For most people who spend a lifetime prudently managing their wealth and their spending habits, the thought of their children recklessly and rapidly blowing their inheritance is disconcerting. According to a study by the National Endowment for Financial Education, 70 percent of all people who suddenly receive a large sum of money will use it all within a few years. According to behavioral scientists, although people tend to be frugal with money that is earmarked for a specific purpose such as a child’s education, they are much more reckless with unexpected windfalls like an inheritance or lottery winnings.
As a parent, you probably already have a good idea if your children are likely to be responsible with the money they inherit from you. If your heirs have built up a considerable net worth on their own, you are probably not too worried about them. However, if your grown kids are still coming to you for financial support, there may be an issue.
One way to prevent your kids from blowing their inheritance is to create a trust for them that appoints an independent trustee to help them manage their finances. Your kids can typically receive all the income generated by their inheritance each year, but they can only access the principal for specific purposes such as health care, education or emergency situations.
You can choose to direct the trustee to distribute some or all of the assets to your children once they reach a certain age. However, I usually don’t recommend this because if you are concerned about your kids blowing their inheritance, why allow them to blow it once they reach a certain age? As for annuities and IRAs, if you are trying to prevent your children from squandering those assets, you can name your trust as the beneficiary for those accounts. However, there may be some adverse tax consequences for naming your trust as the beneficiary of those assets, so you should consult with your tax adviser prior to doing so.
There is a section in the IRS tax code, designed to preserve certain U.S. lands, permitting wealthy investors to significantly reduce their income tax liability. Landowners who are willing to grant a permanent restriction on the use of their property to a qualified organization exclusively for conservation purposes will get a big tax deduction even though they still own and possess the land. Easements could be used to preserve a wildlife habitat, a scenic view, water quality or agricultural property.
According to Yahoo finance, President Trump, has reportedly generated more than $100 million in write-offs through easement deals, including a $39 million deduction on his Bedminster, New Jersey golf course.
Recently, investors looking to reduce their tax liability, have been investing in syndicated conservation easements. These partnerships purchase properties, grant conservation easements, and pass the tax deductions to each partner. The structure works most effectively when the partnership is able to get a high appraised valuation of the easement. It is not uncommon for the appraised value of the easement to be eight to nine times higher than the purchase price of the land. In that case, a $1 million investment could result in a $9 million tax deduction. The deduction can be used to offset up to 50 percent of one’s income.
The IRS does consider this type of strategy as a listed transaction, which requires participants to fill out a special form with their returns disclosing their participation in the transaction. A few lawmakers, who viewed the large tax deductions created by this strategy as excessive, proposed legislation at the end of 2017 to limit the tax deductions to investors. However, the bill did not gain enough support in the face of opposition from large land conservation lobbying groups. Thus, the use of conservation easements remains a viable strategy. You should consult a tax adviser with the appropriate expertise prior to utilizing unique tax strategies.
At the end of 2017 Congress passed the Tax Cuts and Jobs Act. There is a provision in the law that creates a huge financial tax incentive for investments in low income areas called Opportunity Zones. These low income zones are in both inner city and rural areas. Each state has the ability to designate areas to qualify as opportunity zones and those areas must be certified by the Secretary of the Treasury. An entity, such as a corporation or a partnership, may register as a Qualified Opportunity Fund provided that at least 90 percent of its assets are in designated opportunity zones.
If an investor sells an appreciated asset, like a stock or real estate investment, in order to invest the proceeds in an Opportunity Fund, they will be able to defer all capital gains from the sale. When they sell, they will get either reduced tax treatment or if they hold their investment in the fund for at least 10 years, they will not have to pay any capital gains taxes. If it’s sold earlier, it can be rolled in to another opportunity fund. Unlike a tax free 1031 real estate exchange, an investor can transfer proceeds from highly appreciated stocks or even a small business. Additionally, unlike a 1031 exchange, in which all owners of a piece of real estate must all agree to participate in a 1031 exchange to defer taxes, each owner of real property can act independently and decide for themselves regarding an investment in an opportunity zone.
This is an opportunity not only to defer and potentially eliminate capital gains taxes, it’s an opportunity to help society by improving areas that most need it. According to Forbes, there is $6.1 trillion of unrealized gains sitting on U.S. balance sheets. If a small fraction of these gains finds their way into opportunity zones, these areas could become very profitable investments.
Many investors who have watched their account values consistently rise over the last decade are very happy with their investments. However, during times of low volatility and steady gains, investors may tend to under estimate the risk of their portfolios and overestimate their own investment prowess. Eventually, the stock market will have a bad year and equity investors will lose money.
That may be when investors start reevaluating the risk level they are comfortable with. Even if you own a portfolio filled with high quality stocks, you are not immune from market corrections. After all the S&P 500, which consists only of “Blue Chip” stocks, went down more than 50 percent during the market crash of 2008. Therefore, it’s entirely fair to assume your stocks could lose 50 percent of their value the next time we suffer a major correction. If you are truly a long term investor, a large draw-down isn’t the end of the world, as stocks have always rebounded if held long enough.
According to a prominent study by Dalbar, the problem is that most investors under-perform the market because — among other things — they make poor market-timing decisions. When investors see the value of their accounts diminishing quickly, they tend to get more conservative and reduce exposure to stocks. This causes them to miss the eventual rebound.
One of the ways to be a more successful investor is to reduce the potential downside in your portfolio to a level that you can tolerate. First, you need to truly understand and quantify your risk tolerance. You can take two minutes to understand your risk tolerance by going to www.findoutmyrisk.com. Once you know your risk tolerance number, you can adjust your portfolio to make sure it does not have a risk exposure that is higher than you can tolerate.
Ready to Take
The Next Step?
For more information about any of the products and services we provide, schedule a meeting today or register to attend a seminar.