Grantor Trusts

We just attended one of the top estate planning conferences in the country. Held October 28th and 29th the Notre Dame Tax and Estate Planning Institute had speakers from around the country who presented as to the most current thinking on estate planning issues. In this era of legislative uncertainty there is one wealth transfer strategy with significant appeal for high net worth families-- grantor trusts.

Grantor trusts require the grantor (Dad) to pay the income taxes on the trust earnings while the full amount of the trust may accumulate for next generation beneficiaries (children and grandchildren). Structured properly, the income tax paid by Dad on a grantor trust represents transfer to next generation free of estate and gift tax. There are many possible enhancements to the strategy, however at the core stands the grantor trust as a powerful strategy that high net worth taxpayers should consider using.

Public-Employee Union is Biggest U.S. Election Outside Spender

One can't help but notice that on the heels of the U.K. announcing significant public-sector job cuts in an effort to balance their budget, in the U.S. the biggest outside spender for the 2010 elections is the American Federation of State, County and Municipal Employees (AFSCME).  Given an early 2010 Supreme Court decision that permits corporations and unions to use their own funds to pay for political ads, AFSCME is directing $87.5 million to help elect Democrats and presumably protect public sector jobs.

AFSCME's membership has grown 25% in the last decade, the Wall Street Journal reports http://tinyurl.com/284zude.  As government spending at all levels comes into the cross-hairs of those determined to reduce deficits, it is astounding to see the open effort by AFSCME to elect those who they will then turn to and ask for job protection.  Here's hoping the election winners are the candidates who will most honestly approach our budget deficit issues at the local, state and national levels!

U.K. Government Planning Significant Cuts

The U.S. should sit up and take notice at the significant cuts planned by the U.K. government http://tinyurl.com/26lpupc.  As many as 500,000 public sector jobs will be cut, although it is worth noting the U.K. presently has 6 million government jobs in a country with 62 million population, while the U.S. has about 2 million government jobs and 300 million population.

Still, the U.K. is taking the route of trusting that significantly shrinking the public sector will permit the private sector to flourish.  Maybe after the November elections some in political leadership will have the courage to follow a similar theme in the U.S. while we still have time to do more measured cuts and before we are backed into the same drastic cuts corner where the U.K. now finds themselves!

September 2010 Market and Planning Update (Posted to our blog two weeks after sending to clients.)

Change before you have to.

Jack Welch, author, commentator and former GE CEO

PLANNING COMMENTARY

Change is something we all deal with in our lives- whether it is in our financial, personal or social lives. There are different forces of change that occur all around us. One would be change that “collides” with us and that we are reactionary to. This is change that occurs on its own whether we like it or not and whether we’re prepared or not. Another force of change we initiate on our own, under our control, on our timing. We would argue that this second type of change is proactive in nature and can provide the path of least resistance when compared to being strictly reactionary.

In planning for our financial, personal or social lives, if one can confront the fear of change and be proactive about planning for the future they will arguably be more prepared for what’s next down the road. One of our primary goals is to recommend proactive changes in our clients’ wealth plans to help prepare them for what the future holds. We have found that individuals that sit and wait for change to occur in the economy, their income, family situation or family goals are grossly unprepared for the results of that inevitable change. In these instances the only action left to take is reaction- and the options are limited.

This is not to say that we (or anyone that we know of) can predict what changes will occur in the future and jump out in front of them. This inability to predict what change will impact us next is precisely why wealth planning and changing proactively is so crucial to remain prepared for the unknown.

MARKET COMMENTARY

For several months leading up to August, investors avoided equities with mutual fund flows instead favoring cash and bonds. In the month of September, the compelling valuations of stocks combined with somewhat favorable economic news to give stocks a lift. The S&P 500 returned 9% in the month of September, bringing the year-to-date return up to about 4%.

Investors have continued to invest with their eye on the rear view mirror picture of past volatility. This has resulted in continuing inflows to bond funds and significant strength in gold as a safe harbor. We wonder if all investors in gold understand that gold as an investment has no intrinsic value and pays no dividend or interest, or are people buying gold because it is going up and they have lost confidence in other choices.

Since the 2008 credit crisis we have changed our investment approach to be more tactical. Even though many market participants are driven away by market volatility, we believe this offers opportunity to buy lower priced assets at times and sell higher priced assets at other times. This is what we mean by being tactical. For instance in mid-July equities looked to be attractively priced and therefore we increased the portions of client portfolios that we put into equities.

Another example of change that we believe investors must recognize and adapt to is the rise in worldwide importance of emerging market countries like Brazil, Russia, India and China. A significant portion of worldwide economic growth will come from these emerging economies and we think client portfolios must reflect this strength with significant allocations to this area. Demographic forces generally favor these countries with younger workers who are improving their economic circumstances and will expand their consumption of goods and services.

Austerity

Two small articles in today's Wall Street Journal addressing deficit reducing steps by countries outside the U.S. are eye-catching. 

French workers are trying to organize open-ended strikes to protest President Nicholas Sarkozy's plans for raising the retirement age from 60 to 62.  The strike may not be taking hold as the state-run railway SNCF said Tuesday saw 40% of workers on strike and then Wednesday this number was down to about 25%.

In the U.K. plans were announced to cut 192 government agencies (out of 901 agencies reviewed), while another 118 agencies will be consolidated down to 57.  The U.K. government goal is $815 million of annual savings from such cuts.  Interestingly, comments from the U.K.'s largest union, Unite, protested the cuts.

It would seem that the global winners will be those countries, states, and municipalities (and for that matter, corporations) that can most quickly and effectively identify and implement appropriate austerity moves.

90% Tax Rate over Two Generations

Gregory Mankiw is an economist and a professor at Harvard University.  As a conservative (unusual to find at Harvard), he has good insight into income tax rates and how they motivate, or de-motivate, economic taxpayer activity.

Yesterday he wrote an editorial in the NY Times http://tinyurl.com/26j3o3g that sets out how tax rates affect him as one of the taxpayers who make over the magical $250,000 line drawn by the Obama administration to define "rich".  The interesting conclusion that Mankiw arrives at is that he can afford to pay more taxes, but that the very high share which goes to taxes (including estate tax) serves to demotivate him in terms of the effort required to earn more money.  He also makes the point that all consumers will be affected by higher tax rates in terms of the limitations of goods and services supplied by the higher income taxpayers (example recording artists, medical practitioners) that are similarly demotivated.

Knowing that the income tax debate will certainly heat up after the elections with the scheduled December 1, 2010 release of the National Commission on Fiscal Responsibility, readers of this blog may well want to take a look at the Mankiw editorial.

Who pays what share Income Tax in the U.S.?

There is significant debate over U.S. income taxes and who should pay and at what rate.  Any sensible debate should start with facts, and we have found that the Tax Foundation has good facts at  http://www.taxfoundation.org/news/show/250.html. 

The IRS has released new date on calendar year 2008 individual income taxes, with some key points being:

1. The top .1 of 1% of tax returns (adjusted gross income or AGI over $1,803,585) earned 10% of the nation's adjusted gross income and paid 18.5% of all federal individual inocme taxes with an average income tax rate of 22.7%.
2. The top 1 percent of tax returns (AGI over $380.354) earned 20% of the nation's AGI and paid 38% of all federal individual income taxes and had an average tax rate of 23.3%.
3. The top 5% earning taxpayers (AGI over $159,619) earned 34.7% of the nation's AGI and paid 58.7% of all federal individual income taxes at an average tax rate of 20.7%.  This means the bottom 95% of taxpayers paid 41.3% of all federal individual income taxes.
4. The bottom 50% of tax returns (AGI under $33,048) paid a total of 2.7% of all federal individual income taxes at an average tax rate of 2.6%.

We present this data with no editorial comment.  The goal is merely to inform the reader as to who is paying what share of federal individual income taxes in our country.

Fat tails and other talk of risk

An accepted tenent of investing has been that returns group in a "normal distribution" around long-term averages.  As the thinking goes, some years are good, some bad but the possibility of really good and especially the really bad are so remote as to be somewhat dismissed.  The time period that started about two years ago with the September 15, 2008 bankruptcy of Lehman Brothers taught everyone that there was a very distinct possibility of really, really bad returns.

Now some are coming forward with studies to support the idea that the chances of bad returns are really much higher than had been previously thought.  The statistical probability of really bad returns occurring in any quarter by one study is about 5 times higher than previously thought.  The statisticians call such return outliers "fat tails" to describe their higher frequency than the "thin tails" previously assumed.  A very good study on this was recently released by Welton Investment Corporation and can be found on their web site at http://www.welton.com/.  We recommend this study to all who want to better understand the risks of investing going forward.