What happened to the market correction, what happens next, and how can you avoid hitting your GMO (get me out) point? Larry Swedroe of the BAM Alliance and ETF.com gazes into his crystal ball. Plus, 5 questions to ask your estate planner after the new tax law, and what happens to your social media estate after you die? Who will manage all those videos of Joe playing golf on Instagram?
- (01:30) State Tax Workarounds, Estate Planning & Social Media
- (10:07) Larry Swedroe: What Happened to the Stock Market Correction?
- (18:28) Larry Swedroe: Where Do We Go After the Correction?
- (28:01) Larry Swedroe: Where Do We Go After the Correction?
- (37:46) 5 Questions to Ask Your Estate Planner After the New Tax Law
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Risk starts to show up, markets crash, and these investors have to then panic and sell. And that exacerbates the fall. Markets go down, then the next group of investors hit what I call their GMO point when their stomach screams, “GET ME OUT!” and they panic and sell. And so the market goes lower, and that’s how you get crashes. – Larry Swedroe, Director of Research for the BAM Alliance
That’s Larry Swedroe, Director of Research for the BAM Alliance and writer at ETF.com. What happened to the market correction, what happens next, and how can you avoid hitting your “GMO point”? Stick around as Larry gazes into his crystal ball. Plus, 5 questions to ask your estate planner about everyone’s least favorite topic after the new tax law, and what happens to your social media estate after you die? Who will manage all those videos of Joe playing golf on Instagram? With answers to all these questions and more, here are Joe Anderson, CFP® and Big Al Clopine, CPA.
(01:30) State Tax Workarounds, Estate Planning & Social Media
JA: Alan, another day, another week – how are you doing?
AC: I’m doing great. And as always, Joe, we do these shows and we have lots of things planned, but we kind of do them free form. I get asked a lot, “do you kind of plan all this stuff out?”
JA: No you don’t! They’re like, “this is a total sham.”
AC: (laughs) No, I do get asked that. They already know my answer. It’s like no, we just come up with some articles, we kind of ad lib. You and I are not script people, are we? If we had to read a script… when we do our television show, if we had to read a teleprompter? We would look retarded.
JA: Yeah we do guests, and I’ll get this long bio, and I’ll try to read the bio. How awful is that? I can’t even read a bio. (laughs)
AC: Well, I will say you’re better than you used to be.
JA: Oh it was just awful, awful, awful stuff. So I don’t want to get into this whole tax thing.
AC: (laughs) You want a break from tax?
JA: A little bit.
AC: I don’t blame you.
JA: But there are some unique things that some states are coming up with to help large income tax state people to be able to deduct a little bit more.
AC: Yeah, like for example, California, which we’re from, is is trying to figure out a way – let’s just give you an example. If your state tax is $25,000 because you make a bit of money. And right now you can only deduct $10,000 of that. So what they’re thinking about doing is, what if, by December, you could say, state of California, you’re a non-profit. I’m just going to give you a donation for $25,000. Why don’t you then call that good for my taxes? And they actually are working on that right now. Several states are Joe, and I think the problem, of course, is the feds are probably not going to go along with this, and I’m not too optimistic this will happen. But just so you know, if you can deduct your state taxes as a charitable deduction, then they’re fully deductible on your federal return. So it would get around this rule of only deducting $10,000.
JA: So stay tuned, we’ll see what happens. I was listening to this podcast, and there was a CPA and he was talking about the new tax law. And he’s from Georgia I believe, or the South, and he’s like, “well, one of the things that they cleaned up with the tax code is this “loophole” of people writing off their state income taxes.”
AC: (laughs) Right. And if you’re in a low tax state, that’s what you would call it.
JA: I’m like, a loophole?! How is that a loophole?
AC: I actually talked to somebody, I think he is from Indiana, and he’s now a California resident. And he said, “I’m OK with this. I feel like we, the rest of the country, have been subsidizing the west and east coast high tax states for years. It’s about time they don’t have that tax deduction and they pay more of their fair share of federal tax.” And he was a California resident. So I guess it all depends upon where you’re from and your perspective. So a loophole huh?
JA: Yeah. Subsidizing. Well, to each their own. Couple of things that also I found interesting this week, Alan. Did you know that you need an estate plan now for your digital assets?
AC: I have heard that. I don’t quite know what that means. Are you going to educate us?
JA: No, not really. I thought you would. I was just read the title of it. (laughs) I’m not a big social media person.
AC: You don’t have a Facebook page, you have a LinkedIn page. That’s a digital asset, I guess.
JA: And if I die, do you think I care about if people are still going to be wanting to link in with me?
AC: Well, you never know. (laughs)
JA: I don’t think so. (laughs)
AC: But I guess what they’re talking about is, I don’t know, maybe you’re a sole proprietorship and you have a business that uses a lot of digital marketing and you pass away, well, those assets are potentially worth something.
JA: Well here’s the here’s the article. It’s “what will happen to your Facebook account when you die?” What about all your photos shared on social media, your text with loved ones, or documents of cloud storage.” Well, I can see that. “In just a two year period from 2012 to 2014, humans produced more data than in any human civilization before that, and the pace is only accelerating.”
AC: How does that fit into an estate plan though? Does it say?
JA: Can I continue with the document please, sir? (laughs)
AC: (laughs) I can’t wait. I’m just at the edge of my seat.
JA: The law is very clear about handling paper documents, Alan. And other physical property when someone dies. So your home, your brokerage account, your retirement accounts, life insurance. You have a beneficiary designation or the titling of all of this. But a law professor at Drake Law School, who has been studying property transfers for years, he goes, “I’ve seen that laws, regulations in court rulings, are only recently trying to figure out how to handle the ever-changing realm of digital technology. So far in most cases, the information is controlled by the companies that store it, regardless of what users want or direct to what happens to them when they die.” So. I know when I drafted my estate plan, there’s language in my estate plan, and it’s actually a separate document that talks about my digital assets.
AC: There is?
JA: Yeah. Do you have one?
AC: I don’t know. I’ll have to check.
JA: Because I think there’s the privacy and everything else. I don’t know.
AC: Well yeah. Like let’s say Your Money, Your Wealth® goes national. And so now you’re a national figure. So then, I guess people could maybe make money off of your digital assets. So you want to protect that. Is that what that’s getting at?
JA: Yeah. So the law is catching up. It’s looking at, there are different documents that you can now have in your overall estate plan to protect your privacy. But then you have to give direction to certain individuals, such as your successor trustees, things like that, of passwords and how to get into it, and how to either delete it or take it off, download it and things like that. Because with all the data that’s out there, I think you forget about it. It’s like, “I have a home. So I want to make sure that that goes to whoever, my beneficiary designations.” But the last thing I’m thinking about is my Instagram account.
AC: (laughs) Which you don’t have.
JA: I do have an Instagram account! If you want to see me play golf, you just watch Instagram. That’s all my posts.
AC: I see you play golf on Facebook when Robert Rogers posts.
JA: Oh, see I don’t have Facebook so I don’t know.
AC: And you have no control over what he posts. (laughs)
JA: No, I don’t. Hopefully it’s not bad.
AC: It’s pretty interesting. He’ll do slow motion of your swings sometimes.
JA: Really. He’s practicing, Alan. He needs to get that in slo-mo so he can try to copy it when he gets back home. (laughs)
AC: (laughs) I suppose.
We’ve got a whole bunch of valuable estate planning information available at YourMoneyYourWealth.com, including new blog posts on the deductibility of estate planning, incorporating life insurance in your estate plan, and whether you need a trust AND a will. But on a basic level, making sure family records are current and easily accessible when a family member dies or becomes disabled is especially important. Make sure you’re ready before you need it. Visit the white papers section of the Learning Center at YourMoneyYourWealth.com and download our free Estate Plan Organizer! It’s designed to help ensure that all of your assets are accounted for, and that all your desires are carried out upon your departure. Find all the relevant information, fill out the forms completely, keep them up-to-date and store them in a safe, easily accessible place for your heirs. You can even include all your social media information and instructions, right there on page 32. To get your free estate plan organizer, just visit the white papers section of the learning center at YourMoneyYourWealth.com.
(10:07) Larry Swedroe: What Happened to the Stock Market Correction?
JA: Hey, welcome back to the show, the show is called Your Money, Your Wealth®. Joe Anderson here, Certified Financial Planner, with my good friend Larry Swedroe. He’s been on the show many, many times for the last several years. Larry, this is a really good time to have you on. What happened to this correction that supposedly happened, but now almost it’s erased?
LS: Well, I think the best perspective I can provide, Joe, is to look back at what caused the correction that occurred. I love that term, by the way, a correction meaning assuming that the market price was wrong. I don’t know why people believe that. It could certainly be new information that comes out that could cause prices to drop. So the first price was right, prices then react to the new information, obviously it would be bad news. And then the price would be correct again. If there was a correction, it would be easy to identify, and we’d see active managers, obviously, outperforming, selling ahead of the correction. But we have no evidence of that. But if you go back to just two weeks ago and look at the economic news that had occurred building up to that, I can’t find any economic news, really, that would cause anyone to have a concern about an oncoming recession or anything else that would be a reason for stock prices to “correct.” In fact, if we look around the globe, we not only see U.S. economic growth not only strong but accelerating. Corporate earnings are accelerating thanks to the tax cut, and the same things are happening throughout the rest of the developed world. France just set a 10 year low in their unemployment rate, most of the developed world is improving. And we’re seeing that in stock returns around the globe as well. So there really was no economic news. It doesn’t mean, of course, stock prices can’t go down without any news. It’s just a lot of noise in the data.
JA: It was all good news though, it seemed like. Is it the fear of inflation? Or was it the traders that were trading on the VIX? I mean I’ve heard so many different things.
LS: There are a lot of combinations of things, Joe. I wrote a blog for my column at ETF.com, which your readers can find. They go to the website there’s “ETF News and Strategy” in the toolbar. And right below that, it says “Index Investor Corner.” I wrote a blog called “Drivers Behind the Dip” and I speculate, of course, nobody knows with 100% certainty what causes it, but we know it wasn’t corporate earnings, which is the numerator in any valuation. The denominator is the discount rate, the rate at which we discount the future earnings to give us a present value. So clearly, something was happening to drive the discount rate, or what people might call the risk premium for equities. And so you have to look at other sources, other than corporate earnings or geopolitical risk because it certainly isn’t there in any of the data.
I think what happened to some degree is a function of a whole bunch of little things that happened. So you have a lot of people betting on low volatility strategies. So for example, you sell volatility insurance. Most people are buying the VIX, which gives them protection against bear markets. So you are assuming volatility is going to rise, so you buy an option. Volatility jumps up, the volatility had been, say, 12, and the VIX futures might have been 15, and then volatility jumps to 40. Well, volatility usually spikes when you get a bear market because something bad happens and prices crash. You usually don’t get a crash up in stock prices. You don’t get good news all of a sudden breaking out. It happens over time, where markets tend to crash more quickly. So you got those people, and the markets are crashing, and now, they’re all getting hurt, and they have to sell positions to protect themselves, and markets then go lower, and volatility spikes and they have to hedge more, and all these funds that were positioned in that way got hammered. One of them lost, like, 95% in a week. (laughs) So that’s a problem. And then the second thing I think happened to contribute to this is – out of what I think was a major mistake that people happened to get lucky on and did well – for the last eight years, the Federal Reserve has very low-interest rate policies that led lots of people, particularly those who focus on a cash flow approach to investing. So they need yield, and the yields weren’t there. They couldn’t live on the interest from their bank accounts or bonds. So they went out and bought riskier assets, such as dividend-paying stocks, or higher dividend paying stocks, MLPs, REITs, things like that. And they got lucky. There was no risk. We didn’t have a recession, and they got better returns. But they clearly were taking more risk than their stomachs desired, because that would have been there in the first place, but we had massive flows into these strategies to try and boost yield, forgetting that it came with risk.
And then the risk starts to show up. Markets crash and these investors have to panic and sell. And that exacerbates the fall. Markets go down, then the next group of investors hit what I call their GMO point when their stomachs scream,”GET ME OUT!” and they panic and sell. And so the market goes lower and this thing crashes. That’s how you get crashes because you’ve got all the technical traders going. And then, added to that, right before this, we had a record in margin accounts because people thought it was safe after eight years of good markets. We got about $600 billion in short positions, and then when prices fall, you get margins calls, and most people can’t meet that call, putting up more cash. They sell their positions, driving prices even lower. So you’ve got a combination of all these things – people selling their preferred stocks and REITs and MLPs, and even maybe lower-rated corporate bonds. And boom, everything starts going down. And then you get the momentum traders jumping on that, and they start selling. That’s what can happen and that’s how you get a day like October in ’87 when the market dropped 22%. You get these flash crashes, and you get to suffer. We’re now more dominated by these algorithmic trading systems. So I think you’re going to be more and more subject to these dramatic swings, making discipline ever more important.
For more on the ups and downs of the market, check out the blog in the Learning Center at YourMoneyYourWealth.com on the recent market volatility. Find out the potential causes, get some historical perspective, and learn some actions you can take to control the things you CAN control when it comes to stomaching risk in times of market volatility. Visit the blog in the Learning Center at YourMoneyYourWealth.com. For more specific help with your money questions, call Joe and Big Al at (888) 994-6257 – if it’s a good question, the fellas may even answer it for you live on Your Money, Your Wealth®. That’s (888) 994-6257. (888) 994-6257.
(18:28) Larry Swedroe: Where Do We Go After the Correction?
JA: We’re talking to Larry Swedroe, our good friend Larry. Larry is the Director of Research for BAM – Buckingham. They manage billions of dollars, and it’s always a pleasure to have Larry on the show. You’ve been doing this quite some time.
LS: I do want to say how long, but it’s 46 years. (laughs)
JA: I would say today, there’s probably more information and education when it comes to a prudent investment strategy than ever before.
LS: Without question.
JA: But the behavior – do you think it has changed it all?
LS: Yes, I think so. But in only a small percentage of the people still. So what we know is this: when I start in the business now 24 years ago, 1% of all individual money was indexed. Today that number is probably around 15% by individuals. The total of passive strategies is more than a third, it’s approaching 40%, but that’s because institutions, which are more aware of the academic research, have moved faster to a passive strategy. So today, let’s even be generous and say 20% of individuals are indexed. But that doesn’t mean they’re purely passive either, right? They could be indexing and then subject to panic selling, or they could be active traders selling an S&P 500 ETF to buy a small value or emerging market ETF, depending upon what their system is telling them, or their analysis. So just because you’re in index funds, doesn’t mean you’re passive. So I would say the vast majority of individuals are still active in some way, unlike your clients, or our clients.
JA: You know, it’s funny, I saw something when it comes to the SPY of how much outflows happened over the last 10 days of that.
LS: Yeah, it was a record.
JA: Yeah, and that’s supposed to be an index-type. It’s an index fund, it’s the S&P 500 ETF, and so many people jumped out of that. So if you really have a disciplined strategy, then you probably shouldn’t see that many record outflows. (laughs)
LS: In fact, you might have been a buyer, because a 10% move, you might say, “hey, I need to rebalance.” It’s possible. Or you had new cash, you’re going to buy what went down.
JA: Where do you see us going from here? What does your crystal ball say?
LS: It’s cloudy as always. Cloudy and meatballs, as the movie. (laughs) Here’s what I think is really important for today’s investors, and again, you could find an article I wrote recently on ETF.com called The Four Horsemen of Your Portfolio. Unfortunately, if you’re planning on retirement or a younger investor today, the situation for you is a lot worse than it was, say, for me when I was beginning in my investment career and actually had enough income and had paid off student loans and all that stuff. So I was born in 51, so it wasn’t until around 1980 or so I started to be able to invest some serious money. And at that point, stock prices were very low. We had PEs in the single digits, bond yields were very high, and so you had very high expected returns from both stocks and bonds. And in fact, I think you might even be surprised, Joe. What would you guess a 60/40 portfolio generated from 1982 through 2017?
JA: Wow. On an average annual basis?
LS: No, the compound return over the period.
JA: A lot. I couldn’t even begin to guess.
LS: Well most people would say you think stocks got 10%…
JA: Yeah I would say 6 or 7% annualized rate of return.
LS: And maybe the bonds were high yield, so you got a little more. The compound return of a 60/40 portfolio was 10 and a half percent.
JA: Ten and a half.
LS: And today, most financial economists would say that the expected return to a U.S. market-like equity portfolio is in the 6 or 7% range, and bonds are clearly in the 2%, 2.5% range. So you’re talking a 60/40 portfolio, maybe 5%. And so that’s a real problem for people. And all these pension plans that were planning on 7 or 8%. I don’t know how you get there, based upon any reasonable forecasts. And compounding that problem are three other things. The first is, when I was growing up, I knew very few people who are many years older than when they could take Social Security at 65. Maybe you saw a few people in their 70s, but that was pretty rare to go much beyond that. Well today, my generation, if you’re a 65-year-old couple, the second to die life expectancy is 25 years. And that’s an average. So we tell people at 65, if you’re a normal healthy couple, got good genes, you’ve gotta plan for 30 years. No one would have thought anything like that. So you’re faced with lower expected stock returns, lower expected bond returns, and you have to make the money last quite a bit longer.
And to add that, we have a very serious problem with Alzheimer’s, because every five years, the odds of getting Alzheimer’s doubles once you pass 65. So the time you’re in your 80s, it’s like almost 50% and two out of three of them are going to be women. Most people are unaware of that, and they tend to live longer. And we know how costly it could be to deal with that. So people looking at things like long-term care insurance and having enough assets – and then you add on top of that, in about 15 years, the Social Security system will be unable to fully fund its obligations. Now, most people think Social Security is going to go bankrupt. That’s not true. But they would, at that point, have to cut their benefits to 75% of what people were expecting, or they have to raise taxes or do other things, which is a certainty. But none of our government officials have the coverage to deal with it. So you’ve got all these problems, and I think people just aren’t saving enough, and are way too optimistic in their returns assumptions. And we as advisors need to do a good job in educating them about these risks.
JA: Yeah, without question. You’re looking at, also, let’s say if you have a 60/40 portfolio that’s generating 5 to 6% rate of return, you’re also assuming Larry that they’re going to be fully invested throughout that time period, right? How many people got out of the market just in the last 10 days?
LS: Yeah, that’s exactly right. And you have to hope, of course, that the day you retire, the market’s don’t crash because you start withdrawing and that money can’t recover. That’s why it’s important, we think today, while the old rule was sort of, if you maintained a reasonably balanced equity bond portfolio, you could withdraw 4% a year from your portfolio, adjusted for inflation. So the next year you take, if inflation was 3%, you take 3% more money out, that you would have a very low odds – non-zero, but very low, maybe 5% chance of outliving your assets. Today, because the expected returns are much lower, we think that number is 3%. So if you had a million dollar portfolio, and we’re planning on being able to withdraw $40,000 a year, and then adjust it for inflation, today, you should only plan on 3, at least at age 65. So that’s a 25% reduction in your spending power to keep your spending prudent. So that’s another problem that results from the fact that we had spectacular returns, but that drove valuations way up, and bond yields way down. And it’s insane to believe you’re going to earn 6% on bonds like we used to earn when the yield today is 2% or 2.5%.
Making a note of that, withdraw only 3% in retirement at age 65… now, what about the rest? As we just heard from Larry, market volatility can really put a dent in your retirement plans. Is there anything you can do to prepare as you approach retirement? Visit the White Papers section of the Learning Center at YourMoneyYourWealth.com to download our Retirement Readiness Guide. It won’t cost you a dime, and you’ll learn little-known secrets about controlling your taxes in retirement, and preparing for increased longevity, rising healthcare costs, Social Security uncertainty and market volatility. Download the Retirement Readiness Guide from the White Papers section of the Learning Center at YourMoneyYourWealth.com.
(28:01) Larry Swedroe: Rising Interest Rates and Target Date Funds
JA: They’re trying to creep up interest rates, and I think people get a little bit afraid of that. But higher interest rates aren’t necessarily a bad thing.
LS: Yeah, great question Joe. It leads to a good discussion. So first of all, higher rates, you have to break it down into what is the source of higher rates? If it’s economic demand from a strong economy, the GNP is growing, businesses are borrowing to expand. Workers wages are going up. They want to buy more goods. That’s actually good. Because while the denominator, that rate that we’re going to discount those future earnings, is going up. So that means the present value of that stream would otherwise be going down. The numerator is also going up, and they offset each other. However, if the numerator is not going up, and it’s the Federal Reserve that’s raising interest rates because inflation is going up and it needs to tighten monetary policy to prevent the economy from overheating and a repeat of the 1970s, now you get two things happening: rates going up, so the rate you discount, your earnings are going up. That lowers stock prices. Second thing is, people start looking forward and saying, “well, the Fed is tightening, the economy’s going to slow. Corporate earnings will go down.” The numerator is falling, and then it gets worse, because people say, “well that creates more risk, I’m gonna raise the risk premium above that Treasury rate, that safe rate that we start with,” and that’s how you get big bad bear markets that can cause stocks to drop sharply. So that’s the scenario that you want to worry about. I actually am writing a piece today, I’m going to try and get it posted on Monday, saying if you want something to worry about, here it is. And this is the scenario. Economic growth is strong. Wages are rising, but the Federal Reserve is concerned about rising inflation. They start to tighten, inflation does pick up, it overheats, and then the Fed does actually have to tighten hard. And boom, stocks go down. And here’s the problem. All those people who went out of their safe bonds into those higher yielding stuff, their stomachs are going to be screaming. They’re going to be dumping assets for sure. All these “safe assets,” low volatility stocks, MLPs, REITs, junk bonds, emerging market bonds. They’re going to come crashing down in that environment. Now, I don’t predict that. My crystal ball is cloudy, but people should be prepared for that as a possible scenario, and their portfolio should be able to withstand it. Which means you shouldn’t have made that trade in the first place. And if you did, you better unwind it, because that could happen. That’s a reasonable scenario that some people, some gurus, are forecasting. I don’t put any weight behind it, but it’s certainly something I think could happen.
JA: When you look at 10,000 baby boomers turning 65 daily for the next, I don’t know, 12-13 years, and the dividend-paying stocks, the MLPs, the REITs, trying to get a higher yield because they couldn’t find it in the bonds. We’ve talked about this in the past, but this whole notion of going with a high dividend paying stock strategy, and that’s their sole strategy, is a safe way to create the income, because the yields are high, and they’re getting the income that they need, and they have no clue of the risk that they’re actually taking, because I think they assume that the dividend is like a coupon payment on a bond. And it works nothing like that.
LS: Well there are two problems with that. First of all, companies can cut dividends. You’ve seen that happen quite a bit in 2008 it certainly happened. But the second thing is, investors demand a bigger risk premium. Now a high dividend stock may give you a little bit of safety, protection in a bear market, they tend to be a little bit lower volatility. But the market went down 40%, so maybe they went down 30 or 32%. (laughs) That’s still a huge drop! When your clients, in the safe bonds you had them invested in, they were going up 8 or 10%. So that’s a real problem. Vanguard’s high yield fund that year went down something on the order of like 23 or 25%. That certainly wasn’t safe. And that’s what can happen. So we advise strongly that people should avoid those kinds of assets.
JA: What’s your feeling and last take here. I know you’re busy, but I wanted to get your opinion on a target date funds. What’s your thought? With those there’s a lot of people that that’s their the sole investment strategy, hey, I’m retiring in 2030, 2025. I’m just going to invest in that particular fund?
LS: Yeah. So one, I could think of worse things for people, but there are clearly some negatives that people should be aware of. First of all, if you look at 10 different target-date funds for the same year, they’ll have 10 different asset allocations. Some will have a higher equity. Some will have a higher international allocation in their equities, some will own junk bonds, et cetera. So just because it’s a particular date that you retire on doesn’t mean it’s going to be an appropriate fund for you. The second problem has to do what’s called the asset location problem, which is if you have a choice, and you have both a taxable account and your IRA, most people actually get this backward. We want to hold our equities, having a preference to hold them in our taxable account, and our bonds and our tax-advantaged account, like our IRA or 401(k). And if you’ve got a target date fund, you’ve got both stocks and bonds in that same account, which means you’re having an asset location mistake for one of the two.
JA: Yeah most definitely.
LS: But I will say this: for many people, if that’s their sole investment and their asset allocation of that fund is reasonable – and you want to make sure they using low-cost funds like a Vanguard Index Fund, not a high-cost active fund – the benefit of those target date funds is they are more likely to keep people disciplined. They will be automatically rebalancing for you, so you don’t have to have the courage to buy in a bear market. The fund is doing it for you, and hopefully, you’ll avoid hitting the panic button. The data shows, people when they have two accounts, their 401(k) and their taxable, where they are much more likely to panic than their taxable and leave the 401(k) alone. Interesting phenomenon.
JA: Right. And I think I see that as well because, the 401(k), we’ve been taught for years to defer, defer, defer. Don’t touch that money until you absolutely need it, and then when I have money outside of retirement accounts, well we’ve been used to spending money in our checking accounts our whole lives. But when you’re looking at a retirement strategy or a retirement income strategy, when you overlaid the tax implications on the income, it’s like money is money. It doesn’t matter if it’s in an IRA or non, you just want to look at the tax implications of it and make sure that it’s invested appropriately based on what your goals are. You know another thing with target date funds is that I see, and you probably see this too Larry, is that you’ll see someone with like four or five different target date funds. (laughs) What are you doing? If you’re going to use a target date fund folks, you just pick the one you put all of your assets in. That’s what it’s for. But I never, rarely, see that.
LS: That happens, people don’t understand, that’s unfortunate. But I don’t blame them, I blame the education system for failing to provide them with an education sufficient so they can make an intelligent decision or an informed decision.
JA: Larry thanks so much. It’s been a while. All the articles that Larry referred to, we’ll definitely put them on our website so we can get you linked and follow Larry. He’s one of a kind, and I really appreciate your time, my friend.
LS: Yeah, watch for that one on I think hopefully it’ll be up on Monday. And I never know what the editors at ETF.com will change the title to, but my title is, “If You Want Something to Worry About.”
JA: That’s Larry Swedroe, folks.
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Time now for Big Al’s List: Every week, Big Al Clopine scours the media to find the best tips, do’s and don’ts, mistakes, myths and advice to improve your overall financial picture – in handy bullet-point format. This week, 5 Questions to Ask Your Estate Planner After the New Tax Law
AC: So, it’s time to dust off that trust document and go to your estate planning attorney. And here’s the first question you should ask is “will the new federal law affect my estate tax picture?” And for many folks, the answer is yes, because the exemption amount was doubled. So in 2017, you could pass away with $5.6 million of assets. Anything above that would be taxed at 40%. Now that’s doubled to $11.2 million per person. So it basically means that a lot of wealthy families are not going to be paying estate taxes with this doubling up.
JA: Right. When I got into the business it was about $680,000, $675,000?
AC: Yeah, it was $600,000 when I got into the business, that was the exemption amount. And yeah, it was $675,000 for a while.
JA: And so a lot of people were subject to the estate tax at that point.
AC: Right. And so people were doing a lot of crazy things, they were setting up living trusts with the A/B provision.
JA: ABC, Q-Tips…
AC: Yeah, double up, triple up on the exemption. And then, remember, I think it was George W. Bush that brought it up to $1 million.
JA: Yeah, then it was zero. 2011 or 2010?
AC: 2011 I believe, maybe it was 10.
JA: Whenever George Steinbrenner died was when.
AC: I think was ’10 actually, because in 2000… no, it was ’11, because in 2001, I think it went to $1 million and then it gradually went up to $3.5 million in 2009.
JA: Yeah something like that. Anyway.
AC: But now, under Obama, it went up to $5 million per person, which has been indexed for inflation. So we were basically at $5.6 million, and now that’s doubled to $11.2 million per person. So why this is important is, you may completely want to change your asset transfer strategy. For example, if you’re gifting assets to the kids right now, you might want to kind of pull back on that, because anything you gift to your kids, or grandkids, whatever you paid for this asset, they take over that same basis. So if you have $100,000 stock that you bought for $10,000, if you gift it to them, yes you get it out of your estate. And there are ways to do that. But now there’s a $90,000 gain, and your kids, grandkids, when they sell it, they’re going to have to pay that tax. Now, if you were to pass away, and they inherit it, there’s a full step up in basis. So where you might want to have been doing a lot of gifting before, so that you keep your estate below $5.6 million, now you might want to do just the opposite. Not gift it, so that your kids, grandkids will get a step up in basis.
JA: Right. So depending on the size of your estate, you either want to be gifting or not gifting.
AC: Right. The second question is, “what does the new tax law mean by the exemption limit for married couples?” And this is a really important one. I think a lot of people have no idea about this. So I said it was an $11.2 million exemption per person, but it’s not automatic. So here’s the way it works: when the first spouse passes away, the surviving spouse needs to file Form 706 within nine months after the passing of the deceased.
JA: It’s a death tax return.
AC: It’s a death tax return, and you don’t have to pay any tax, but what you do is, you establish the values of assets, and that first spouse basically gets the $11.2 million, and it preserves the $11.2 for the second spouse when they pass away. Portability is what it’s called, and it’s not automatic. You have to take action. Interestingly enough, so many people missed this deadline, because they had no idea about this stuff, and so the IRS has now made it easier to correct it after the fact. But now that you know the facts, just do it properly. Which is file an estate tax return, form 706, within nine months after the passing of the first spouse.
Number three. “Will the new federal law affect my state estate tax?” (laughs) I’ve already lost you, Joe. Get this, Joe, because we don’t have this in California anymore. There are 15 states that have some form of estate tax. Your old hometown Minnesota is one of them. Iowa, Nebraska, Washington, Oregon, Kentucky, Tennessee, Pennsylvania, New Jersey, Massachusetts, Rhode Island, Connecticut, Delaware, Maryland, and the District of Columbia. All of those states and the District of Columbia have a state estate tax, meaning that you may get out of paying federal estate tax if your assets are below that $11.2 million, but you may have to pay an estate tax to the state. And I was actually just looking at Oregon recently, it’s relatively low. I might be off, but I think it’s like a million dollars, give or take, is the limit. Anything above that is, you have to pay an estate tax to Oregon. And I checked it out because we had a client that was thinking of moving to Oregon, and they decided not to, because of estate tax issue. So just be aware of that. This is good news for federal, but it may not affect your state that you live in. The fourth thing is, “Are my estate documents customized to fulfill my wishes and avoid unintended consequences?” Well, that’s something that you should be probably reviewing every five years anyway because laws change, your goals change, your favorite cousin is no longer your favorite cousin, but they’re getting all your assets, or however you originally set it up.
JA: Why would your favorite cousin get all your assets? That sounds like Jerry Lee Lewis. (laughs)
AC: (laughs) Because it’s your favorite cousin.
JA: That’s a little bit too close, there. (laughs)
AC: But also, kind of more mundane things like you may have things in there for certain monies to take care of your ailing parents, and maybe they’re no longer here. There are things that you have to review from time to time.
JA: Yes you do.
JA: Thank God. This is pretty boring, isn’t it? This is gonna kill me. Good thing we’re talking about estate planning!
AC: (laughs) Well, it’s everyone’s least favorite topic, even mine. But it’s important. “How soon should I come in for another review of my estate plan?“
JA: I would come in now, the law has changed. Check it out. Because you probably have an A/B provision that automatically funds the B trust. You don’t want that to happen. There’s portability. You can just do a simple trust. I would highly recommend everyone go see an attorney.
AC: Right. And the A/B provision, so people did that so they doubled up on their exemption.
JA: Now they don’t need to.
AC: And when you do that, then there’s a step up in value the day of the first spouse passing, but then that locks in that value. When the second spouse passes, the step up is only on what’s left, not the whole thing. Now, in some cases, you still want the A/B provision, if you have mixed families and things like that. So I’m not saying you shouldn’t have it. But I think I could say this, Joe: the majority of older trusts out there have A/B provisions, and the majority of people that have them probably don’t really want them anymore.
JA: Yeah. That’s it for us. For Big Al Clopine, I’m Joe Anderson the show’s called Your Money, Your Wealth®. We’ll see you next week.
So, didja still want to leave everything to your favorite cousin there, Jerry Lee? If not, visit the Learning Center at YourMoneyYourWealth.com to download the free Estate Plan Organizer. Make your plans and wishes known on the most boring, least favorite topic there is, and get it out of the way for a few years by putting it all in the Estate Plan Organizer. Download it free from the Learning Center at YourMoneyYourWealth.com
Special thanks to our guest, Larry Swedroe. Learn more in the Index Investor’s Corner at ETF.com.
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