as well. And so the principle of the loan could be reduced each year using your annual exclusion gift.

So, that's another way to help kids or other family members with opportunities for investing for various purposes over time with a really low interest rate. 

So, for people who have depressed assets and want to make larger gifts or transfers out of their estate, I'm going to talk about two strategies that they can use. 

Number one, very similar to the first one, but making a larger gift using a portion of your lifetime gift exemption. Remember that's the $11.58 million that each person has available to gift with no gift tax consequences. And using some or all of that lifetime gift exemption, using low-value assets that you have, that you expect that you'll recover in the future, or appreciate in value going forward, and moving some of those assets out of your estate into trust for the benefit of kids or maybe making those gifts directly or trusts for the benefit of multiple generations. So, you can set up a trust, not only for the benefit of children, but also grandchildren, great-grandchildren and future descendants as well.

Another strategy that we're seeing a lot with clients right now is something called a grantor retained annuity trust, also known as a GRAT. So, this is a way to transfer appreciation of an asset outside of your estate to children, or a trust for your children's benefit, without using any of your gift tax exemption. And the way you do that is to take an asset that you think is relatively low in value, to put it into the trust. As a grantor retained annuity trust, you as the grantor retain an annuity payment back to you from the trust each year for the term of the trust and that term could be two years, five years, 10 years, whatever you choose. And you're going to take back some payments from that trust over time until you've essentially taken back the entire principle that you put in plus a little bit of growth based on those super low interest rates that we have right now. 

If the asset appreciates inside the trust over the term of the trust, then all of that additional appreciation is going to accrue for the benefit of your kids, or the trust that it goes to for your kids' benefit, at the termination of the GRAT.

So, these are some of the ideas that would work really well right now. Given not only the low values that we're seeing, but the current low interest rate environment and the really high gift and estate tax exemption we have today.

Rich Scarpelli: Miranda, sounds like a tremendous opportunity. A lot of valuable information you shared with us on some of the strategies. I know we're coming up upon our 30 minutes. Why don't we take some questions?

As I look through, Miranda, I'll direct this towards you. You take this one. Is it possible to execute a will on your own? And would you advise somebody to do that as well?

Miranda Holmes: Those are really great questions. The first answer is yes you can execute a will on your own. Number one, there are a lot of software programs out there on the internet or forms that you can fill out where you can put together a pretty basic, straight forward will and you just need to have two witnesses who sign the will. You can also draft a will in your own handwriting called a holographic will, and sign it. 

So, you can do that on your own, but generally speaking I prefer to have people go to an estate planning attorney who specializes in putting together estate planning documents, so that we can make sure that the estate plan, not only the will, but the rest of the documents that you need are customized to your particular circumstances. We want to make sure that it operates exactly as you're intending. And all the state oriented situations, laws and other things are taken into consideration.  

And in addition to that, an estate planning attorney can help you make sure that if in your case it makes more sense to do a revocable living trust with a pour-over will, that you can have both those documents in place and you can appropriately re-title your assets in the name of your revocable living trust. As well as look over all of your beneficiary designations and make sure that your beneficiary designations for your retirement accounts and your life insurance policies are all coordinated so that your entire estate plan is going to work together in conjunction in a way that makes sense.

So, I definitely recommend that while you could do the will on your own, it's best to go see an estate planning attorney.

Rich Scarpelli: Thanks, Miranda. I definitely agree with that opinion.

Let's take question number two. What type of life insurance should I consider? Why don't I take that since I touched upon it? I don't think I touched upon types of life insurance. So what type of life insurance should I consider?  Let's go back to the two aspects that I talked about, income replacement and estate tax or death tax liquidity. 

With respect to income replacement, usually an individual would want to replace income for a certain number of years, call it 10 years, 15, years or 20 years. And in that case, generally speaking, not in every situation, but generally speaking, you probably look to term to fill that need, term life insurance.

Term life insurance, you have a flat level premium that's paid every year for a 10 year, 15 or 20 year period. And then it lapses, it's done unless somebody converts it to a permanent type of policy. Which I'll actually talk about that next.

So, for estate tax and death tax liquidity purposes, usually you'd want that throughout your lifetime, until the very end. Because it's there to pay for estate taxes and provide liquidity to the estate. So, in that case you'd look to more permanent types of policies, like maybe a universal life policy or a whole life policy where as long as you pay the premiums every year, it'll be there throughout one's lifetime. 

So, that's just a brief answer on the type of life insurance that one should consider.

Miranda Holmes: I have an additional thought. So, there are some circumstances where permanent life insurance can also make sense for folks who are in a very high tax bracket, maybe have a lot of income, a lot of ordinary taxable income. Life insurance policies by their nature have a tax deferral component to them where any cash value in the policy is going to grow on a tax deferred basis and can come out later on down the road in a tax advantage manner.

So, for some people who are looking for additional tax deferral strategies, having permanent life insurance can be another way to take advantage of that tax deferral aspect of life insurance. 

Rich Scarpelli: Thanks for adding that, Miranda. I still have somebody asking a question regarding if we thought, said something to the effect that if we thought tax rates were going to go up, what can we do?

Well, I mentioned the IRA Roth conversion and like you just mentioned, it could be a great tax advantageous way to utilize insurance.

So, let's look at one more question as we run up on time. Any opportunities with the Cares Act? Why don't I cover that?

So, why don't I cover some aspects that may be hidden in there that folks don't necessarily know about? There's the Small Business Administration loans that are in there, which I think people are familiar with. But there's two items that folks maybe should be aware of. And it's around retirement plans and it's around charity.

So, around charity, let's tackle that first. The government, the IRS, is giving people the ability to take a, what we call, a $300 above the line deduction. That means it's before one itemizes. Even if one does not itemize, they just take the standard deduction, they'll still be able to take this $300 deduction. So, if folks are giving to charity and they typically take the standard deduction, guess what? You get the benefit of the $300 deduction. Don't miss out on that as you file your tax returns which are due, by the way, July 15th. If you do a refund, I would file right away.

The second aspect that's in the Cares Act with respect to charity are the AGI limitations, Adjusted Gross Income limitations. When one itemizes deductions, that's where their charitable deductions show up. Individuals are limited to how big of a deduction they can take. And it's based upon a certain percentage of adjusted gross income. 

In the prior year, the limit for cash was 60% of adjusted gross income. Granted, any excess could be carried over for five years. But that limit has gone from 60% to 100% gross income. Which is really a tremendous deduction that one can get to offset much of their income that maybe they've earned throughout the year. 

So, I know we're running a little over time. We've got a few more questions coming in, but in respect of everybody's time, I think we'll pause there. For those questions that we weren't able to address, I strongly urge everyone to reach out to their First Republic professional. And we also have additional resources and materials and articles in the Articles and Insights section at the website,

So, I really appreciate everybody joining us today. And I hope you all enjoy the rest of your week. Take care.


The strategies mentioned in this recording may have tax and legal consequences; therefore, you should consult your own attorneys and/or tax advisors to understand the tax and legal consequences of any strategies mentioned in this recording. This information is governed by our Terms and Conditions of Use.