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Nov 04 2019

Travel and Technology in the 21st Century

November 4, 2019

Written by Kelly Inglhofer, Marketing and Communications Coordinator

The future of luxury travel is constantly evolving as new technology impacts our entire experience. People now have more options than ever before on where they can go, how they can travel, and what they can do once they arrive. This article takes a look at the most luxurious and technologically advanced travel destinations and experiences.

Destinations

The first destination is out of this world, literally. The Aurora Station hotel is a space craft that will take guests in low orbit around the earth for 12 days. Orion Span, the company behind this new travel experience, is currently accepting $80,000 deposits to be added to the waitlist. The first guests plan to launch in 2022 and will undergo three months of theory and exercise training. There will be two crew members on board to prepare meals and assist with a variety of activities. Activities include volunteer research science tasks, star gazing, and cargo transfers. To further put it in perspective for how far our technology has come, this civilian aircraft will depart 61 years after the first human entered space in 1961.

For the ecofriendly traveler, Wilderness Safari Bisate Lodge in Rwanda is a must. Guests stay in an eroded volcanic cone adjacent to the Afro-alpine forests. Villas are created with environmentally friendly materials, and the entire safari camp is eco sensitive. The most noteworthy experience during your stay will be observing the gorilla groups that inhabit the Volcanos National Park. This destination truly allows visitors to be at one with nature.

The Golden Eagle Trans-Siberian Express is a destination and travel vehicle combined. This Russian train voyage will take you on a 15-day journey through Russia and includes iconic stops in Moscow, along Lake Baikal, and in Yekaterinburg. Onboard, guests have private luxury cabins, personal cabin attendants (who are available 24/7), consistently changing views, and executive chef-prepared meals. For those of you who like to relax with some fine wine, there is a bar lounge car with a resident pianist on a grand piano.

Experiences

Have you ever eaten five and a half meters below the surface of the ocean? Norway’s Under restaurant allows you to dine with an unparalleled view of marine life in the North Atlantic Ocean. The focus of your meal is on marine research and understanding our relationship with our neighboring sea creatures. The restaurant itself was built with the purpose that, throughout time, it will become part of its marine environment and its shell will operate as an artificial reef. There is one set menu that head chef Nicolai Elltisgaard rotates seasonally to reflect the plethora of fresh ocean delicacies and local vegetation.

Taking travelers in the complete opposite direction is Germany’s highest beer garden, atop the country’s highest mountain, Zugspitze. For beer lovers, foodies, and extreme hikers alike, this unique restaurant offers authentic German cuisine, organic beverages, countless alpine mountain peaks, glacier snow, and of course, beer. The only way to trek to this remote location is on foot or via cable car. For thrill seekers who want some activity before they dine, Zugspitze offers skiing passes and mountain train rides. The garden has indoor seating for the perpetually chilly and, if that isn’t enough, this spot has been named on CNN’s top beer gardens from around the world.

Our last experience is a humbling tour through the temples of Bayan, Myanmar. The site, officially known as the Bagan Archaeological Zone, is comprised of thousands of abandoned temples. From the 11^th to the 13^th centuries, this spot was said to be the most religious and culturally rich region in the world. A three-day entry ticket to the zone is about $17 USD and allows you to explore at your own will. Visitors can also take advantage of bicycle tours and hot air balloon rides over the archeological site. While not clearly focused on technology advances, this experience hits our list due to the advancements that have kept the temples standing and safe to observe. After centuries of weather and human urbanization impacts, 3,800 monuments and temples still stand.

How Far We Have Come

Each of these destinations and experiences are uniquely advanced by technology. Who would have imagined that we could travel out of this world, eat at the bottom of the ocean, or view temples of the cultural capital of the world ages ago? As technology advances the experiences of luxury travel, the same is true for other industries.

At MRA Associates, we view technology as an important element in our firm’s strategy to be innovative, improve our clients’ experience and outcomes, and be more efficient. Needless to say, we are excited to see where the future will take us!

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Kelly Inglhofer

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Nov 04 2019

Retirement Plan Industry Update – Q3 2019

November 4, 2019

Written by Dave Westra, Partner, CFP®, AIF®, CPFA and John Brimhall, Client Advisor, CFA, CPA, CFP®

Retirement Plan Participant Sues Plan Sponsor for Cybersecurity Breach

A former employee of Estee Lauder, Naomi Berman, claims that someone made three unauthorized distributions, totaling $99,000, from her 401(k) plan account. Berman is suing Estee Lauder and plan service providers for failing to safeguard her retirement account and breaching their fiduciary duties. The plaintiff claims that by the time she received a notification, the distributions had already been processed.

The lawsuit claims that the unauthorized distributions took place in late 2016. Between October 24, 2016, and January 2, 2017, Berman “made at least 23 calls” to Hewitt Associates, the plan’s recordkeeper. Upon completing its review, Hewitt Associates notified Berman that “no money had been recovered and added that her plan account would not be made whole for the losses".

The lawsuit seeks to restore her account balance and lost earnings.

(Steyer, 2019)

Safe Harbors Available to Retirement Plan Sponsors

A safe harbor is a provision in law that provides protection from liability under specific situations or if certain conditions are met. In an effort to encourage companies to offer retirement plans to their employees, the Internal Revenue Service (IRS) and Department of Labor (DOL) offer a number of safe harbor provisions to protect plan sponsors.

The following is an overview of the most common retirement plan safe harbor provisions:

Section 404(c): Allows plan sponsors to shift the responsibility of investment management decisions to their plan participants.

While there are a number of requirements to obtain 404(c) protection, the following is a summary of the basic pillars:

Offer a broad range of at least three diversified investment options
Provide participants access to sufficient information to make informed decisions, including
- Annual fee disclosure notice
- Investment option prospectuses, financial statements, and reports
Provide written confirmation for participant decisions (e.g., investment election change)
Allow participants the ability to make investment changes regularly (at least quarterly)

Qualified Default Investment Alternative (QDIA): Protects plan sponsors from liability for investing a participant’s assets in a default fund.

Basic requirements:

The participant fails to make an investment election
The default investment meets certain criteria, including
- Target date fund
- Balanced or lifecycle fund
- Managed account

Mandatory Cash-Outs: Protects plan sponsors from liability for initiating a distribution of a “small” account balance for a terminated employee. For balances greater than $5,000, the plan administrator cannot initiate a distribution without the participant’s consent.

The plan sponsor must provide written notification to the terminated employee that describes his or her distribution options, explains the force out provision, and provides the participant sufficient time to initiate a distribution or rollover.
- Less than $1,000 – send the terminated participant a check
- Between $1,000 and $5,000 – roll over the account balance to an IRA

Employer Contributions: When a plan sponsor makes either an eligible matching contribution or nonelective contribution, it can automatically pass annual nondiscrimination tests (such as the ADP/ACP and top-heavy tests).

Requirements:

Matching contribution options
- Basic Match - 100% match on the first 3% of deferred compensation, plus a 50% match on deferrals between 3% and 5% (4% total).
- Enhanced Match – must be at least as much as the basic match at each tier of the match formula. A common formula is 100% match on the first 4% of deferred compensation.
Nonelective contribution
- 3% (or more) of compensation, regardless of the participant's deferral amount.
Employer matching and nonelective contributions must be 100% immediately vested.

Qualified Automatic Contribution Arrangement (QACA): A newer type of safe harbor, the QACA provision combines automatic enrollment, automatic escalation, and QDIA mapping. QACA allows plan sponsors to automatically pass annual ADP/ACP and top-heavy tests.

Basic requirements include:

Automatic enrollment at 3% or more
Automatic escalation at 1% or more annually, up to at least 6% (maximum 10%)
Matching contribution of 100% on the first 1% of compensation deferred and 50% on deferrals between 1% and 6% (3½% total)
Default participant balances into the plan’s QDIA
Vest participants with a two-year cliff

Electronic Delivery of Required Disclosures (PROPOSED): The DOL recently proposed a new Electronic Disclosure Rule which would give plan sponsors safe harbor protection for providing required disclosures online. The DOL estimates that this change could save plan sponsors $2.4 billion in printing and mailing costs over the next ten years.

(Umpierrez, 2019)

Common Mistakes That Arise During Retirement Plan Audits

It is important to understand, recognize, and avoid these common mistakes when administering your retirement plan(s):

Definition of Compensation

This continues to be one of the biggest issues found during plan audits. Compensation is not black and white, as it may capture some types of benefits not as easily identified as cash compensation. Not only is it important to understand how eligible compensation is defined in the plan document, but plan administrators need to verify that the payroll codes are set up properly to include or exclude various types of compensation.

Timely Remittance of Employee Deferrals

Ensuring consistency when remitting employee deferrals is imperative. Once a plan sponsor has established that they can process deferral remittances within a certain number of days, this becomes the standard going forward.

Eligibility

It is important to understand how eligibility for participant deferrals and company contributions are defined in the plan document. The plan administrator is required to verify that an employee has met the eligibility requirements before being enrolled in the plan and/or permitting deferrals and funding company contributions.

Vesting

While plan sponsors often rely on their recordkeeper to track vesting, the ultimate responsibility falls on the company to ensure the calculation is correct.

Forfeitures

Plan sponsors need to use plan forfeitures in a timely manner and in accordance with the plan document (e.g., plan expenses, matching contributions).

Distributions

It is important that distributions are processed in accordance with the plan document and made to the eligible participant. If the plan administrator is responsible for approving distributions, the company should have a documented process for reviewing and authorizing distributions.

Participant Elections

When a plan participant initiates a deferral rate change, the plan sponsor must process the change in a timely manner. It is prudent to have a documented process for receiving change notices from the recordkeeper and updating the payroll system in a timely manner.

(Morris, 2019)

Health Savings Accounts (HSA) – Still Evolving

Since 2004 (when HSAs were established), we have seen exponential growth in the number of HSA accounts and assets. According to Devenir’s 2018 Year-End Research Report, there were more than 25 million HSA accounts, with $53.8 billion in assets, as of December 31, 2018. There are several factors that have contributed to the rapid growth of HSAs, including lower health care spending by companies and a desire for their employees to take on greater decision making in how their health care dollars are spent.

HSAs are tax-free savings and investment accounts that allow taxpayers to save and pay for eligible medical expenses with pre-tax dollars. These accounts empower individuals to make affordable healthcare choices that best fit their needs. Due to the triple tax advantage that they offer, pre-tax contributions, tax-free growth, and tax-free distributions for qualified medical expenses, many professionals in the industry have called HSAs the “heavyweights of tax-advantaged accounts”.

To assist plan sponsors and consumers in understanding and evaluating the HSA provider landscape, several organizations, including Devenir, Morningstar, and PLANSPONSOR magazine, have issued research reports and provider rankings.

While most recognize that the industry has evolved, there is consensus that there is still room for improvement.

Opportunities for Improvement:

Fees vary widely by provider
Most providers require participants to maintain a cash balance before being able to invest excess funds
While investment menus have improved, there is an opportunity to lower fees and simplify options
Transparency is inconsistent for relevant information (e.g., fees, yield on checking account)
Yields on checking accounts remain low

Progress:

Fees continue to decrease
The quality of investment options remains strong and is improving

(Morningstar, Devenir, 2019)

Preventative Care Services Expanded for HSA Participants

On July 17, 2019, the IRS provided guidance that expanded the types of treatments and services that constitute preventive care. Certain preventative care, including the Affordable Care Act’s required preventative services, can be provided at low or no cost without requiring the participant’s annual deductible to be satisfied. The new IRS guidance provides additional treatment and services for chronic conditions.

The following chart lists some of the treatments and services that are covered for chronic conditions.

(IRS, 2019)

Works Cited

Steyer, R (October 16, 2019). Participant sues Estee Lauder over 401(k) security breach. Retrieved on October 21, 2019 from https://www.pionline.com/courts/participant-sues-estee-lauder-over-401k-security-breach

Umpierrez, A (September 18, 2019). What Safe Harbors Are Available to Retirement Plan Sponsors?. Retrieved October 21, 2019 from https://www.plansponsor.com/in-depth/safe-harbors-available-retirement-plan-sponsors/

Morris, A (September 26, 2019). 10 issues that can land you in hot water during an employee benefit plan audit. Retrieved on October 21, 2019 from https://www.benefitspro.com/2019/09/26/10-issues-that-can-land-you-in-hot-water-during-an-employee-benefit-plan-audit/

Devenir Research. (2018) 2018. Year-End HSA Market Statistics & Trends Executive Summary. Retrieved on October 23, 2019 from https://www.devenir.com/wp-content/uploads/2018-Year-End-Devenir-HSA-Research-Report-Executive-Summary.pdf

Morningstar. (2019) Health Savings Account Landscape. Retrieved on October 23, 2019 from https://www.morningstar.com/lp/hsa-landscape

IR-2019-129 (July 17, 2019). IRS expands list of preventative care for HSA participants to include certain care for chronic conditions. Retrieved on October 22, 2019 from https://www.irs.gov/newsroom/irs-expands-list-of-preventive-care-for-hsa-participants-to-include-certain-care-for-chronic-conditions

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Oct 07 2019

Is Discussing Money with Family and Friends as Taboo as Talking Politics and Religion?

October 8, 2019

Written by Evan Judge, Partner, CFA, CFP® and Trevor Moore, Senior Client Associate

Money. It’s how we buy groceries, pay for electricity, and save for retirement. There are thousands of books, TV shows, and movies all about money. It’s an essential part of our everyday lives, yet as soon as you bring it up during your Fourth of July BBQ, the room goes silent. Then all your friends and family are staring at you, wondering why you would say such a thing. You look around and find yourself asking, ‘What, is there something in my teeth?’.

Politics and religion have always been the taboo topics when it came to discussions with family and friends; has money now been added to that list? Below are two different advisor’s perspectives on what they have experienced and how they believe the culture needs to shift.

“My Parents, Grandparents, and Children…They Have More in Common Than They Think” – Trevor Moore

Over the past year or so, I’ve taken notice of a handful of conversations between various members of my family, on the topic of personal finance. Some of them were directed toward me while others were observed at various family functions. A few were about specific topics while others were more general in nature. I noticed conversations between recently retired folks, experienced retirees, and some couples with kids between one and nine years old. The level of detail provided by most was not surprising to me, though there were a couple who left no unanswered questions about their finances. There was one common theme with all the questions, stories, and ‘what if’ scenarios I observed – security.

What it means to be financially secure is different to all of us, and there is no single ‘right’ answer to get us there. Security is defined as ‘the quality or state of being secure’[1],so to have financial security would mean that you are in a state of being secure with your finances. If that’s the case and everyone wants to be financially secure, then why aren’t we talking about it more? Chances are if you know someone in the financial industry, they’ve been asked the question, ‘What should I be investing in these days?’. This is a great question and there’s nothing wrong with asking it…not until it comes from a family member, that is. From my observations, this question was treated like small talk rather than a serious attempt to better plan for someone’s financial future. Once I took a few minutes to reflect on the conversations, I realized it was because discussing money with family makes people uncomfortable and, when the topic comes up, most will choose to avoid it.

My son is almost two years old and really has me thinking about his financial future, and not because he has a habit of breaking expensive things. It’s because I want him to understand how finances work, and for him to feel comfortable talking about money later in life. He has no concept of money yet, but my wife and I feel that starting at a young age will set him up for success. We have discussed a few strategies on how we might manage his education over time. Like most kids I knew growing up, if I wanted to have money to spend on baseball cards or candy from the ice cream man, I had to work for it. I had a list of chores and, if I did all of them for the entire week, my parents would give me $5. This helped teach me the benefits of earning money, then being able to spend or save it. I’m hopeful we can implement a similar strategy, as the long-term benefits of something so simple can really make a difference. As is the case with financial security, there are

endless ways to achieve our education goals, but as long as we start somewhere, it’s possible that money won’t be so taboo anymore.

“I entered this industry to help people reach their financial goals. Why can’t we talk about them?” – Evan Judge

Looking back to when I first decided to go into this industry, I was excited. I was excited to not only do something for a living that I was personally interested in, but I was also excited to learn “what to do and how to do it”. I was excited to become a resource not only for my clients, but also for friends and family if/when I was needed.

Full disclosure, I am not the friend to call if you need help installing a bathroom vanity, assistance with your golf swing, or determining what wine goes best with salmon. Those are examples of situations where I would not prove much help whatsoever. However, I can be useful in other areas, specifically personal finance. Who’s got two thumbs and can walk you through the difference between a traditional IRA and Roth IRA? THIS guy!

The problem is, rarely do friends or family seek my assistance, experience, or knowledge in this arena. I have heard everything else, whether it be personal medical issues, family and relationship problems, or tragedies. However, rarely do my conversations segue into personal finances. Why is this? Is it pride? I think that definitely plays a role. Many people in my age bracket are reluctant to divulge income and wealth levels as that may be perceived as their level of “worth” or consciously/subconsciously treat it as a form of competitiveness. There are many variables and it varies by person, but it is real.

Discussing personal finances is taboo, but it shouldn’t be; it is too important. I encourage everyone to drop the pride and seek guidance* to ensure your financial trajectory is pointed in the right direction.

*If any friends or family read this, call me. I am happy to help and promise not to call you to help install a bathroom vanity.

How do we change the perspective?

After taking a look at both situations, it is obvious that discussing money with family and friends has become taboo. However, this is a cultural norm we seek to change. Ultimately, people want to feel secure with their financial situation, have a fulfilled and prosperous life, and provide for generations. In order to do this, you need to evaluate your goals and create a plan to reach them.

We can help you do that. Let’s break the cycle and get the conversation started.

[1] https://www.merriam-webster.com/dictionary/security

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Jul 05 2019

2017 Tax Act and Qualified Opportunity Zones: Is It Really an Opportunity?

July 5, 2019

Written by Russell Bucklew, Partner, CFP®, JD and Christopher Bergthold, Senior Client Associate, CFP®

The Tax Cuts and Jobs Act of 2017 (TCJA) included a tax break for investors related to realized capital gains. Through this program, an investor may receive tax benefits, including potential deferral and elimination of tax, by investing those gains in a Qualified Opportunity Zone Fund (QOZF).

Qualified Opportunity Zone Funds are investment vehicles targeting properties, businesses, and other assets within outlined opportunity zones in the US. These zones were created alongside the TCJA and are designed to incentivize investment in distressed areas. There are around 8,700 opportunity zones demarcated across the country, and investors can receive significant deferral and in some cases a reduction in capital gains taxes by investing in opportunity zones.

How do opportunity zone tax benefits work?

General Tax Benefits

The first tax benefit is the temporary deferral of federal income tax on realized capital gain until the earlier of the taxpayer’s disposition of the QOZF interest or Dec. 31, 2026. To receive this benefit, the taxpayer must invest the capital gain into a QOZF within 360 days of the capital gain triggering event. At the end of the deferral period, the taxpayer must include in gross income an amount equal to the excess of (a) the amount of deferred capital gain (or the fair market value of the QOZF investment if lower) over (b) the taxpayer’s basis in the QOZF, which is initially treated as zero.

The second tax benefit is up to 15 percent of the unrealized (deferred) gain invested in a QOZF is eliminated if the investment is held for at least seven years prior to Dec. 31, 2026. This happens through a basis increase equal to 10 percent of the deferred gain, if the investment is held for five years, and a further 5% basis increase in year seven. In order to receive the full 15% benefit, the QOZF investment must occur no later than Dec. 31, 2019.

The third benefit is that no federal income tax will be paid on QOZF appreciation if the investment is held for at least ten years. The benefit comes from a taxpayer election to increase its tax basis for the fund to fair market value at the time of the sale or exchange of the investment. This election can only be made for sales transactions that occur no later than Dec. 31, 2047.

In summary,

Investors may reinvest capital gains from existing investments and defer, and potentially reduce, capital gains taxes.
If held, the original investment’s tax basis increases by 10% after five years and by 15% after seven years.
After ten years, investors may permanently defer gain from contributed assets with unrealized appreciation and eliminate capital gains from the appreciation of opportunity zone investments.

Example:

A business owner contributes $11 million asset with $1 million of basis and a long-term cap of $10 million. During the ten-year period, the $11 million asset appreciates $7 million to $18 million.

Year One: Client owes 23.8% or $2,380,000 in long term capital gain tax. ($10 million x 23.8% = $2,380,000)

Year Five: Client received 10% basis increase to $1,100,000; gain is reduced to $9,900,000, and tax is reduced to $2,356,200.

Year Seven: Client received an additional 5% basis increase to $1,150,000; capital gain is reduced to $9,850,000, and tax is reduced to $2,344,300. Total tax savings on basis increase is $35,700.

Year Ten: Client pays no tax on the appreciation of QOZF investment with an unrealized gain of $7 million, referred to as “interim gain.” The capital gains tax avoided on the appreciation in the QOZF investment is $1,666,000. Adding the basis adjustment tax savings of $35,700 to capital gain tax avoidance of $1,666,000, bringing the total tax savings to a total savings of $1,701,700.

Disclaimer: This example is for illustration purposes, using the highest capital gains tax rate (20%) and a 3.8% net investment income tax. There may be additional considerations including, but not limited to, state income tax, holding period, basis calculation, alternative minimum tax, and other factors. Please consult with your tax advisor for advice on your specific scenario.

The Hot Financial Topic

There’s enthusiasm for the new tax breaks provided by opportunity zones. However, there are many questions about how the law is applied, and the uncertainty is causing investors to delay putting funds to work. Brett Theodos, a senior researcher at the Urban Institute, said the administration has signaled it is interested in gathering more data. However, for now, he said there are “more questions asked than answers’’. Senators Cory Booker, a New Jersey Democrat who’s seeking his party’s presidential nomination, and Tim Scott, a South Carolina Republican, plan to introduce legislation requiring the IRS to collect data from tax-break recipients to show how their investments are altering economic conditions in their opportunity zones. In other words, is this legislation a tax ‘give-away’ for the rich only, or is it accomplishing its intended purpose of rehabilitating and changing the landscape of economically hard-hit areas?

One of the first funds that hit the ground running is Virtua Partners, a Phoenix-based private equity firm. In July 2018, they launched their first QOZF called Virtua, a $200 million fund that includes three Phoenix-area projects: a 130-room Marriott hotel with furnishings by West Elm, 81 single-family townhomes with a swimming pool and clubhouse, and a 90-unit apartment complex near Arizona State University’s campus in Tempe. According to Virtua representative Derek Uldricks, all three projects would have been completed even without the tax break, but the tax breaks accelerated fundraising by attracting additional investor interest.

Another Phoenix-based real estate firm – Caliber – launched a QOZF to gather $500 million in investor capital targeting $1 billion of hospitality, commercial, and residential real estate investments in the Southwest growth markets of Arizona, Texas, Colorado, Nevada, and Utah. According to Brion Crum, Director of Strategic Relationships, Caliber was able to reposition and take advantage of existing projects in opportunity zones. Interest in opportunity zone investing resulted in additional investor capital, allowing Caliber to expand the purpose and scope of existing projects. Examples include a new hotel for Tucson’s convention center, a revitalization of historic downtown Mesa in a mixed-use project, and energy-efficient townhomes in Tempe.

Some investors are buying in opportunity zones to take advantage of the tax benefits in areas that meet the letter of the law, but not the spirit. In other words, some properties fall within the technical definition and fit in the geographic location but may not be distressed or fit the spirit of what the legislation envisioned. Caliber is seeking to invest in impoverished areas and those intended to benefit from the policy and purpose behind the legislation. Essentially, they are investing in the path of progress, but in distressed areas translating into value pricing and more potential for upside appreciation. One example Brian gave is a large tract of undeveloped land south of Coors Field in Denver, Colorado; while it lies within the geographic parameters and the path of progress with potential for upside appreciation, it is genuinely a distressed area and one that will benefit by redevelopment. This appears to be a very sound strategy.

According to Brian, most of the investment in QOZF stems from business owners transitioning into retirement and sales of professional businesses like doctors exiting their practices. Investors selling concentrated positions of stock may also qualify for the tax break. For example, investors who own low basis, appreciated positions in growth stocks like Apple or Google might defer and reduce significant capital gains, invest in QOZF, and reduce or eliminate the gain on the QOZF investment. Real estate investors may also use QOZF to identify qualified property under the like-kind exchange rules in IRC 1031, allowing an investor to “defer” paying capital gains taxes on the sale of an investment property.

Conclusion

Investing in opportunity zones is brand new, and the final verdict is yet to be determined. Many of the technical rules are still being ironed out, and there are potential traps and unintended consequences. The legislation intends to drive rehabilitation and renovation in poor neighborhoods by providing economic stimulus and social benefits and attracting attention to these areas. Examples include retail, restaurants, apartment buildings, and new manufacturing facilities, to name a few from a long list of possibilities. However, the adage “don’t let the tax tail wag the dog” applies here. In other words, don’t be so focused on tax issues that you lose sight of basic investment principles. See Maneesh Shanbhag article: What is the Opportunity Zone Tax Incentive Really Worth?.

High net worth investors and people transitioning appreciated assets with built-in capital gain are excited about the tax planning opportunities with Qualified Opportunity Zone Funds. This subject is a hot topic at country clubs, cocktail parties with the elite, and professionals including money managers, attorneys, and accountants. No question there are planning opportunities and exciting tax minimization strategies available to taxpayers staring at significant taxable gains. However, we should not allow the “flavor of the day” or the newest idea to steer us away from our discipline and process around investment choices.

To keep us focused and disciplined, here are four rules to help guide our decision making:

The investment has merit on its own, regardless of the opportunity zone tax benefit. If you get tax incentives but don’t make any money, it doesn’t make sense.
The solution will fully qualify for the intended benefits. There are some funds that will mix opportunity zone qualifying deals with non-qualifying deals. Mingling the two may give your accountant stomach acid. Consider single strategy solutions and don’t mix the two.
The operator should have a long track record of success. We don’t want to invest with someone who is starting their first fund to capture opportunity zone money and earn a fee. Invest with experienced real estate developers and managers who can enhance returns with the opportunity zone tax benefit.
Fees need to be reasonable. Access to opportunity zones shouldn’t increase costs.

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Jun 27 2019

Q2 2019 Market Commentary: Winning The Loser’s Game

June 27, 2019

Written by Nathan Erickson, CFA®, CAIA, Managing Partner and Chief Investment Officer

To view and download a PDF of this commentary, click here.

Anyone who has either played sports or watched children play sports knows that valuable life lessons can come from the experience. Sports can teach teamwork, strategy, the joy of winning, the frustration of losing and, along the way, can lead to the development of lifelong friendships. While the experience and enjoyment of sports can be similar no matter who you are and what sport you play, a distinct difference exists between success at the professional level and success at any other level. Dr. Charles Ellis, founder of the investment advisory firm Greenwich Associates and the former chair of the Yale University Endowment fund, has spoken about this difference many times, and he has related it to our experience as investors in the book “Winning the Loser’s Game”.

Dr. Ellis would suggest that we consider the game of tennis. Regardless of the level, the rules are the same. However, the difference between tennis at the professional level and tennis for everyone else is that professionals win points, and amateurs lose points. Professional tennis players make strong, well aimed shots and seldom make errors. They win by scoring more points than their opponents. Amateurs, on the other hand, rarely beat their opponent, but often beat themselves. They hit the ball into the net or out of bounds, or they try to make plays that are beyond their capabilities. An amateur who wants to win should focus not on making great shots but on avoiding mistakes. By being conservative and keeping the ball in play, an amateur allows his opponent more opportunities to make mistakes than he makes and, ultimately, he ends up winning by not losing.

Dr. Ellis relates the concept to investing in that most investors, to be successful, should focus on making as few mistakes as possible, as opposed to attempting to outsmart markets or other investors. Trying to win in investing is trying to guess when markets will go up or go down, or concentrating portfolios in certain areas or sectors. As humans, we tend to make these decisions far too late anyway. We have a tendency to “buy high” and “sell low” instead of the opposite. A great example is the recent enthusiasm around gold as an investment. The excitement of gold is not because it has hit an all-time low or looks cheap on a relative basis, but because it is at its highest price since 2013. Does this happen in any other area of our lives? Do we buy a new 70-inch tv because it just doubled in price, or a new car because the advertised price is $10,000 more than it was last week? Only in the investment world do people get excited about buying things at higher and higher prices. When we try to win in investing, greed and fear of missing out lead to poor decisions.

“Offense Sells Tickets but Defense Wins Championships.”

This quote has most often been attributed to Bear Bryant, the former head coach of the University of Alabama football team, who finished his career with six national championships. The quote has been used thousands of times by countless others in sports to emphasize that successful teams focus on defense, not on offense.

Dr. Ellis, in an interview with AQR Capital Management, spoke specifically about the Yale Foundation and its phenomenal track record of investing. Yale is far and away the best performer among college endowments, as measured by rate of return. However, Dr. Ellis would tell you that the magic of how Yale invests is that it has always been defensive:

“Really strong defense makes the offense easy. Most of the trouble in investment management is not because you came just a little short of having superb investment results. It’s because you made a mistake.”

(Ilmanen & Sullivan, 2015)

He then goes on to speak about a conversation he had with the Chief Investment Officer of the Yale Endowment, Dr. David Swensen, just prior to the financial crisis. In 2006-2007, the U.S. economy was very strong, there were few reasons for concern, and investing appeared easy. Undoubtedly, Dr. Ellis and others were concerned about Yale not keeping up with other endowments or the market in general. The conversation probably wasn’t a surprise to Dr. Swensen because in the 2006 Yale Endowment annual report he wrote a commentary called “The Futility of Diversification”, which stated:

“Sticking with portfolio diversification can be painful in the midst of a bull market. When mindless momentum strategies produce great returns, market observers wonder about the time and effort expended in creating a well-structured portfolio. During a roaring bull market, diversification seems to punish investors. For the five years ending June 30, 2000, the S&P 500 returned an amazing 23.8 percent per year. Indeed, institutional investors who sought diversification’s free lunch by holding foreign equities saw those diversifying assets lag terribly. During the five years when the S&P produced 20-percent-plus returns, developed foreign markets, as measured by the MSCI EAFE Index, generated an 11.3% annual return, while emerging markets, as measured by the MSCI EM Index, returned 1.0% annually. Alternative asset classes, like absolute return and real assets, fell hopelessly behind the blistering U.S. stock market. By the late 1990s, many investors questioned the wisdom of owning any assets other than U.S. equities, especially high-flying technology stocks, asserting the inherent superiority of American companies and the inevitable dominance of high-tech businesses. Making the mistake of extrapolating future returns from a strong historical base, investors picked the absolute worst time to abandon diversification and increase allocation to U.S. equities, as the stock market’s remarkable run had brought valuations to unprecedented heights.”

(Yale University, 2006)

Returning to Dr. Ellis, he recalled having the following conversation with Dr. Swensen sometime in 2006-2007:

“David, this is going to surprise you, but I’m concerned that you may be too careful, too defensive, too protective. I just wonder; should you be a little bit more assertive and take a little bit more risk?”

Dr. Swensen replied “Honestly, I don’t know. But I do know one thing. Just about the time you think there’s never going to be a horrific negative surprise, one comes barreling along. I may be too careful. I may be too protective. I may be too defensive. Though knowing history, I think it’s probably a good idea.”

Dr. Swensen ended his commentary in the 2006 Yale Endowment report as follows: “In spite of the opportunity costs of diversification in the late 1990s, the University continued to believe in the importance of a properly diversified portfolio with superior risk and return characteristics. Each asset class that had dampened returns in the late 1990s – bonds, foreign equities, absolute return, and real assets – drove the Endowment to a series of positive returns in the face of an equity bear market. In fact, the University’s discipline of sticking with a diversified portfolio contributed to the Endowment’s achievement of the top long-term record of any college or University endowment.”

When people think about the long-term success of the Yale Endowment, they immediately attribute it to the amount of alternative assets or the manager selection, or Yale’s ability to invest in top tier managers given its network and reputation. Yet we believe both Dr. Ellis and Dr. Swensen would attribute the long-term success to a focus on defense over offense.

Maybe This Time is Different?

If one re-reads Dr. Swensen’s recap of the late 1990s above, it is difficult not to conclude that it sounds eerily similar to the world we live in today. Howard Marks, founder of Oaktree Capital, spoke about the commentary they’re hearing about why “this time is different” and why the current environment may last in perpetuity. Among those reasons:

There doesn’t have to be a recession.
Continuous quantitative easing can lead to permanent prosperity.
Federal deficits can grow substantially larger without becoming problematic.
National debt isn’t worrisome.
We can have economic strength without inflation.
Interest rates can remain “lower for longer”.
The inverted yield curve needn’t have negative implications.
Companies and stocks can thrive even in the absence of profits.
Growth investing can continue to outperform value investing in perpetuity.

(Marks, 2019)

Again, these are justifications Marks and his team are hearing from seasoned investment professionals on why there should be no concern about the current environment. Any reader of this list should be confused by at least one of those statements. Several of them sound completely irrational. In recent years, the U.S. has simultaneously experienced economic growth, low inflation, expanding deficits and debt, low interest rates, and rising financial markets. As Marks says, it is important to recognize that these things are essentially incompatible. They generally haven’t co-existed historically, and it’s not prudent to assume they will do so in the future.

It’s Not a Video Game

For investors in diversified portfolios (which is almost everyone who has hired an advisor), returns over the last several years have been lower than expected. International equity markets haven’t contributed, bond returns are low, and many other diversifying asset classes have not contributed much to return. Diversified investors have chosen to play defense with their money in a period of time when markets appear to have video game-like ease (most of us can really only be Serena Williams or Andre Agassi in a video game). Have we all been too careful? Have we all been too protective? Have we all been too defensive? Maybe we have.

At MRA, we are charged first with protecting our client assets, and second with growing those assets. Over-aggressive investing can lead to a fatal mistake, especially for investors who are taking withdrawals from their portfolio. Enduring the full impact of a bad equity market while making withdrawals can compound the effects so dramatically that they may never be recovered. Our approach in managing portfolios has resulted in prioritizing defense over offense. It seems like forever since we’ve experienced a bad market and, in July, it will officially be the longest U.S. recovery on record. However, as Dr. Swensen said, just about the time you think there’s never going to be a horrific negative surprise, one comes barreling along. Our defensive approach is not selling many tickets, but our goal is to win, and winning in investing is all about lasting through good and bad markets.

Works Cited

Yale University (2006). 2006 Yale Endowment Annual Report. Retrieved June 25, 2019 from https://static1.squarespace.com/static/55db7b87e4b0dca22fba2438/t/578e42a5e58c629352d75dc1/1468940966928/Yale_Endowment_06.pdf

Ilmanen,A. & Sullivan R. (2015, June). Words From the Wise: Charles Ellis on Challenges Facing Investors. Retrieved June 15, 2019 from https://www.aqr.com/Insights/Research/Interviews/Words-From-the-Wise-Ellis-Executive-Summary

Marks, H. (2019, June). This Time It’s Different. Retrieved June 25, 2019 from https://www.oaktreecapital.com/docs/default-source/memos/this-time-its-different.pdf

Jun 13 2019

Estate Planning in the Aftermath of the 2017 Tax Cuts and Jobs Act

June 13, 2019 Written by Russ Bucklew, Partner, CFP®, JD; Mary Ann Hennelly-Favata, CFP®, Senior Client Advisor; and Ena Dashi, Senior Client Associate

Now that it has been almost 16 months since the passage of the 2017 Tax Cuts and Jobs Act (TCJA), it’s time to come up for air and ask the question: what is the overall impact on estate planners and their clients?

For estate and gift tax planning, the 2017 TCJA made a significant amendment to the laws. The fundamental change was an increase in the exclusion amount. The amount that an individual may gift to other individuals, during their life or exclude from his or her estate at death (if unused), rose from $5.49 million per person to $11.4 million. Therefore, married couples may now exclude $22.8 million from their estate without any estate tax consequences. Since the generation-skipping transfer (GST) tax exemption is based on the gift and estate tax exemption, the new GST exemption amount has also been increased to $11.4 million.

Now that we have a high exemption, the false assumption is that fewer people will need sophisticated death tax planning. Many estate planning checklists will need to be revised now that fewer people will be subject to the estate tax. According to the Tax Policy Center, less than 0.1% of the 2.7 million people who died in 2018 will pay an estate tax. However, given the potential change in political parties in the executive and congressional branches and the 2017 law sunsetting without congressional action in 2025, the need for planning is more critical than ever.

Question: Why should I worry about my estate plan if I am not impacted or taxed by the law changes and higher exemptions?

Answer: There are many reasons to plan. Here are three considerations:

First, nearly all of the legislation that affects individual taxes, including the estate and gift taxes, is set to expire at the end of 2025. This means that the exemption amounts could decrease to 2017 levels (adjusted for inflation) within six years.

Second, a new Congress could change the law before then and bring the exemptions back down to 2017 levels or, worse, even lower. For example, Senate Bill S. 309, introduced by Bernie Sanders, is affectionately called the “99.8 Percent ACT” for its anti-wealthy sentiment, and it indicates a significant effort in this direction. A key provision includes lowering the estate tax exemption from $11.4 million to $3.5 million, reducing it to the 2009 level, shaving off almost $8 million of the exclusion that could be lost forever. Sanders’ proposed legislation will also reduce the gift tax exemption to $1 million. So, even though some intend to postpone until 2024 or 2025 to make gift tax free transfers under the lifetime exemption, waiting may be costly. Therefore, a family may not need to worry about the estate, gift, or GST tax today, given the sunset provision and the changing political winds; it is future generations—children and grandchildren—who almost assuredly will be impacted. Accelerating the restoration of the pre-TCJA exemption levels would reduce the deficit while affecting just a few thousand large estates. Taking such action now could also curb enthusiasm for making the higher thresholds permanent when they expire at the end of 2025. Our estate planning checklists should prepare for any scenario.

Finally, estate planning is never exclusively about tax minimization. For most individuals, wealth is lost in nontax ways, such as elder financial abuse, divorce, lawsuits, and spendthrift heirs. Modern estate planning prioritizes asset protection (protecting trust assets from potential creditors or spendthrift beneficiaries) alongside tax efficiency and other considerations. Other considerations include minor children, pets, friends, and business partners. Plan for the end of life decisions and incapacity. Address how to provide for a potential beneficiary that is disabled or with special needs.

The higher exclusion amounts are shifting the emphasis from transfer tax to income tax planning for many estate planners’ checklists and their clients.

One key area is the emphasis on taking advantage of the basis step-up. When an asset is passed on to a beneficiary, its value is typically more than what it was when the original owner acquired it. A step-up in basis is the readjustment of the value of an appreciated asset for tax purposes upon inheritance, determined to be the market value of the asset at the time of inheritance. Many estate planners’ checklists should incorporate analysis and opportunities to avoid income tax through planning on low basis assets.

One area of renewed interest is the formula General Power of Appointment Clause (GPOA). The power of appointment is given to an older (or ill) beneficiary with a net worth less than his or her remaining exemption amount. The strategy builds in flexibility with a formula that does the following: 1) only applies to assets with a basis less than fair market value (FMV); 2) does not allow exercise in the event of federal or state estate tax; (3) has an ordering provision granting it the priority over highest tax rate assets first; and (4) takes into consideration whether there are assets that likely won’t be sold any time soon. For example, a 90-year-old beneficiary gets a GPOA over stock in XYZ Corp. valued at $2 million with a $1 million tax basis and $1 million built-in capital gain. After TCJA, he will not owe any estate tax because of the increased exemption amount. Thus, the GPOA is exercised, causing the assets to be included in the 90-year-old’s estate, and he gets a step-up in value at death, saving the 20% long-term capital gains tax due on the appreciation. Before TCJA, the asset may have been subject to a 40% estate tax resulting in $800,000 of tax. After TCJA, he is under the exemption amount with no estate tax, freeing the asset up to bring it back into the estate and triggering a basis step-up, saving income tax on the gain of $200,000.

Question: Given that estates now have a high bar for estate taxation, the existence of separate trust legal entities and the income tax consequences of higher brackets must be reviewed and considered in light of the overall changes. Does it make sense to continue to pay higher tax rates inside an irrevocable trust, when the reason for creating the trust – lower estate tax consequences – has been eliminated, even if temporarily?

Answer: For single individuals, the 37% income tax rate applies for taxable income starting at $510,300 and, in the case of a married couple filing jointly, starting at taxable income above $612,350. However, in the case of estates and trusts, the 37% rate kicks in above $12,500. Also, a 3.8% Medicare surtax on “net investment income” is often assessed against individuals and estates and trusts. A state income tax may also be a factor.

The governing instrument of trusts can confer an infinite number of possibilities for distribution powers on a trustee for income or principal. Given the compressed income tax rates and the current framework of income taxation of individuals and trusts, a trustee could make distributions to current beneficiaries to minimize the overall tax impact. While this may result in increased income taxation to the beneficiaries, it will reduce taxation overall of assets in the trust (taxed at a higher bracket). Ironically, the legislation that increased the trust tax rates was designed to do just that.

In the aftermath of the 2017 TCJA, many of the trusts created for tax planning reasons may no longer be relevant or necessary. Under state law, many estate planning professionals and their legal counsel are taking full advantage of opportunities to change the trust by the use of non-judicial settlement agreements; an irrevocable trust may be modified or terminated with the consent of all interested persons as long as the change doesn’t violate a material purpose of the trust. Another technique for changing the income tax status or other unwanted trust provision is taking advantage of the “decanting” statutes available in most states. These statutes allow the formation of a new trust and termination of the old one.

Just as you decant wine by pouring it from its original bottle into a new one, you can pour trust assets from one trust into a new one, leaving the unwanted terms in the original trust.

Conclusion

Passage of the 2017 TCJA, with increasing exemptions and exclusion of tax for estates up to $11.4 million, may be creating more complacency and a lack of interest in planning. Even before the act, most consumers procrastinated and avoided preparation. The bottom line is, laws come and go. Some stay, some go, and some expire. What is constant is YOU! Your needs, wants, and wishes… You need to put an estate plan in place before something happens to you. IF you wait until you are incapacitated, it will be too late for you to make a plan. Take control of your LEGACY and architect it with the help of an estate attorney, wealth advisor, and CPA. Collaborating with other professionals is wise. Saving time and hassle is money well spent. According to one study of why clients don’t sign their estate plans, 95.9% said the plan did not meet their goals, 93.4% said the attorney made me uneasy, and 90.9% said the plan was incomprehensible. Don’t be a statistic. ACT NOW!

Supplemental Graphs and Data