Financial Planning Insights: What to Know In Today’s World

First Republic Investment Management, Advanced Planning
April 12, 2021

Although we’re living in an uncertain time, there’s comfort in knowing that many of the financial cornerstones that experts have always advised on still stand. With any financial goal, for example, it's essential to understand where you want to go and what you want to accomplish. You can start this process by writing down your goals and being as specific as possible about dollar amounts and time horizons. Consider what you think each particular goal will cost, when you'll need that goal to take effect and how long it will last. Label financial goals as part of your short, medium and long-term plans, and prioritize them from most to least important. With the basics in place and a timeline set for your goals, you can move on to figuring out ways to take advantage of the current market and to ensure that you are always prepared for the worst. Taking the current economic market we're facing today into consideration, these are some smart areas to look into adjusting.

Risk Management

Managing your future risk means taking a look at what's happening in the market today and adjusting your financial goals as necessary. These actions can help you weather certain storms.

Establish an emergency fund.

Establishing an emergency fund allows you to meet cash flow needs during a time of potential loss of income. An emergency fund is typically an easily accessible account — like a checking account — where you set aside cash reserves in anticipation of unforeseen circumstances. Experts traditionally recommend setting aside three to six months' worth of living expenses, which could be more or less depending on your risk tolerance.

Assess your insurance needs.

Loss of one's health and ability to work is another risk. Disability insurance with the appropriate coverage, for example, would help keep you afloat if you were injured and unable to work. Life insurance is another critical element. Start by reviewing how much and what types you have, and what you might need to feel adequately covered in the event of the death of a loved one. Life insurance may be purchased for a variety of reasons. Two common reasons generally revolve around income replacement and estate tax liquidity.

Regarding income replacement, consider what dollar amount you would need to support family members or loved ones, and how much potential loss of income you would want to replace. This usually means replacing income for a certain number of years. Besides income, you may want to cover additional liabilities — like mortgage obligations, credit card debt and future education costs for children. A term life insurance policy usually helps fill that need with a flat-level premium that's paid every year.

You may also want to consider estate liquidity. You may have a taxable estate at the state or federal level, and life insurance can provide the cash necessary to meet those tax obligations, without your heirs having to take it from their inheritance. In the case of estate liquidity, you might want to consider a more permanent plan, like a universal life or whole life policy.

Check on your estate documents.

Estate planning is the process of ensuring your assets pass to whom you want, when you want and in the way you want. An estate plan also ensures that our affairs are taken care of properly if we're incapacitated. Now is an excellent time to review what you have in place to make sure it fits within your asset distribution goals, or to create one if you don't already have one. The four key documents to an estate plan include:

  • Will: Tells your executor how to distribute your estate, as well as potentially naming guardians for your minor children.
  • Revocable living trust: Instructs your successor trustee on how to take care of and distribute your assets. Including this in your estate plan can help you avoid the lengthy and costly probate process, as long as you title all appropriate assets in the name of the trust.
  • Power of Attorney: Authorizes another person to make financial decisions on your behalf if you’re unable to do so.
  • Health Care Directive: Includes two parts. The first, a health care proxy or power of attorney, gives another person the ability to make medical decisions on your behalf. The second, a living will, allows you to name the specific medical treatments you do or do not want, especially if you’re in a terminal condition or not expected to recover from unconsciousness. It’s especially important to revisit your current documents now, as they may involve information regarding life support treatments (including ventilators), which may be an essential element of healthcare when it comes to COVID-19 treatment.

Cash Flow, Income Tax and Retirement Planning

After assessing your risks, it’s more important than ever to get back to planning financially for your future. In this new environment that includes:

Set savings and budgeting goals.

Take a look at your savings and spending, and develop a complete picture of your assets as well as your liabilities. Writing the details down on paper puts your financial picture into context and makes it easier to make some tough adjustments if necessary. Revisit your time horizon, as you may need to reassess short-term and long-term goals, like retirement. When it comes to savings and budgeting, the 50-30-20 rule is a good guideline. To follow it, take your after-tax income and put:

      • 50% towards necessities like mortgage, groceries, utilities, etc.
      • 30% towards discretionary spending like monthly subscriptions, vacations and entertainment
      • 20% siphoned off and saved for long-term goals like retirement and college savings.

Consider a Roth IRA conversion.

One retirement income-tax strategy that's timely is converting a traditional IRA to a Roth IRA. A traditional IRA is an account where one generally contributes pre-tax dollars, and those assets grow on a tax-deferred basis. Income tax is due on the distributions made from this type of account. For a Roth, after-tax dollars are contributed, and that account will grow in a tax-free manner until it's finally distributed, generally with no taxes due. In that way, a Roth has a tremendous tax-free compounding and distribution effect. Now is an excellent time to look into this option for several reasons:

  • Due to recent market volatility, your traditional IRA could be worth less today than it was five months ago, which means that upon conversion, your overall tax bill will be lower than it would have been.
  • Income tax rates may go up eventually. That means you could convert your accounts now at a lower rate, and any future rising rates would not impact those funds.
  • Some individuals may have lower income this year, putting them in a lower tax bracket, or your business could be generating a net operating loss, reducing or potentially offsetting your taxable income. In other words, it’s a highly advantageous time to take a look at this type of conversion today.

Explore wealth transfer opportunities.

Your assets may have dropped in value over the last few months because of the pandemic, recession and economic uncertainty. The government has also lowered interest rates to some of the lowest we've ever seen, with the highest gift and estate tax exemption in history. If you're thinking about helping other family members or moving assets out of your estate to allow them to appreciate outside of your estate to minimize future estate taxes, the following are some actions worth considering:

  • Gifts: The annual gift tax exclusion 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. In this way, you can gift assets that have dropped in value to your children, grandchildren, other family members or to trusts, and allow those assets to appreciate outside of your estate over time. An example would be giving shares of a stock that’s dropped in value down to $15,000 to your child. If that stock were to grow to $25,000 in the next year or two, you would have successfully transferred the entire $25,000 in value to your child gift tax-free.
  • Intra-family Loans: Right now, a nine-year loan may have an interest rate of under 1%. You can take advantage of these low interest rates to lend money to family on an interest-only basis. That allows family members to use that capital to invest in a business or buy a house, and pay only that small amount of interest to you each year on the balance you've loaned to them. This strategy also allows them to repay the original principal at the end of the loan term, which could be many years from now. As an additional way to save, you can also use your $15,000 annual exclusion to forgive the loan interest that your family would otherwise pay you each year. If the loan interest is less than $15,000 each year, you can also use the additional amount to forgive any principal on an annual basis. For larger gifts, you may consider using a portion of your lifetime gift exemption, which is $11.58 million. In this way, you could take any low-value assets that you expect to appreciate in the future, and move them out of your estate into a trust for the benefit of your kids or multiple generations. You may also wish to make those gifts directly to your kids.
  • Grantor Retained Annuity Trusts (GRATs): GRATs are a way to transfer the appreciation of an asset outside of your estate to children, or to a trust for your children's benefit, without using your gift-tax exemption. To do so, begin by transferring a low-value asset into this type of trust for a specific term of years over which you believe the asset will appreciate. As the grantor, you retain an annuity payment back to yourself from the trust each year for the term of the trust. These annuity payments will typically add up to the original principle you put in, plus a small amount of growth based on current low interest rates. If the asset appreciates inside the GRAT during the term, the additional appreciation accrues for the benefit of your kids (or other family members) and is transferred to them or to a trust at the termination of the GRAT.

Although this can be a stressful and confusing time, in terms of your financial options, there are a number of moves that you can make today that could have positive consequences in the future. When you're ready to learn more — or for any additional questions you might have — the experts at First Republic Bank are a phone call away, and they are ready to serve.

The strategies mentioned in this article 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 document. This information is governed by our Terms and Conditions of Use.