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Good Intentions Can Diminish Over Time

Moore for Your Money
By Byron Moore

Question: My plan is to leave everything to my wife after I’m gone and she’s doing the same with me. Then when the second one of us is gone, the kids will get everything more or less equally. That’s what our wills say. We are both in second marriages and both us have our own set of children. But they are all adults, on their own and doing fine. Everyone gets along fine. Isn’t this simple approach the best?

Answer: Your plan strikes me as loving, well-prioritized, simple… and potentially disastrous.

I’ve got no issues with what you intend to do, nor with the intentions of everyone involved. But good intentions have a way of diminishing over time and under stress. Your children are grown. You gave them a home and an upbringing and that’s now bearing the fruit of stability and independence in their own lives as they start their own families. You want to be sure your wife is taken care of if you pass before she does.

But your good-hearted intentions are no guarantee that those intentions will be followed. Consider just a few things that could prevent your intentions from becoming reality.

Lawsuit. I’ve had more than one widow in my office whose husband died as a result of an accident. In one case I recall, the fault of the accident was clearly the husband’s, who had died in the accident. Imagine losing your spouse in an accident, then being sued for his or her causing the accident!

If you simply leave everything of yours to your wife, those assets may be vulnerable in the event of a lawsuit.

Next spouse. People have been known to get married after the death of a spouse. You may swear up and down you won’t, but… see my earlier comments about good intentions. If you or your wife remarries, will they then leave “everything” to that next spouse? Maybe. But isn’t “maybe” a problem? Do you really want someone you’ve never met to inherit what you and your wife have built together?

Future outlaw. Your adult children are all getting along well now. That’s wonderful. But have you ever known of couples that divorce after 20 or 30 years of marriage? I’ve got a whole list of them. After you and your wife are gone, do you want to leave your life’s wealth to your children, who might then have split it with a spouse that splits?

Financial rookie. I have no idea if this caution fits your situation or not. But many couples have one spouse who “handles the money” with little or no interest or involvement by the other. I’ve seen plenty of examples both ways – sometimes the wife calls all the financial shots. Other times, that’s the role assumed by the husband.

If your marriage works like that, do you want your wife’s first year of widowhood to also be her rookie year as the financial manager of the family wealth?

These are only possible scenarios to spark your thinking. I am not an attorney and this column does not contain legal advice. You need to talk to an experienced, qualified attorney concerning all of these matters.

An attorney may suggest the use of certain types of trusts, ownership arrangements or management agreements made ahead of time to address the specifics of your situation. You won’t know any of that until you speak with an attorney.

Your good intentions are a wonderful motivator and a great place to start. Just don’t stop there. Make sure there are structures in place to carry out once you are gone what you so nobly intend while you are alive.

Otherwise, your good intentions might die when you do.

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Investment Insights

Sequence Risk May Be The Biggest Problem For Retirees
by Mike Jones

Over the next several years professionals in the financial services industry are going to be called upon to solve an extremely difficult problem: providing income to millions of retirees who have placed the majority of their life savings into publicly traded securities.With interest rates still hovering around historical lows and stock market prices setting record after record, it is correct to ask, “Where do we go from here?” and “How in the world do we attempt to sustain a fixed or inflation adjusted standard of income from a portfolio of volatile assets?”

The problem is one of simple math. As stated above, millions of investors are depending on investment returns from volatile assets to deliver income from the time they retire until their death. Using averages for investment returns or simulations that work 85% of the time provides no comfort to such investors. It is the sequence of returns that matters most.

What good is it to a retiree to make 50% on your life savings if you have lost 50% the prior year? That would mean your $1,000,000 fund is worth $650,000 after just two years (assuming a 4% distribution rate). Keep that up and you will be broke before you know it. Avoiding a large negative return in the early years of one’s retirement is CRITICAL to making the money last.

Dr. Wade D. Pfau, CFA®, is a Professor of Retirement Income in the PhD in Financial and Retirement Planning program at The American College of Financial Services. He is also a contributor to the College’s Retirement Income Certified Professional® (RICP®) designation program curriculum.

Dr. Pfau graciously shared information from his forthcoming book, How Much Can I Spend in Retirement, to subscribers of the FA (Financial Advisors) website. In the article “Managing Sequence Risk for Retirees,” Dr. Pfau suggests four techniques retirees may employ to mitigate the threat of running out of money in retirement:

1.Spend Conservatively. This techniques advises investors to keep reducing the amount they distribute from a portfolio the more aggressive they make that portfolio. At least at first. This allows the more aggressive investment strategy time to succeed thus enabling the investor a chance to harvest bigger sums down the road. While this is mathematically feasible, it is highly impractical for most retires.

2.Maintain spending flexibility. This approach only works for those retirees who have other sources of income. It espouses a fluctuation in income that is mirrored to the fluctuation in return.  If you have a meager year in performance you take out a meager distribution.  If you have a robust year, it’s party time. This greatly reduces sequence risk but is an option only to a small percentage of investors.

3.Reduce Volatility (when it matters most). I actually like this one and subscribe to it in many cases. A portfolio of reduced volatility risk is a portfolio of reduced sequence of return risk. This concept can be applied two ways. The first is to greatly reduce the risk factors during the early years of retirement. Since it is the investment returns during the first 5 to 10 years of retirement that reek the most havoc on the eventual outcome, then why not just lower the risk? One can also reduce volatility after a period of economic growth and market expansion, i.e. dynamic asset allocation. Not losing money when others are can certainly benefit a retirement portfolio as money will be available to make investments when they become attractive again. Please don’t try this one on your own. It must be applied with discipline.

4.Buffer Assets. This final technique encourages investors in the securities markets to buffer against down markets by setting aside money that can be a resource when markets turn down. The return on these assets cannot be correlated to the securities market as they would not provide a buffer if that were the case. In other words, diversify. But diversify intelligently. Many investors forget that last admonition.

The road ahead for retirees and their investment professionals is going to be a tricky one. We know that. Fortunately, many brilliant minds are thinking ahead to ways to avoid the worst of those potential problems.

If you are nearing retirement and haven’t done so already, talk with your financial advisor about his or her recommendations on how you should approach tapping into your retirement savings to best avoid sequence risk.

 

Professional Perspectives: Dynasty Trust 101

By:  Scott Sewell, attorney and shareholder McAfee & Taft in Oklahoma City

This article was originally posted in Spring of  2010

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Scott Sewell

Since joining McAfee & Taft A Professional Corporation in 1982, I have been assisting individuals and families with careful planning for the management and disposition of their assets. One of the most powerful tools available to these individuals and families is the dynasty trust. Properly structured, a dynasty trust can keep an individual’s assets from being included in his or her estate, so the assets can pass estate tax-free from one generation to another.

A dynasty trust is designed to hold assets in trust without direct ownership being transferred to any beneficiary (i.e., your children, grandchildren, great-grandchildren, etc.). The value of the dynasty trust is that the trust’s assets are available to provide for the health, education, maintenance and support of each and every one of your descendants. Then, for example, when a child dies, the remaining trust assets will pass to individual trusts for each of that child’s children. This pattern can go on repeatedly through the generations as allowed by state law. As long as the dynasty trust does not allow too much access by the beneficiaries, the trust’s assets are not regarded by the IRS as being “owned” by the beneficiaries and are therefore not subject to estate tax in their estates when they die. This presents a marvelous opportunity for the trust’s assets to grow for future generations because any appreciation in those assets is also exempt from estate taxes. An additional benefit to the dynasty trust is that, because the trust’s assets do not belong to any of the beneficiaries, the assets are generally protected from creditors of the beneficiaries in the event of lawsuits and divorce.

One particularly important aspect in the creation of a dynasty trust is the selection of a trustee. A corporate trustee is often the best choice because an individual will not live long enough to carry out the trust’s provisions. In addition to longevity, a corporate trustee offers the following advantages:

  • It is a specialist in handling trusts and has investment and tax expertise.
  • It is impartial — free of emotional bias and conflicts of interest with the beneficiaries.

When considering the implementation of a dynasty trust into an estate plan, the key questions to ask are (1) Do you want your assets to be protected from future divorces and lawsuits your children may face and (2) Do you want your assets to be able to grow and pass federal estate tax free from your children to grandchildren? If the answer to either question is “yes,” then you should consider a dynasty trust as a part of your estate plan. Transferring wealth to future generations without the assets becoming subject to the claims of ex-spouses, creditors or the IRS is the way that dynasties have been created in the past and the way in which dynasties can be created in the future.

Scott Sewell’s practice is principally focused on the representation of individuals, families and business owners in the areas of strategic estate planning involving wealth preservation and transfer, estate and trust administration, and business succession.