Tax Terms: Carried Interest and the Buffett Rule

Contributed by: Matt Trujillo, CFP®

If you followed the 2016 campaign coverage as closely as I did, than you probably heard some tax-related terms repeated time and time again. Two terms in particular were “carried interest” and the “Buffet Rule.” For those that aren’t terribly familiar with these terms I will attempt to give a brief description of each.

What is "Carried Interest?”

Carried interest refers generally to the compensation structure that applies to managers of private investment funds, including private-equity funds and hedge funds. As a result of the carried interest rule, fund managers' compensation is taxed at lower long-term capital gain tax rates rather than at ordinary income tax rates. Both Clinton and Trump released plans calling for carried interest to be taxed as ordinary income.

What is the "Buffett Rule?”

In a 2011 opinion piece, Warren Buffett, chairman and CEO of Berkshire Hathaway, argued that he and his "mega-rich friends" weren't paying their fair share of taxes, noting that the rate at which he paid taxes (total tax as a percentage of taxable income) was lower than the other 20 people in his office (Warren E. Buffett, "Stop Coddling the Super-Rich," New York Times, August 14, 2011).

As Buffett pointed out, this is partially attributable to the fact that the ultra-wealthy typically receive a high proportion of their income from long-term capital gains and qualified dividends, which are generally taxed at lower rates than those that typically apply to wages and other ordinary income.

The "Buffett Rule" has since come to stand for the tenet that people making more than $1 million annually should not pay a smaller share of their income in taxes than middle-class families pay. As a result, some have proposed that those making over $1 million in annual income should have a flat minimum tax of 30%.

What is the right thing to do? That is not for this humble author to decide. But at least now, some of you can be better informed about what these terms mean the next time you hear them on the news!

The tax environment is evolving rapidly. Be sure to talk to a qualified professional before implementing any changes to your tax and investment strategy.

Matthew Trujillo, CFP®, is a Certified Financial Planner™ at Center for Financial Planning, Inc.® Matt currently assists Center planners and clients, and is a contributor to Money Centered.

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The information contained in this blog does not purport to be a complete description of the securities, markets, or developments referred to in this material. The information has been obtained from sources considered to be reliable, but we do not guarantee that the foregoing material is accurate or complete. Any opinions are those of Matt Trujillo, CFP®, and not necessarily those of Raymond James. There is no guarantee that these statements, opinions or forecasts provided herein will prove to be correct. While we are familiar with the tax provisions of the issues presented herein, as Financial Advisors of RJFS, we are not qualified to render advice on tax or legal matters. You should discuss tax or legal matters with the appropriate professional.

More Potential Changes Under the Trump Administration

Contributed by: James Smiertka

The New Year always brings changes, but this year may be particularly notable. We have a new U.S. President & our Congress is ruled by a Republican majority. This surely brings a new direction for the country and also the prospect of policy and regulatory changes.

As we know, President Trump made tax reform a key issue during his campaign, and he has proposed wide-ranging changes to the U.S. tax system. Additionally, with the GOP with majority control of the House and the Senate, there is a better chance for an overhaul of the federal tax system than in the past. Changes will most likely not be quickly completed, and it is likely that any tax reform will not take place until late 2017 or early 2018.

Here are some of the potential changes:

Estate Tax

• Trump’s plan seeks to repeal the current estate tax as well as the alternative minimum tax (AMT) and generation-skipping transfer tax (GSTT)

• Total repeal is unlikely

• $10 Million exemption (per couple)

  • Assets above this amount would be subject to capital gains tax

• Likely change to the asset basis step-up for heirs

  • Date of death value rules likely preserved for heirs of smaller estates

  • Limited basis step-up for heirs inheriting from larger estates

• There is also the potential for state estate taxes to disappear as they are based on the federal estate tax system

Gift Tax

• Will most likely stick around in some form

  • Prevents income shifting from donors in high tax brackets to the donated in lower tax brackets

• If the estate tax is repealed, we could be looking at a change to the lifetime gift tax exemption in the neighborhood of around $1 Million or higher (lifetime), with the annual gift tax exclusion preserved (currently $14,000/year)

There are a wide range of possible combinations of estate & gift tax reform, and potential tax planning opportunities depending on the details of that reform. Here are some potential scenarios, per Michael Kitces:

While there are many potential planning scenarios for both individuals and businesses, nothing is certain. Only very broad strokes have been “painted” thus far. Regardless, Center for Financial Planning, Inc. is always staying up to date with the most recent changes. Make sure to speak with your financial advisor if you have questions on any of these topics.

Also, make sure to check out our previous blog on the new administration’s potential impact to marginal tax brackets, standard deductions, and capital gains tax.

James Smiertka is a Client Service Associate at Center for Financial Planning, Inc.®

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The information contained in this report does not purport to be a complete description of the securities, markets, or developments referred to in this material. The information has been obtained from sources considered to be reliable, but we do not guarantee that the foregoing material is accurate or complete. Any opinions are those of James Smiertka and not necessarily those of Raymond James. There is no guarantee that these statements, opinions or forecasts provided herein will prove to be correct. Sources:

• Kiplinger Tax Letter, Vol. 92, No. 2 (1/27/17)
• http://www.forbes.com/sites/ashleaebeling/2016/11/09/will-trump-victory-yield-estate-tax-repeal/#aef41902bf2a
• https://www.kitces.com/blog/repeal-estate-gift-taxes-and-carryover-basis-under-president-trump/
• http://www.forbes.com/sites/nextavenue/2016/12/12/what-the-trump-tax-proposals-mean-for-high-net-worth-retirees/#5f7253b17ef4
• http://www.cnbc.com/2017/01/22/how-trumps-proposals-may-affect-every-income-tax-bracket.html

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The Connection between Home Renovations and Financial Planning

Contributed by: Nick Defenthaler, CFP®

About two months ago, my wife and I decided that it was time to take the plunge and finish our basement.  As I’m sure many of you can relate to, our 18 month old son’s toys have quickly taken over our living room. What was once a peaceful area for us to relax and watch some TV, has literally turned into a mini-jungle gym! We wanted more room for his play area as well as give us some extra space for entertaining friends and family. Home renovations are a pain. We’ve all been there. They’re expensive, stressful, and can often time end up being a money pit. After much thought and months of saving, however, we decided it was the right time to move forward with our project.

I think it’s important to note that I am NOT a do-it-yourself kind of guy. The extent of my handyman skills are changing lightbulbs and hanging a picture. I think acknowledging this as a weakness is extremely important. Since I know home improvements are not my forte, we’ve elected to delegate this work and hire a professional to make sure our project was done properly and to our liking. Even if I had the expertise to do some of the work on my own, I know I wouldn’t want my spare time to be consumed working on the basement. I’d much rather spend that time with my family and friends. 

We spent several weeks interviewing different contractors to determine who we felt would be the best fit for our project. Many things were taken into account throughout this process. Referrals from friends and family, quality of work, level of comfort and cost, just to name a few. We probably met with five contractors who all wanted the job, and who were all fairly close in price. Jack, the contractor we ended up hiring, was not the cheapest, but he wasn’t the most expensive. We decided to move forward with him because we gained a level of trust with him and knew he did quality work for mutual friends and family members. Jack won me over when I called him about five times within two days, asking him what probably seemed like simple, and more than likely, dumb questions. To Jack’s credit, however, he never lost his patience with me or made me feel silly for asking them. He was willing to make sure my mind was at ease, knowing this was not something I was an expert in. Although the process has been stressful at times, Jack has kept us in the loop the entire time, been extremely honest and overall, has done a phenomenal job building out our basement to how we had envisioned. 

As our basement is in the final stages of completion, I couldn’t help but take a step back and realize how many similarities existed with our home renovation and how we work together with clients at The Center. Over our 30+ year history, in my opinion and experiences, the clients that have the most potential success are those who realize that investing and financial planning is not an area of expertise or something they want to spend free time on. They value delegating, have the desire to hire a professional they trust and know we will be with them throughout each step of life to help them achieve their personal and financial goals. One of the best pieces of advice I was ever given was to always identify and accept the things you are not an expert in, and hire a professional to do the work right for you. I firmly believe those who find the most success in life are masters at this. By doing so, it allows us to focus more energy on the areas we are truly passionate about. Time is hard to come by, why not try to spend more of it on the things that create more meaning and happiness for us and our family? So give us a call when you’re ready to delegate, we’re always here to help and answer your questions!

Nick Defenthaler, CFP® is a CERTIFIED FINANCIAL PLANNER™ at Center for Financial Planning, Inc.® Nick is a member of The Center’s financial planning department and also works closely with Center clients. In addition, Nick is a frequent contributor to the firm’s blogs.

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Any opinions are those of Nick Defenthaler, CFP®, and not necessarily those of Raymond James.

We're Expanding!

Contributed by: Lauren Adams, CFA®, MBA

If you happened to visit The Center in December (perhaps for your annual review or maybe just to drop off a gift for Toys for Tots), you may have noticed an unusual amount of construction workers milling around and near our offices. You may have heard the occasional drill or hammer while chatting with Gerri or having a coffee in the reception area. You may have even come in to find a wall there one day and gone the next. To our December visitors, thank you for pardoning our dust. We really hope you’ll like what we did with the place.

2016 was a major year of investment in our team and resources at The Center. I was hired in July as the Director of Client Services, Jeanette LoPiccolo, CRPC®, who was hired as a Client Service Manager, Emily Lucido and Ashley Frank, both Client Service Associates, all came on in September, and Josh Bitel, another Client Service Associate, was added to our team in December. These new faces brought enthusiasm and fresh ideas with them… but things also started to get pretty cramped around here. And so, to cap of a year of major investment, the partners decided that it was also time to expand our physical location as well.

Now, visitors to The Center will notice that the office opens up both to the left and to the right from the lobby. We’ve added over 2,000 square feet of new space, new offices, new workstations, and even a new conference room where we can hold additional client and team meetings. We’ll be putting the finishing touches on our new space in the coming weeks; walls will receive special touches and additional furniture will arrive. This new space will allow those that were previously sharing close workspaces to spread out, and for us to arrange our departments, including Financial Planning, Investments, and Client Service, together to help share knowledge and function more cohesively. With the addition, Matt Trujillo, CFP®, and Nick Defenthaler, CFP®, will now have room to host client meetings in their offices.

We also have room to grow.  This year marks 32 years since our founding. Our commitment to the financial planning process, putting clients first, and providing exceptional service hasn’t changed since Dan Boyce, Marilyn Gunther, and Estelle Wade started the firm in 1985, and we know our steadfast commitment will allow us to continue to grow into the future. So come in, say “hi!” and see our new space!

Lauren Adams, CFA®, MBA is Director of Client Services at Center for Financial Planning, Inc.®

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Why Approaching Difficult Topics Now Could Help Avoid a Mess with Parents’ Finances

Contributed by: Sandra Adams, CFP®, CeFT™

As I write this, we are a couple of weeks into 2017, and already I have been involved with two client family meetings – adult children meeting with their parents about their parents estate planning and finances. I am sure this is just the tip of the iceberg for this type of meeting – and I am so thankful. Why? Because these families are planning ahead! Approaching these sometimes very difficult topics now can be the key to avoiding a very big mess later.

You might think “So, what’s the big deal? Mom and Dad seem to have things under control. They can pay their bills just fine, they seem to be financially comfortable, and I don’t want to invade their privacy and ask them too many questions about their money, so let’s leave well enough alone until we really need to get involved.”

Here are just a few of the “big deals” that could occur for those who wait until mom and dad can’t handle things (i.e. in this case, parents now are unable to handle financial affairs due to incapacity):

• Parents may not remember where they hold accounts, what their account numbers are, passwords, etc.

• Parents may not remember all income sources, amounts, etc. (pensions, Social Security, etc.) and may not have been reconciling checkbooks.

• Parents may not have been paying bills and may not remember what bills need to be paid (you are lucky if they have bills set up for auto bill pay, as many of this generation have been uncomfortable setting this up).

• Parents may or may not have a filing system and/or record keeping system that you can understand; depending on the stage of their incapacity, they may or may not be able to explain it to you.

• If your parents have existing Durable Powers of Attorney (General/Financial and Medical) that give you authority to act on your behalf, you can hope that they are up to date and written broad enough instructions to be used with most financial and medical institutions.

• You can hope that there aren’t too many other surprises that you didn’t expect!

My advice is always to follow the proactive planning of some of my clients, and start talking to your parents in advance of a crisis (or in advance of “that time” when parents can no longer do things themselves). Sure, it is not always the most comfortable conversation to start, but you might be surprised to find that many older adult parents find comfort in knowing that their children (1) want to be involved, (2) are interested in their well-being, and (3) know that there is a plan in place once the family meeting has taken place. Start the process of planning for your parents today! Don’t hesitate to contact me if I can be of assistance (Sandy.Adams@CenterFinPlan.com).

Sandra Adams, CFP® , CeFT™ is a Partner and Financial Planner at Center for Financial Planning, Inc.® Sandy specializes in Elder Care Financial Planning and is a frequent speaker on related topics. In addition to her frequent contributions to Money Centered, she is regularly quoted in national media publications such as The Wall Street Journal, Research Magazine and Journal of Financial Planning.

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The information has been obtained from sources considered to be reliable, but we do not guarantee that the foregoing material is accurate or complete. Any opinions are those of Sandy Adams and not necessarily those of Raymond James. There is no guarantee that these statements, opinions or forecasts provided herein will prove to be correct. Prior to making an investment decision, please consult with your financial advisor about your individual situation.

Fourth Quarter Investment Commentary

Contributed by: Angela Palacios, CFP®

2016 has been the year of the stock market taking major geopolitical news in stride. From the UK Brexit vote to an unexpected Trump victory in the U.S. presidential election, the market has shrugged off some major news that could have jolted it in a very negative way. Equity markets, however, once again demonstrated their resilience, and along the way this has become the second longest bull market in US history as of April of 2016. The S&P 500 ended the year up strong returning 11.96%, while bonds gave back great returns in the first three quarters of the year (they were up 5.8% as of 9/30/16) to end up only 2.65% on the Barclays US Aggregate Bond Index. International markets continued to struggle as they were nearly flat in 2016 with a 1% return for the MSCI EAFE while emerging markets bounced back strongly returning 8.5% on the MSCI Emerging Markets index.

Source: JP Morgan

2017 is likely to usher in a market driven more by fiscal policy than by monetary policy. The Federal Reserve is anticipated to continue their slow pace of raising interest rates into the New Year while Trump takes office very soon and launches his 100 day action plan. So if you choose not to give up and move to Canada, here is what we are watching in the New Year!

Trump’s 100 Day Action Plan:

Donald Trump has plans to shake up many potential areas such as trade, Obamacare, immigration, education (common core), tax code, and infrastructure improvements. Political risk could amplify volatility globally, although it hasn’t yet. This populist movement as shown by Brexit and our own election (people fed up with the status quo) is a theme likely to continue abroad as France, Germany, and Holland will host their own elections in 2017. The U.S. dollar has reached its highest level in 14 years in the wake of the presidential election, and a strong dollar has traditionally been a headwind for the earnings of large companies with significant international exposure. Taken together, these factors tell a somewhat cautionary tale for equities going into 2017.

The Economy:

Our economy continues to chug along with unemployment at very low levels. According to the Bureau of Labor Statistics as of November 2016 we were at 4.6% unemployment. We are considered at full employment now. This means that wage inflation is starting to pick up, although slowly, which could start to be reflected in the overall inflation rate creeping up in the U.S even though it has been subdued for an extended period of time. Inflation currently stands at 1.7% (bls.gov). 

A Note on Diversification:

2016 has tested our patience on diversification yet again. Locally, The U.S.’s flavor of the month benchmark has morphed from the S&P500 to the Dow as the benchmark to keep up with. Pure U.S. equity exposure has continued to drastically outperform a diversified portfolio to historically unusual levels. This year other asset classes have had the opportunity to shine as Emerging markets*, small cap equities** and high yield debt*** have also performed well. Diversification seems to once again be working after a long drought. We, at The Center, still see merit to utilizing a diversified approach when it comes to managing our investments. As geopolitical risk rears its ugly head around the world, it will likely be important to tap into the long-term returns of many different asset classes to hopefully limit portfolio volatility.

We understand that you need to retire and achieve your goals regardless of what markets are doing. This is why we build portfolios to be all weather and stick by our strategy of diversification as a sound long-term approach to investing. It is a task that we take very seriously and we thank you for your continued trust in us.

Checkout Investment Pulse, by Angela Palacios, CFP®, a summary of investment focused meetings for the quarter.

Does the order in which you achieve your average returns really matter?  Of course, it all depends.  Check out when the sequence of returns matter!

Nick Boguth, Investment Research Associate dives into the surprising reality of what it takes to dig out of the hole of negative returns.

Jaclyn Jackson, Portfolio Coordinator, discusses the trends of investor behavior during significant events over recent history.

If you have topics you would like us to cover in the future, please let us know! As always, we appreciate the opportunity to meet your financial planning and investment needs. Thank you!

Angela Palacios, CFP®
Director of Investments
Financial Advisor

Angela Palacios, CFP® is the Director of Investments at Center for Financial Planning, Inc.® Angela specializes in Investment and Macro economic research. She is a frequent contributor The Center blog.

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* As measured by the MCSI EAFE Index
** As measured by the Russell 2000 Index
*** As measured by the Barclays Aggregate Bond Index
The information contained in this report does not purport to be a complete description of the securities, markets, or developments referred to in this material. The information has been obtained from sources considered to be reliable, but we do not guarantee that the foregoing material is accurate or complete. Any opinions are those of Angela Palacios, CFP®, and not necessarily those of Raymond James. Expressions of opinion are as of this date and are subject to change without notice. There is no guarantee that these statements, opinions or forecasts provided herein will prove to be correct. Investing involves risk and you may incur a profit or loss regardless of strategy selected. Diversification does not ensure a profit or guarantee against a loss. The S&P 500 is an unmanaged index of 500 widely held stocks that is generally considered representative of the U.S. stock market. The Dow Jones Industrial Average (DJIA), commonly known as “The Dow” is an index representing 30 stock of companies maintained and reviewed by the editors of the Wall Street Journal. The Barclays US Aggregate Bond Index is a broad-based flagship benchmark that measures the investment grade, US dollar-denominated, fixed-rate taxable bond market. The MSCI EAFE (Europe, Australasia, and Far East) is a free float-adjusted market capitalization index that is designed to measure developed market equity performance, excluding the United States & Canada. The EAFE consists of the country indices of 22 developed nations. Investing in emerging markets can be riskier than investing in well established foreign markets. Investing involves risk and investors may incur a profit or a loss. International investing involves special risks, including currency fluctuations, differing financial accounting standards, and possible political and economic volatility.

Investor Ph.D.: Sequence of Returns

Contributed by: Angela Palacios, CFP®

When planning for our goals, we often think in terms of “What return will we average over time?” But does it matter what pattern these returns happen in? What if they are choppy or we experience very negative returns right before we need the money or as we are drawing it? The answer can be startlingly different depending on what phase of your goal you are in.

If you are accumulating for a future goal the sequence of how to help achieve your returns in general doesn’t matter as long as you average what you need at the end. Look at the following example:

Source: Blackrock

The chart below shows two 30-year income scenarios. The solid line shows a withdrawal plan that started off with three years of negative returns in a row. The dotted line repre­sents a withdrawal plan with the negative years at the end. Both plans started with $250,000 and both took out $12,500 per year inflated by 3% for inflation. No other actions were taken to manage income withdrawals. Both plans had a 6.6% average annual rate of return on the underlying investment for the 30-year period.

These nuances are why it is critical to work with a financial planner to plan for and pursue your goals!

Angela Palacios, CFP® is the Director of Investments at Center for Financial Planning, Inc.® Angela specializes in Investment and Macro economic research. She is a frequent contributor The Center blog.

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The information contained in this blog does not purport to be a complete description of the securities, markets, or developments referred to in this material. The information has been obtained from sources considered to be reliable, but we do not guarantee that the foregoing material is accurate or complete. Any opinions are those of Angela Palacios, CFP®, and not necessarily those of Raymond James. Expressions of opinion are as of this date and are subject to change without notice. There is no guarantee that these statements, opinions or forecasts provided herein will prove to be correct. Investing involves risk and you may incur a profit or loss regardless of strategy selected.

Investor Basics: Drawdowns 101

Contributed by: Nicholas Boguth

It is imperative to try to avoid major drawdowns when investing. This may seem intuitive, but let’s take a closer look.

Drawdown is a metric used to measure risk. It is a measure of the peak-to-trough decline of an investment or portfolio. Minimizing drawdown is arguably more important than seeking large returns when it comes to investing, and here is why:

Below is a simple chart showing the returns investors would need to get back to where they started if they lost 10%, 30%, and 50%. The math is relatively simple: if you start with $100 and proceed to lose 50%, you now have $50. In order to get back to the $100 that you started with, your $50 would have to gain $50, or increase by 100%.

So the math is simple, but who really cares about the hypothetical? Let’s look at how the S&P 500 actually performed compared to diversified portfolios during the drawdown that started in ’07. The chart below, from JPMorgan’s Guide to the Markets, shows how the S&P 500 lost over 50%, and took 3 FULL YEARS before it recovered back to its peak. Compare that to the 40/60 portfolio. Since the drawdown was significantly less, it was a much quicker recovery and broke even after just 6 months. This is why it is important to try to avoid major drawdowns when investing.

For a more in depth look on drawdowns and sequence of returns, check out the Investor PhD blog written by our Director of Investments, Angela Palacios, CFP®.

Nicholas Boguth is an Investment Research Associate at Center for Financial Planning, Inc.® and an Investment Representative with Raymond James Financial Services.

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The information contained in this blog does not purport to be a complete description of the securities, markets, or developments referred to in this material. The information has been obtained from sources considered to be reliable, but we do not guarantee that the foregoing material is accurate or complete. Any opinions are those of Nick Boguth and not necessarily those of Raymond James. Expressions of opinion are as of this date and are subject to change without notice. There is no guarantee that these statements, opinions or forecasts provided herein will prove to be correct. Investing involves risk and you may incur a profit or loss regardless of strategy selected. The S&P 500 is an unmanaged index of 500 widely held stocks that is generally considered representative of the U.S. stock market. Keep in mind that individuals cannot invest directly in any index, and index performance does not include transaction costs or other fees, which will affect actual investment performance. Individual investor's results will vary. Past performance does not guarantee future results.