It ticks up with a bumpy rise. You ride toward the peak with great anticipation. You reach the top, take in the view if only momentarily, then the free fall begins. You are whipped around the ups and downs, highs and lows, and sometimes thrown for a loop.
The past few years of this wild ride in the global markets is leaving many with stock-market whiplash – and asking one key question:
What can I do to ride out these various volatility waves?
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“Inflation, interest rates, geopolitical issues, and domestic political issues … there is a lot going on in the world that is causing volatility in the markets,” said Wyeth Greene, CFP®, Private Wealth Planner at Regions. “There are strategies that you can deploy during market drops and rallies to provide a long-term benefit.”
Greene recently penned a thoughtful piece with tips on estate planning strategies during volatile markets for Regions Wealth Insights addressing four specific strategies that clients can use to take advantage of market uncertainty and reduced asset values to better achieve their tax and estate-planning goals.
Is a Roth Conversion Right for You?
For individuals considering a Roth IRA conversion, doing so during reduced market values in which asset prices have dropped may mean lower ordinary income tax due at the time of conversion.
“A Roth provides a lot of opportunity for tax-free income during retirement, and some individuals don’t really need the income from required minimum distributions (RMDs), which are taxed,” noted Greene. “Converting means you are no longer required to take minimum distributions and your investment grows tax-free.”
But there are a few considerations.
“Once you convert from a qualified retirement account, you will pay ordinary income taxes on the amount converted, but from that day forward any growth, withdrawals or passing to heirs will be forever income tax-free,” Greene said. However, he does note that, “there are a lot of things to consider; it may not always be the best fit.”
For example, Greene explains that based on an individual’s age and time horizon, there may not be enough time to break even from the tax they would pay today to do the conversion – or perhaps they don’t have heirs that would benefit from the income tax-free inheritance.
Other important considerations are the five-year rule and how to pay the tax bill upon conversion.
“If you do a conversion, you don’t want to take the money out earlier than five years,” noted Greene. “This is because withdrawals from the Roth IRA may be subject to taxes and penalties if the account has not been owned for at least five years. You also need to make sure you have assets other than the converted money to pay the taxes owed.”
Finally, it is important to consider tax rates now compared to what you expect during retirement.
“If your tax rate is high today and you expect that to be significantly lower in the future, you may not want to do a conversion. We just don’t know where taxes are going, so having some differentiation in assets in retirement can be beneficial.”
To Exercise – or Not to Exercise?
That is the question for many who own stock options.
Many employers offer equity compensation in the form of NSOs (Non-Qualified Stock Options). Timing when to exercise these options can be tricky, as doing so may result in ordinary income tax on the spread between the strike price and the current fair market value.
Volatile markets, specifically when there has been a drop in market values, may offer an excellent opportunity to consider exercising.
“If you are considering selling some of your stock options in a depressed market, that spread will be lower,” Greene said. “You decrease your ordinary income tax burden by exercising while the value is lower.”
Once exercised, the employee now owns these shares, and can choose whether to sell them immediately or hold them long term.
Gifting to Reduce the Estates Tax Burden
Often, we see high net-worth clients looking for ways to reduce their estate tax burden upon their passing, and gifting during their lifetime is a common strategy for achieving this goal.
The potential drawback, however, is that gifts made during life may reduce one’s lifetime estate tax exclusion amounts upon death.
Therefore, Greene notes, “For those who would like to gift assets to family or other beneficiaries during their lifetime, the implementation of an outright gift may be an effective strategy during a market downturn. If assets such as stocks and bonds have decreased in value and you gift today, you are reducing the estate’s tax burden while allowing for future growth outside of the estate.”
Gifts made today at lower values preserve a larger lifetime exclusion amount at death.
Lifetime gifts may be in the form of business interest, stock, mutual funds, real estate or other assets that may be subject to value fluctuation.
Is it Time for a Substitution?
Market volatility does not only consist of downturns. There are also strategies that can be employed to take advantage of sudden increases in asset values. One such strategy is known as the power of substitution.
“The power of substitution is a privilege that grantor trusts offer, allowing the grantor to swap assets out of the trust for assets in the trust if equal in fair market value,” explained Greene.
A grantor trust is designed to reduce estate taxes and benefit heirs. And leveraging the substitution powers of this type of trust is another way to take advantage of current market uncertainty. This can be strategic if an asset currently held in trust has increased substantially in value.
If left in trust, the asset will not receive a stepped-up basis upon the grantor’s death, meaning the beneficiary will be stuck with the grantor’s original cost basis. However, if the appreciated trust asset is removed from the trust, and replaced with cash of equal value, the appreciated asset is now in the name of the grantor individually and can receive a stepped-up cost basis upon the grantor’s death.
“A lot of our clients are wondering what, if anything, they should be doing in a volatile market,” said Greene. “These are just a few strategies that can be employed in the interim as we await more stable market cycles.”
If you have questions about your estate planning strategy as you navigate these turbulent waters, a Regions’ Wealth Advisor can introduce you to the Regions Wealth Planning group to help you understand your options, and work with you in reaching your financial goals.
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