A recently released survey conducted by Spectrem Associates for CNBC showed that millionaires are becoming less-enamored of equities (and risk) and are looking to increase their allocation toward safer investments.
This sentiment was even more pronounced among respondents over aged 55 and those with over $5 million to invest.
Here are a few strategies that can help your cautious clients earn more net return while scaling back on risk.
Maximize Returns on Cash
The survey said those getting out of the market were moving money to bond funds, Treasurys, money market funds, and checking and savings accounts.
But brokered certificates of deposit offered via your firm may offer a much higher rate of return than those liquid rainy day funds and Treasurys, and with less uncertainty and lower expenses that are inherent with most bond mutual funds. Just make sure that clients understand that brokered CDs can fluctuate in value until the maturity date, and if the money is needed before that date, the CDs may be sold for more or less than the face value.
Better yet, CDs offered directly by banks and credit unions usually only have a small penalty for early withdrawal, limiting the downside if the client needs the money before the CD matures. Several institutions around the country are offering close to 3 percent interest on five-year CDs if you’re willing to shop around for your clients.
No matter where you get CDs for your clients, consider “laddering” them out so that equal amounts come due at regular intervals. For instance, if your client has $200,000 to allocate toward the CDs, you may want to divide that amount up to have $50,000 coming due each year for the next 4 years. Then, at each maturity date, the client can use the proceeds to cover living expenses or invest in other opportunities they may find.
Clients with active 401(k) plans may be able to avoid the risks of bond funds and instead use a “stable value” account, assuming one is on the plan’s investment roster.
Finally, for non-retirement accounts, Series I savings bonds currently pay 2.52 percent (adjusted every May and November), and the interest is exempt from state taxation. The tax bill can be paid each year or delayed until the bonds are cashed in. Buyers can only purchase $10,000 per person per calendar year, so interested clients should get to www.treasurydirect.gov to get theirs before the end of 2018.
Trim Those Taxes
Selling appreciated equities and equity funds can trigger a hefty and unwanted tax bill for your clients, so some thought and analysis is required of you and your clients before you submit the “sell” order.
First, consider selling any equity investments held within tax-deferred accounts, such as 401(k)s, IRAs, Roth IRAs, and annuities. For securities held outside of those accounts, begin by selling any positions that will generate a loss that can then be used to offset taxable capital gains and/or income.
If you are selling profitable positions, check the purchase date to make sure any realized gains will be taxed at the long-term rate, which could be as low as 0 percent.
If the security has a gain that would be taxed at short-term rates upon selling, talk with the clients about the certain cost and benefit of selling that investment now versus the ambiguity of waiting until any would-be gain enters long-term taxation territory. Working clients should of course maximize their pre-tax retirement savings options, especially until they get down below the top of the 12 percent federal income tax bracket.
The lower taxable income may make it more likely that any realized capital gains will also be taxed at a lower rate and reduce the chances of getting hit by the Net Investment Income Tax.
Just for Retirees
Retired clients don’t have the luxury of offsetting taxable gains with increased retirement plan contributions. But they too have several pitfalls and opportunities to contemplate when moving out of the market.
Realized capital gains could not only boost the clients into a higher tax bracket, but the profits could also make their Social Security payments taxable or make a greater portion of the Social Security income subject to taxation.
The formula to determine the taxation of Social Security takes the client’s adjusted gross income, plus “non-taxable” income, such as tax-free bonds, plus half of their Social Security benefits. You can try CalcXML’s specific calculator for free here.
If the result is between $25,000 and $34,000 for singles ($32,000 and $44,000 for married joint filers), 50 percent of the benefits will be taxed as ordinary income. Over $34,000 for singles and $44,000 for married filers, and 85 percent of the Social Security payments will be considered taxable income.
On the other hand, proceeds from sold investments that were held outside of retirement accounts can be used to cover future ongoing or extraordinary living expenses, which means the clients can then withdraw less in taxable funds from IRAs, 401(k)s, and annuities.
Whether your clients are working, retired, or somewhere in between, it’s a good idea for you to contact their tax preparer now to see what gains can be realized this year with as little tax pain as possible.
Clients with appreciated assets, such as shares of stock, may want to donate those shares directly to a qualified charity instead of selling the securities or writing a check to the organization.
The charity can use the full proceeds after selling the donated shares, and the donor gets a tax break on the value of the shares, and doesn’t have to calculate the actual cost basis and dates of purchase.
Better yet, the clients can donate the appreciated shares and/or cash to a donor-advised fund now and take the tax break this year. They can then direct distributions from the DAF to qualified charities in future years. They won’t get a tax deduction on the distribution at that time, but perhaps they will be in a lower tax bracket and the deduction would be less valuable than if it were taken now.
Kevin McKinley is principal/owner of McKinley Money LLC, an independent registered investment advisor. He is also the author of Make Your Kid a Millionaire.