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FSP Speaker: Prepare for Super Committee-Related Portfolio Adjustments

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PHILADELPHIA — Advisors must be prepared to make quick adjustments to clients’ retirement portfolios in response to the recommendations of the new “Super Committee” created by the Budget Control Act of 2011.

So warned Robert Keebler, who spoke here during the first of two general sessions of a clinic organized by the Society of Financial Service Professionals (FSP), Newtown Square, Pa.

“When we get Nov. 23–when the Super Committee unveils its proposals for further reducing the budget deficit–you’ll want to block out time to review their committee’s recommendations because they will likely affect your clients,” Keebler, a partner at Keebler Associates, Green Bay, Wis., told FSP clinic attendees. “The scary part is that some of the committee’s recommendations could be implemented as early as Jan. 1, 2012. That means you will have just 38 days to develop pivot points based on three unknown variables: The 2012 elections, congressional action to reign in the nation’s deficit, and the direction of the economy. You will all have to work very quickly to come up with solutions.”

Advisors must be able to “work at the intersection between finance and tax” and develop strategies that will minimize the tax bite for high-net-worth clients during both the wealth accumulation and retirement income distribution phases of a financial plan, Keebler said.

Keebler noted, for example, that for affluent individuals in high-income tax brackets, current tax law favors placing bonds in individual retirement accounts (IRAs), and positioning stocks inside taxable brokerage accounts. The reason: The long-term capital gains rate on stocks, now 15%, is substantially lower than the top 35% rate the high net worth pay on interest earnings from bonds.

Tax strategy also comes into play when deciding on an appropriate sequence for withdrawing funds against multiple retirement accounts. To illustrate, Keebler cited a hypothetical retired couple who must annually take $150,000 from a $1 million Roth IRA, a $2 million IRA or a $3 million brokerage account. Keebler said the couple can minimize income tax by withdrawing first against the brokerage account, then the IRA, and thereafter the Roth IRA.

“If you really want to gain an edge in the marketplace, then you have to bring this tax knowledge to the table,” Keebler said. “By following these [income distribution] strategies, you can add between 3 and 5 years to someone’s retirement income. That’s substantial.”

Keebler added that interest in life insurance as a tax-sheltered vehicle is sure to rise absent changes to new tax provisions that take effect in 2013.

(Among the changes scheduled to take effect that year is a new 3.8% Medicare “surtax” that will apply to all taxpayers whose income exceeds a certain threshold amount. A taxpayer occupying the 39.6% marginal bracket will, with the surtax added, pay a marginal of 43.4%. Add in state income tax, and the effective marginal rate rises to about 50%, Keebler said.)

Cash values inside life insurance grow tax-deferred, just as they do inside annuities.

Keebler said insurance offers an additional advantage for those seeking to use the cash value for retirement income: The non-taxable principal (or basis) is drawn down first, then income-taxable earnings (also known as FIFO (first-in, first out), as opposed to LIFO (last-in, first out)).

Affluent investors will also be attracted to insurance because of the product’s high internal rate of return and (especially for second-to-die policies) low mortality cost, Keebler said.

“The beauty of life insurance is this: When a policy eventually matures, the proceeds are distributed tax-free,” he said. “For very affluent families, we’ll recommend a second-to-die policy because the mortality cost on the contract is considerably less than it is for separate, individual policies.”

Keebler added that he strongly urges clients who are thinking of canceling their life insurance policies (because, for example, they expect to fall within the current estate tax exemptions at death) to keep the policies in the event that a future Congress lowers the exemption or raises estate tax rates. Without life insurance proceeds, he said, beneficiaries of an estate might have to pay tax on the estate from an inherited IRA

“Clients need to have a source of liquidity to pay any eventual estate tax,” Keebler said.” “The last thing you want to do is reach into a Roth IRA to pay the estate tax because all future distributions from a Roth over a 30- to 40-year life expectancy of a child come out tax-free. That has to be a critical consideration in any estate plan.”

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