From the October 2009 issue of Investment Advisor • Subscribe!

October 1, 2009

Wealth Matters

Advisors like Myra Salzer are not standing pat in helping clients with their estate and tax planning, despite uncertainty over the Administration's plans. Here's how your peers are taking action now

More On Tax Planning

from The Advisor's Professional Library
  • Charitable Giving Charitable giving can reduce your clients’ tax liabilities. However, the general and verification rules for the deduction of charitable gifts must be understood in order to take full tax advantage of such gifts.
  • ETF Taxation The use of ETFs may be attractive to certain investors. The tax advantages may make them even more attractive.

While the outcomes of the healthcare and financial services reform debates now in high gear in Washington will have pivotal effects on advisors this year and into next, lawmakers have yet to weigh in on another vital issue of importance to advisors and their clients: whether to let the estate tax expire in 2010. If Congress fails to act this year, the current tax rate of 45% for assets above $3.5 million will expire in 2010, and return at higher rates in 2011. Come 2011, the previous exclusion of $1 million returns, and the top rate for assets above that amount would revert back to the 55% level set in 2001.

The fate of the estate tax lies in the hands of the Senate Finance Committee and its chairman, Max Baucus (D-Montana). While Baucus has been embroiled in healthcare reform, a spokesman for the Senator told Investment Advisor that the Senate Finance Committee chairman knows that action on the estate tax this year is a "must-do proposition," as a result of the Bush-era rates resetting. That said, however, Congress's prolonged indecision (at press time in mid-September lawmakers had still not gotten even close to rendering a decision) has left advisors paralyzed in helping clients with their estates. "To invite a client to put together an estate plan that could be invalid in a few months is a tough sell," says Myra Salzer, president and founder of The Wealth Conservancy in Boulder, Colorado.

But like other advisors (more about which later), Salzer isn't sitting on her hands when it comes to estate planning for clients. Her way of dealing with estate planning for clients now--and not waste their money by drawing up what will likely be a temporary estate plan--is to help clients organize their estates, and those of family members, through a product she created called EstateLogic. Not only is Salzer the founder of Wealth Conservancy, she also established in 2005 Executor's Resource, Inc., and is the brainchild behind two of the firm's products--EstateLogic, launched in October 2008, as well as the yet-to-be-released ExecutorLogic, which is due out in 2010.

More than 100 advisors use EstateLogic now, and Salzer says she expects that number to jump to thousands of users by the end of the year. Not only are advisors drawn to the product, but "we are getting interest [in EstateLogic] from the insurance and employee benefits industries, as well as financial service providers," Salzer says. EstateLogic is an online tool that advisors and their clients can use to gather, store, update, and share information about the client's estate and legacy.

As Carl "Skip" Rapp, president and CEO of Executor's Resource, puts it: EstateLogic's role "is to bring all of the relevant information of the estate together, and that really extends from documents, to financials, to legacy, and personal instructions you want to leave behind." Salzer says EstateLogic is a great way for advisors to "build rapport with their clients" and offer them a service that will help them "retain a client's assets under management after the client dies." Salzer cites a report conducted by Allianz which showed that 80% of clients' heirs, including the surviving spouse, leave their advisors after the death of a client. "But if the advisor is involved in helping to settle an estate, if all of the executor's needs are on one software package that's co-branded with the advisor, that's an instant way to build rapport and serve" the client's entire family, she says. Recall, too, that Salzer, a member of the Investment Advisor Leaders Council, first came to prominence as an expert on understanding and serving wealthy families.

By offering EstateLogic to their clients, advisors provide a valuable service to an executor of an estate, "because the executor has no idea what they are in for," Salzer says. Adds Rapp: "About 90% of executors are close family members or friends, and they are not prepared for the amount of work involved."

Rita Johnson, a planner with The Millstone Evans Group of Raymond James and Associates, says her firm is in the process of rolling out EstateLogic to its clients. "It seems like every few weeks we have a client who's facing" being the executor of an estate, she says. The "biggest benefit" of using EstateLogic, Johnson says, is that it "will enable us to deepen our relationship with clients. We're not estate planning attorneys, but it's very important as the advisor that we do the comprehensive financial planning, and that we help people make sure they have their ducks in a row so they are prepared down the line."

Another benefit about EstateLogic, Johnson says, is that "it's not just about estate planning; it's possible for our clients to store [other] documents that they may need." For instance, she says, "older baby boomers in transition, who may be partially retired, tend to be moving around a lot--they may have two homes--so they can access their documents regardless of where they are."

Amy McDuffee, director of channel planning at Executor's Resource, notes that The Millstone Evans Group is taking "a unique approach in that as part of the service offering, they will actually be scanning and uploading documents for clients into EstateLogic." McDuffee adds that Executor's Resource provides "flexibility in how advisors can offer EstateLogic to clients. The client account fee can be paid for by the practice, or self-paid by the client." McDuffee says the "middle of the road" version of EstateLogic costs about $11 per month or $129 per year. "The advisor can choose to pay that fee or just make [EstateLogic] available and recommend that his clients pay for it."

As for ExecutorLogic, Salzer is in the late stages of raising money to develop the product, which she says will function "like a TurboTax kind of solution for executors to settle estates." Rapp adds that ExecutorLogic will be "more of a workflow tool than an aggregation tool" like EstateLogic. "The role of the executor is different: he or she has a finite task and that is to settle an estate within a certain amount of time." ExecutorLogic, Salzer says, "will enable an executor from their desk to settle an estate in multiple states within the U.S. without any experience and save thousands of dollars on legal and accounting fees."

Now let's turn our attention to the broader issues of taxation, on which everyone seems to have an opinion. The IRS even has a page on its Web site filled with tax quotes, mostly humorous, from an array of notables including Oliver Wendell Holmes, Jr. ("Taxes are what we pay for a civilized society."), Albert Einstein ("The hardest thing in the world to understand is the income tax."), and the ever-popular Unknown ("People who complain about taxes can be divided into two classes: men and women."). For most advisors, however, tax talk has never been more serious.

With an expected $1.6 trillion deficit for the fiscal year ended September 30 and the Obama Administration forecasting a deficit in excess of $9 trillion over the next decade, no one grounded in reality is talking about tax cuts. There are numerous measures to be taken up by the current Congress that will have tax implications for advisors and their clients including, but not limited to: healthcare reform, carbon cap and trade policy, the estate tax, and capital gains tax rates. While no one knows for certain what the future tax picture will look like (see The Scope of the Problem sidebar, in which attorney John Scroggin paints a picture of what likely will happen), a number of advisors around the country have been working with their clients to make the most of the current situation.

President Obama certainly got the attention of Ben Ledyard, director of wealth strategies for Boston-based Silver Bridge Advisors and head of the firm's new Wilmington, Delaware office, when during his healthcare address to Congress on September 9 he indicated that whatever reform was ultimately arrived at should not add another cent to the deficit. "This is going to be expensive, so if we're not going to borrow against it, who's going to pay for it?" Ledyard asks. "Ultimately we know that some effective tax hikes are going to come."

Alan Weinstein, a CPA with more than 30 years experience and a founding partner of RWE Private Wealth, a new wealth management firm in Orlando, agrees wholeheartedly. "The big issue right now is trying to plan for tax rate changes in both the income tax area and the estate tax area," he says.

Not Standing By Idly

"Wealthy people have to get the best after-tax return and the most tax-efficient return they can get," says Keith Springer, who runs his Capital Financial Advisory Services out of Sacramento. "The key for most wealthy people is not to lose your money. Their benchmarks are purchasing power, inflation, and taxes and they really shouldn't be concerned about beating the market. As a money manager, it's up to me to take care of it."

Carrie Coghill Kuntz, president of D.B. Root & Co. Wealth Management in Pittsburgh, says there are a number of steps advisors can take right now to help their clients avoid future taxes. "We're looking at portfolios and where we have appreciated assets, really taking gains off the table and paying the taxes now," she says.

She also notes that if future tax rates are expected to be higher, then deferring taxes on retirement savings may not always be the best idea. "We want our clients to be taking advantage of all the matching that their 401(k) plans and so forth offer, but we're not so quick to say, 'Max out your plan!' any more."

One of the issues that Kuntz expects to be important to clients over the next few years will be Roth 401(k)s and Roth IRA conversions. She's not alone in that thinking.

"I'm in the process of reaching out to clients that I think would benefit from a Roth conversion or a multi-year conversion strategy now that most people's IRAs are dramatically lower than they were two years ago," says Cathy Pareto of Cathy Pareto Associates in Coral Gables, Florida. "You get a little bit of hemming and hawing when you tell them what you're doing is advancing the tax payment on it, and for some of the less sophisticated investors you have to explain why this is a good time to consider it."

She says that once clients understand that in all likelihood tax rates will be higher in the next few years, and she crunches the numbers to show them the impact that strategy could have on their total wealth, they start to get it. Pareto stresses, however, that the strategy only makes sense if the client has the ability to pay that tax from another source.

"Assuming that in a couple of years our rates will be higher, we have to re-think tax deferral," Pareto observes. "Is tax deferral really that important if tax rates down the road might be at 40% or 45%? What I recommend to people who might be in a crappy plan is just to fund up to where you get the maximum employer match. Get your free money and then maybe consider funding outside of that in tax-sensitive funds."

Like Kuntz in Pittsburgh, Pareto is also advising clients to take some of their gains off the table now. "It's not a question of if we're going to have higher tax rates, it's when and for whom, really," she says. Pareto says there has been some talk within the Administration of bumping the capital gains rate back to 20%, which is not an unreasonable assumption. So she's suggesting to some clients who have booked some losses over the last few years to start to offset them with gains. "Where they have embedded gains from previous years, they could book those gains now at 15% and then buy [the same securities] back, so going forward we've minimized what they would pay at 20%," she explains. "The interesting part of that is unlike when you're booking a capital loss, like for tax loss harvesting at the end of the year, there's nothing that would preclude you from buying that security right back. There's no wash rule there. There's nothing that says you can't buy it right back because you booked a gain."

Don't Leave It to the IRS

Advisors are also not waiting around to see what the shape of the new estate taxes will be. "We've known since 2001 that the estate tax laws were in flux," notes Kuntz. "We've also known coming out of last year that with such wealth destruction we had to revisit the estate planning paths that our clients have been on," she says, bemoaning the continued lack of clarity from Washington. In the meantime, her firm has been looking at client income and outlays and looking at estate planning tools currently in place, such as second-to-die life insurance policies, to determine if they're still viable.

"The estate tax is due to sunset January 1," notes Weinstein. "Nobody really believes that's going to happen. It will probably end up that there's a $3.5 million exemption per person and it will be taxed at a high rate of 45%. That's similar to what we have today."

"A $3.5 million per person estate exemption, that's a reasonable number, as long as it doesn't go back to $1 million or $2 million," agrees Springer. "At $7 million per couple, that covers most people, but you're always looking for proper estate planning. You always want to make sure it's passed on to the right person, it's set up in the right kind of trust. That's the key."

Among the estate planning tools that Weinstein favors are family limited partnerships, and grantor retained annuity trusts (GRATs). "The beauty of a family partnership is that if done right, you maintain control over it, whereas with some of these other techniques you literally have to give up control to pull it out of your estate," he says. "One other thing that's worth noting is that in a lot of these, especially family partnerships, you get a leverage factor by discounting the value of what you give to your relatives, based on typically two things--a minority-interest discount and a lack-of-marketability discount.

Under a GRAT, the individual making the grant puts assets expected to increase in value into a trust and receives annuity income from that trust for a specified period. At the end of that term, the assets become a taxable gift to the beneficiary. In a recent note, the California Society of CPAs explained that "tax savings are achieved because the annuity payments are calculated to result in a gift tax value of zero. It's anticipated, however, that the actual interest earned will be higher than the 7520 rate (the current IRS interest rate, which changes monthly, also known as the Applicable Federal Rate, or AFR), leaving a substantial value in the GRAT at the end of the term." That value is then passed on to the beneficiaries tax free.

"For a GRAT to work, the person who makes the gift has to survive the term of the trust," Weinstein continues. "If not, there's really 'no harm, no foul,' other than the cost of the documents and putting the thing together, so it just comes back into your estate as if you did nothing." As important as taxes are to consider, one thing that both Weinstein and Ledyard warn about is "letting the tax tail wag the investment dog." "If a stock is $100 today, and it's run up since March 9, obviously you can realize that gain today for 15%, but if you thought there was a little more run in the market and you liked the stock, and ultimately you think it could go up to $120, you're still netting a higher rate of return," says Ledyard. "I would say to any client with over a 5% exposure to any one position, or even an asset class, certainly now is a good time to take advantage of what we know are lower tax rates. We've had a pretty good run in the market and I always say, 'There's never a good time not to diversify.'"

"First it's got to make good investment sense and then it's got to make good tax sense," agrees Weinstein. "I've been practicing as a CPA since 1977, and when I started practicing, the rate on ordinary income--dividends, interest, partnership income--was 70%. And we had a 50% tax on earned income. When you look back to that, we have a long way to go and we did all right then. Everybody gets all upset about tax rates, and nobody wants to pay any more than they have to, but compared to what I can remember, it doesn't scare me. I don't think there's a political stomach to go much over 40%, so if a deal can make money and you get to keep 60% of it...that doesn't trouble me."


E-mail Washington Bureau Chief Melanie Waddell at mwaddell@investmentadvisor.com and Managing Editor Bob Keane at bkeane@investmentadvisor.com.
Reprints Discuss this story
This is where the comments go.