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Investments Don't Live in a Bubble: Coordinated Asset Planning

| February 12, 2018
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Your assets should not live in a bubble. When many clients first come into our office and meet with us, they often come in with what we call a “junk drawer” of financial products. Every home has a junk drawer. In my home, it is in the kitchen. The junk drawer is the place where you throw all the things that you know you may need, but you don’t know exactly why or where it should go. So, it goes in the drawer.

The same thing happens with many people’s financial lives. As they become more successful, they begin to pick up different investment accounts. Like a multiple 401(k)’s from all their past jobs, real estate investments, IRA’s, life insurance policies, brokerage accounts, and the hot investment that their Uncle Eddie talked to them about over Christmas break.

As we go about our lives we begin to accumulate our own financial “junk drawer.” They are all good things that we know we are going to need, but we aren’t exactly sure how or when, OR how all of these different assets play with each other.

One of the thing that makes Redstone Financial Group’s, Retirement Efficiency Matrix so important, is coordinating your “junk drawer” of financial products to maximize the potential for return, cost efficiency, and tax savings.

Let me give you a few examples of how Coordinated Asset Planning can have a tremendous effect on your investments and your retirement.

Tax Loss Harvesting

Investopedia.com defines tax loss harvesting as, “a strategy of selling securities at a loss to offset a capital gains tax liability. It is typically used to limit the recognition of short-term capital gains, which are normally taxed at higher federal income tax rates than long-term capital gains, though it is also used for long-term capital gains.”

So, what does that mean in human terms? Like we discussed before, as people begin to become more and more successful, they accumulate more and more assets. As well as more and more income. All these symptoms of financial success can also trigger more and more taxes. So, tax loss harvesting is way to help lower some of those taxes.

When we help build a portfolio for a client, we know that each individual security in that portfolio is doing a different task. We strive to make sure that our client’s investments are diversified across many different types of asset classes as well as being spread across different individual holdings. With that level of diversification, you are always going to have some “winners” and some “losers” in any portfolio at any given time. Even though we have labeled some of our holdings in a portfolio as losers, that doesn’t mean we still don’t love them for the long term, so… how can I use that “loser” to my advantage. Let’s run through an example.

Let’s say that you are heavily involved in buying and selling investment property real estate, not your primary residence. I am also going to assume that you are good at buying and selling your real estate for a profit/gain. If you had a taxable brokerage account large enough, what we would strive to do is offset the gains from your real estate holdings by utilizing tax-loss harvesting in your brokerage account. When we get together for your annual review, we would discuss how your real estate ventures are going. If in that conversation you indicate to us that you will have some tremendous gains, then in coordination with your CPA, we try and offset those gains in your brokerage account by looking at the top “losers” in your account. We will then sell those positions for a loss, then the portfolio manager will make sure you don’t buy back into those same exact “loser” holdings until at least 30 days has passed. By doing this the portfolio manager avoids the wash-sale rule and you are able to realize the loss to hopefully offset your real estate gains.

This is an excellent example of a Coordinated Asset . Keep in mind that Redstone Financial Group or HTK does not offer tax or legal advice.

Jim vs Jon – Benefits of a Death Benefit in Retirement

Let's suppose for a moment that you two individuals, Jim and John. Both Jim and Jon are responsible with their affairs, love their families, and both have saved for retirement. But the strategy for their retirement planning differ in a few major ways.

Jim listened to every so-called “financial expert” on the radio. He decided he wanted to simply buy a term insurance policy. When he was 45 years old he bought a 20-year term life insurance policy with enough death benefit that his family would not need anything financially if he were to die prematurely. This was a very responsible step that protected his family throughout his working years. Jim did this with the notion that he would have enough assets in retirement that he could then “self-insure” himself. He felt the need for life insurance would no longer be needed.

Just like Jim, Jon also decided that life insurance was a needed component to his overall financial plan. Jon also got enough death benefit to provide everything his family would need if he were to die prematurely. The one main difference in their approach was that Jim purchased a portion of his death benefit in permanent insurance (whole life or universal life). He still had a substantial amount of term insurance to make sure he covered the entire life insurance need, but he wanted to make sure he had a certain amount of death benefit still in force after the 20-year term life insurance policy had expired. Over the years, as Jon’s income increased, he decided to convert a portion of his term life insurance to more permanent insurance. His goal was to have a permanent life insurance death benefit equal to his retirement income assets.

Now, flash forward to Jim and Jon’s retirement. Both men are 65-years old and have now retired.

Jim has now accrued $1,000,000 of income producing assets, but no longer has any life insurance coverage. Just like every retiree, the risk of running out of money has become paramount. In order to protect his nest egg, Jim places his assets in a safe, income producing investment that will spit him off a reasonable rate of return. Let’s assume that Jim is earning about 5% on his $1,000,000 of retirement assets. Because of his fear of running out of money, Jim simply withdraws the interest ($50,000) from his account. Let’s also assume he is taxed an even 25% on his 5% withdrawal. So net income to Jim is about $37,500 per year.

Jim uses this approach to provide his retirement income every year until his death at age 95. He has never touched his principal throughout retirement because he has been terrified of multiple pressures on his money. For example, what if he was unable to earn 5% on his money? What if he had a medical emergency? What if he spent too much money in retirement and he died early, but left his wife without an income because he spent the original $1,000,000 of assets? At his death he leaves his heirs his original $1,000,000 of assets that he used to live off the interest.

Because Jim did not have any permanent life insurance in his retirement years, that put a tremendous amount of stress on his assets. A lot of factors had to occur perfectly for him to have the type of retirement that would simply get him by.

Now, Jon has also decided to retire at age 65. Jon has accrued the same $1,000,000 of assets. But Jon has a permanent life insurance policy with a death benefit of $1,000,000. Because Jon has a life insurance death benefit in his back pocket, that now give him the ability to actually spend his $1,000,000 of retirement assets.

Like Jim, Jon places his assets in a safe, income producing account. Let’s assume the same 5% rate of return on his retirement assets. The big difference is; Jon figures out a pay down schedule on his assets from the age of 65 to age 95. Jon gets to live off of principal and the interest from his $1,000,000 account. So instead of a gross withdrawal of $50,000 like Jim, Jon is able to take a gross withdrawal of just over $64,000. After the same 25% tax, Jon has a net income of about $51,500, about 38% better lifestyle than Jim in the first year of retirement.

The next year, Jon takes the same $64,000 gross withdrawal from his account, but because he is living on more principal and less interest, his taxes due decreases and his net income increases. This happens year after year for Jon, thus giving him a bit of a net cost of living increase.

In the event that Jon dies before the age of 95, and he has spent a majority of his retirement assets, he is not worried about disinheriting his sweetheart wife because he has that life insurance death benefit in his back pocket that will replace his assets for her to continue living.

So, having a permanent life insurance policy in retirement with adequate death benefit allows you the option to have a better income in retirement, potentially lower taxes in retirement, and ensures you don’t disinherit those you care most about. Although the upfront premium of permanent life insurance may be higher, the actual cash value in the life insurance that has accumulated over the last 30+ years.

The point is… it gives you options!  

Now… l have to make the lawyers happy and add the disclosure that this is just a hypothetical example intended for illustrative purposes only and does not reflect actual performance of any particular retirement strategy. This example is not predictive of future results. A client’s individual results will vary depending on their individual circumstances.

That being said, this is an excellent example of Coordinated Asset Planning.

Coordinated Asset Contributions

This last concept is very simple and direct, but it is a contribution method that allows you to make more contributions to different asset accounts, WITHOUT increasing the amount of money from your checking account.

It works like this, let’s assume you have grown an account to a set level, and let’s assume that it is a taxable bond account that is worth $1,000,000. Let’s assume that this account consistently averages a 5% growth/dividend rate, but you have decided to keep the account value at the $1,000,000 level, but want to fund other asset locations. One option could be to take the 5% growth from this account ($50,000) out every year, and fund another aspect of your plan. You could use that $50,000 to fund a permanent life insurance policy, a municipal bond account, or even a Roth 401(k) option.

Doing this can accomplish two things, 1. Because the taxable bond account is being kept at its $1,000,000 threshold by taking out the 5% growth every year, we are keeping the tax liability, on that account, level and not creating a compounding tax situation. 2. By use of this account, we are able to contribute to multiple tax-favored locations, without any additional funds from our checking account pockets. So, we are able to use a taxable account to help fund a tax-favored location.

This is an excellent example of Coordinated Asset Planning.

Here at Redstone Financial Group, we are focused on our client’s maximizing the money they are putting towards their financial plans so that they can be as efficient as possible. We employ our propriety planning model known as the Retirement Efficiency Matrix, that tries to be fee-conscience and tax-efficient.

If you would like some help with coordinating your assests for greater efficiency, we can schedule a phone call to discuss a game plan that is right for you. You can do so by clicking here at “Schedule Now” and grabbing your slot on our calendar.

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