Use Asset Location to Pay Less in Taxes and Get More Money out of Your Investment Portfolio

Block Woman surveys scattered piles of coins placed on a grid of squares

What if you didn’t have to save more than you already are, if you didn’t have to change what you invested in…and you could still get more money out of your investment portfolio? Pretty nice, eh? Well, you can.

May I introduce asset location.

Asset location is an investment strategy that puts certain types of investments into certain types of accounts based on the investment’s tax characteristics and the account’ tax treatment. The goal is to create larger after-tax returns for your investments. “After-tax” is the money you can actually spend. Pre-tax numbers are simpler to understand…but not as useful.

Vanguard estimates that proper asset location can increase after-tax return by 0..05 to 0.3% each year. Sounds…kinda small. But if you compound that over years, and talk about it in dollars and not percentages, it can sound…kinda big.

In this post, I’ll describe a lot of the nitty gritty of asset location, and I’ll end with how we use it here at Flow for our clients’ investment portfolios.

This Is the Icing, Not the Cake.

You do not need asset location to be a successful investor. It is icing on the investment cake. That cake’s ingredients?

  • Broad diversification. Owning not 1 stock or 10 stocks, but 1000 stocks.
  • Low cost
  • An appropriate “asset allocation” for the amount of time until you need the money. That is, the balance of stocks and bonds in your portfolio. Yes, we’re talking asset ALLOcation vs. asset LOcation. Sorry about that! I don’t pick the names!

(You can learn more about our beliefs about what constitutes good investing, in this blog post.)

To boot, the younger you are and the smaller your investment portfolio, how much you save is usually more important than all those things. 

But if you’ve already got the cake, and you’ve got the personal wherewithal to ice the cake, or if you’re working with a financial planner whom you’re paying to ice the cake, then yeah, let’s do this thing.

The Rules of Asset Location

Here are the rules that govern asset location:

Rules based on tax-efficiency:

  • Put your tax-efficient investments in your taxable accounts.
    For example, a total US stock market index fund. “Tax efficient” means your investment doesn’t produce much investment income (interest, dividends, capital gains distributions) during the year.

  • Put your tax-inefficient investments in an IRA or 401(k) (or other tax-protected account).
    For example, a taxable-bond fund.

Rules based on growth potential:

  • Put low-growth investments in a traditional IRA or traditional 401(k) (or other pre-tax account).
    For example, a total US bond-market fund.

  • Put high-growth investments in a Roth IRA, Roth 401(k) or HSAs (or other after-tax or tax-free account).
    For example, an S&P 500 fund.

One more rule that doesn’t fit neatly above: Put international-stock funds in taxable accounts. These funds typically pay foreign taxes, and if you hold them in taxable accounts, you can get a foreign-tax credit for those taxes paid, reducing your US taxes. If you hold them in a tax-protected account, you can’t get that credit.

Put ‘em together and what have you got?

Bippidi boppidi…oh wait, no.

You get a decision matrix like this:

Why Does Tax Efficiency Matter?

If you were retired, it’s possible that having investments producing income throughout the year wouldn’t be a bad thing. You’ll need money to live on, after all! You can use that investment income (interest, dividends, fund distributions) as that income.

But if you’re still working, your job provides all the income you need (god willing). You don’t want to have to pay taxes on income you don’t need. So, we want to minimize taxable income coming from your investments.

Which means we put tax-efficient investments in an account where you do pay taxes, because those investments won’t create much taxable income. And we put tax-inefficient investments in accounts that are tax protected, because regardless of how much income your investments create, you don’t owe taxes on it.

Why Does Growth Potential Matter?

Because we want to minimize the bucket that the government can take taxes out of and maximize the bucket that you own 100% yourself.

Let’s say you retire and have a $1M portfolio. The after-tax size of your portfolio varies depending on how much of your portfolio is in a pre-tax IRA vs. a Roth IRA. The bigger your Roth IRA is relative to your pre-tax IRA (for the exact same total portfolio balance!), the more money you will have to spend.

In this chart, you can see that when the $1M is split evenly between a Roth IRA and a traditional IRA, your after-tax portfolio is worth “only” $840k. (We’re assuming a marginal (i.e., top) tax rate of 32%.)

But let’s say you used asset location over many years, putting your high-growth investments in a Roth IRA and your low-growth investments in a pre-tax IRA. As a result, your Roth IRA is worth $600k, and your traditional IRA $400k. In this scenario, your after-tax portfolio would be worth $872k. Same $1M total portfolio…but a bigger Roth bucket gives you more money to spend.

Follow these rules gently, not obsessively.

These are guidelines. You can get a lot of the benefit of asset location by adhering only loosely to these rules.

You don’t have to put all your stock holdings in a Roth or even taxable account. It’s okay to have some in a pre-tax IRA! Just get a good chunk of your stock holdings (especially if they’re tax inefficient) in your Roth IRA to increase your lifelong tax savings.

Balance Optimization (Icing) with Simplicity

Asset location is easy enough to do, at a high level.

The more narrowly defined your investments, the more exacting you can get in your asset location…but at the cost of portfolio simplicity. So, I’m not sure you should get that exacting.

For example, a high-level implementation of asset location would mean getting most of your stock investments into a Roth IRA and most of your taxable bond investments into a traditional IRA.

In contrast, let’s say you break your portfolio down into individual stocks, commodities, micro cap US stock funds, small cap, mid cap, large cap, both growth and value, equivalent complexity on the international front, private-company stock, cryptocurrencies, etc. You now can pick the best account for each of those 10+ types of investments to go into. That’s harder to set up in the first place and harder to maintain.

I recommend getting most of the value of asset location with the least amount of setup and maintenance required. Asset location is optimization enough unto itself. I don’t believe you need to optimize the optimization.

The Challenges of Asset Location

An asset-location strategy is a multi-year (-decade) commitment. As with pretty much any investment strategy, there are challenges that you should really think about before you commit to it.

Each Account Will Perform Differently.

I used to work at a financial advisory firm that did not use asset location. They invested all of a client’s multiple accounts the same.

If the client’s target asset allocation was 90% stocks/10% bonds, then by gum, their taxable account was 90% stocks/10% bonds, their pre-tax IRA was 90% stock/10% bonds, their Roth IRA was 90% stocks/10% bonds…and all the spouse’s accounts were also 90% stocks/10% bonds.

I asked the lead advisor one day why they didn’t use asset location. He explained (I paraphrase) that a lot of clients couldn’t handle the fact that each account would perform differently than the others, and that their spouse’s accounts would also perform differently than theirs.

Your all-bond pre-tax IRA would grow 3% in a year, and your spouse’s stock-heavy taxable account would grow 16% in one year. Or one loses 3% while the other loses 20%. That doesn’t feel good.

Asset location is a portfolio-level strategy, not an account-level strategy. That means you have to be prepared for each individual account to perform differently. Your focus should be on The Total Portfolio. How did all your accounts perform together?

Big Money Movements In and Out of an Account Can Create a Challenge.

Let me tell you a story about difficulties we ran into when implementing asset location in a client’s portfolio.

We were managing this client’s Financial Independence (aka Retirement) portfolio, which consisted of a taxable account, a traditional IRA, and a Roth IRA. The portfolio’s asset allocation was 85% stocks/15% bonds. As prescribed by the basic asset location rules, all her bonds were in the traditional IRA.

Then we helped her roll that traditional IRA money into her 401(k) so that we could do a backdoor Roth IRA for her. Now, with her IRA emptied out, her asset allocation was…100% stocks. Eeek.

We needed more bonds. How to get them? We had two types of accounts to put them in: her Roth IRA and her taxable account.

I didn’t want to put them in her tax-free Roth IRA, as that’s the account where I want to put our “growthiest” possible investments.

That left her taxable account. But in order to buy more bonds, I’d have to sell some of the existing stocks, creating a taxable gain. She’s mid-career as a director at a big tech company. She’s earning a bunch of money, at a very high tax bracket. I really don’t want to create capital gains taxes if possible.

In her case, thankfully and coincidentally, around the same time, she received a gift from a family member of a bunch of a single stock. Whenever a client has a concentration in stock like that, we create a diversification strategy. In this case, part of that strategy was to use the sales proceeds to buy bonds.

You can perhaps see how, if she didn’t have the luck of that big gift, we likely would have ended up doing something “suboptimal” in either her taxable account or her Roth IRA in order to achieve the more important target of getting bonds back into her portfolio (i.e., getting her asset allocation back on target).

This same thing can happen when you do a big Roth conversion. Before the conversion, you have all sorts of pre-tax money, and you can hold bonds there. After the conversion, you have less pre-tax money and more Roth money. How will you make sure that the portfolio’s asset allocation is still on target?

It Makes Your Investments More Complex.

One benefit to investing all your accounts the same way is that, if you put more money into an account or take money out of an account, it’s easy to figure out how that account should be invested with its new (higher or lower) balance: The exact same as it was before. Was it 90% stocks/10% bonds before? It still is.

If you use asset location, every time you add a lot of money to or take it out of an account, or every time you do your annual “rebalancing” of your portfolio, you have to figure out how to change the asset allocation in each account to ensure that the total portfolio’s asset allocation is still correct (remember, the asset allocation is more important!), while still obeying the basic rules of asset location.

Tax Laws Can Change, Undercutting the Value of Asset Location.

The value of asset location comes from the fact that you have to pay taxes on investment income and withdrawals from pre-tax accounts. The higher the taxes, the bigger the value of asset location.

As tax law changes, asset location could become less valuable. (Of course, it could go the other way, too.) Certainly, if tax rates fall, asset location becomes less valuable. Already, the value of putting real estate investment trusts (REITs) in tax-protected accounts (IRAs, 401(k)s, HSA) isn’t as great as it used to be, because now you can get some tax benefits by holding real estate in a taxable account.

What We Do at Flow

At Flow, in our clients’ portfolios, we follow the good ol’ 80/20 rule: we want to get 80% of the benefits of asset location with 20% of the work (and complexity).

Here’s our focus:

  • Roth IRAs and HSAs get stock funds.
  • Pre-tax IRAs get taxable-bond funds.
  • Taxable accounts get everything else.
    • If we need more bonds in the client’s portfolio, we’ll often use tax-free (aka, muni) bond funds in the taxable account.
    • We use broad market index funds, so all our stock funds are tax efficient, whether they’re here in the taxable account or in the tax-protected Roth.

This strikes me as a good balance of simplicity and tax optimization. Other advisors with good investment philosophies and implementations do it differently. As I’m fond of quoting:

“There is no perfect portfolio. There are many perfectly fine portfolios.”

Do you want your investments managed in a way that balances optimization with your ability to understand what’s going on? Reach out and schedule a free consultation or send us an email.

Sign up for Flow’s twice-monthly blog email to stay on top of our blog posts and videos.

Disclaimer: This article is provided for educational, general information, and illustration purposes only. Nothing contained in the material constitutes tax advice, a recommendation for purchase or sale of any security, or investment advisory services. We encourage you to consult a financial planner, accountant, and/or legal counsel for advice specific to your situation. Reproduction of this material is prohibited without written permission from Flow Financial Planning, LLC, and all rights are reserved. Read the full Disclaimer.

What It’s Like to Work with Flow: The Annual Renewal Meeting

Two Block figures face each other across a tabletop that has 3 pieces of white paper on it.

Most people have no idea what working with a financial planner is like.

Every prospective client I speak with has questions about what it’s like to work with us at Flow. While nothing can replace the actual experience, I hereby swear to write as much as necessary to paint that picture! No word left unturned!

Let’s start with our Annual Renewal Meeting.

Why? Because it is the keystone of our ongoing relationship with you, year after year.

Did you notice that we call it a Renewal Meeting, not a Review Meeting? That’s on purpose! Yes, we review the last year so we can celebrate your accomplishments and progress. More importantly, we renew your vision, your energy, and the plan to bring that vision to life. I think that’s exciting!

How You Can Use This Post

While I’m writing this primarily for those of you who might want to work with us at Flow, I can see it being potentially useful for several groups of people:

You are looking for a financial planner. You can judge whether Flow might be a good fit for you, and you can use our description to help evaluate other planners and their services.

You are already working with a financial planner. You can see if we’re providing something for our clients that you’re not getting from your planner (and would really like to get). Or maybe it’ll simply reassure you that your planner is great or “thank goodness they’re not like those Flow weirdos.”

A Disclaimer (Naturally): Things Always Evolve

After over eight years in business, I have tried a lot of different ways of doing things. Many things. Many ways. So, it’d be foolish to imply that the way I approach the Annual Renewal Meeting now is definitely the one I’ll still be using in five years. But I also have experimented enough to know that the current way is good and sustainable and I’m in no rush to change it.

(I wrote an article for an industry blog explaining why I moved to the Annual Renewal Meeting from my previous approach.)

Why You Should Care about the Annual Renewal Meeting

If I had to choose a single reason that the Annual Renewal Meeting is important to you, I’d say: It forces you (and your partner) to set aside meaningful time to sit with, think about, and talk about your life and finances.

Left to our own devices, most of us won’t do that. Sure, we’ll low-key worry about our finances all the time, but we won’t have an actually helpful, organized conversation about it. Why would I do that nonsense? Amorphous anxiety makes me feel alive, alive I say!

Isn’t that a ringing endorsement of working with a financial planner? “Work with me! I’ll…schedule time on your calendar!”

But of course, you know how important that actually is sometimes. Having sat with enough clients in this way for years now, I find it kinda beautiful to observe what often comes out of this time and focus, especially with a third party (i.e., me, in case that wasn’t obvious) who really cares about you being happy and fulfilled.

But wait! There’s more!

You are more confident and comfortable, because now you know what’s actually going on across your entire financial life. How has your net worth changed, and why? How are your investments performing? Are you on track to max out your 401(k) by year’s end? How much cash do you have?

You now know what you need to change, instead of just stressing over what might need to change. Your life and finances change over the course of a year. Someone needs to figure out how you need to change your finances in response. That’s us. We’re the someone.

You know which top one or two priorities to focus on. You’d be overwhelmed if we just gave you an undifferentiated list of all the stuff you need to think about and do to improve your finances.

You can get excited about what comes next! Most of us get trapped into thinking about only the demands (and joys!) of the now. We neglect to look ahead to what we can build our lives into. The Annual Renewal Meeting is your chance to do that, along with someone who’s an expert not just in personal finance, but in your personal finance. (Again, me. That expert is me.)

Behind the Scenes: How We Prepare for the Meeting

Of all the hours spent on the Annual Renewal Meeting, the vast majority of them are spent behind the scenes, us beavering away, invisible to you. You’ll see the results of that work in the meeting, and I thought it might be helpful to see how we do that work.

#1 Understand the Big Picture

We want to start with a strong handle on the Big Picture of your financial life, kind of like looking at the picture on the boxtop of a jigsaw puzzle. When we start at that Big Picture level, we better understand how the details fit in, and we can more usefully discuss any issues you bring up.

To build that picture for ourselves, we look at:

  • Your Written Plan (your statement of financial purpose, goals, and net worth)
  • Your answers to our pre-meeting questionnaire
  • Notes from last year’s Annual Renewal Meeting and meetings since then
  • Recent email conversations
  • Our “Future Meetings” document (a “dumping ground” Google doc where we record thoughts throughout the year as we think of something that might be important for you)
  • Tasks previously assigned to you or us

In all this prep, we use a “past/present/future” framework to try to create a unified picture of your life. We want to understand what has come before (and what we can learn from it), what’s happening now (that’s the only stuff we can change), and what might happen in the future (that we should start thinking about and maybe planning for).

We’re regularly building a list in the backs of our heads of: What are your strengths? What are the opportunities for you to improve? What are the most urgent and/or important things for you to focus on?

#2 Review the Financial Planning Technical Stuff

We review a long list of technical things in your financial life. This part is probably more along the lines of what you’d expect of a meeting with a financial planner. Maybe you’re interested in the specifics, or maybe you glance over the list and think, “That’s cool. Looks like you know what you’re doing. Carry on!”

Would you benefit from reviewing these parts of your financial life, as we do for the Annual Renewal Meeting? 

  • Education funding: Investments, savings rate, account balances for your kids’ education
  • Cash flow/Savings rate: For financial independence (retirement), shorter term goals
  • Paystub review: 401(k) and HSA contribution status, anything … peculiar on your paystub
  • IRA Contributions: Eligibility for IRA contributions (direct Roth, backdoor Roth) and a plan for when to contribute and how to fund the contribution
  • Cash cushion: Cash you have vs. cash you need, a plan for the “too little” or “too much,” interest rate
  • Company stock: Concentration in your total portfolio, sales strategy, upcoming expiration dates, options-exercise strategy
  • Your child’s age: If they’re turning 16, auto insurance and liability insurance; if they’re turning 18, preparation for them becoming legally independent (like HIPAA release)
  • Your age: Changes to your contribution limits for your 401(k), IRA, or HSA; eligibility for withdrawing penalty-free from retirement accounts
  • Withdrawal rate/dollars: If you’re living on your investment portfolio, both historical and projected
  • Coast FIRE analysis: If we suspect you might be close to or in Coast FIRE (Don’t know what that is? More or less no one does. Read the linked blog post. It’s a powerful concept!)
  • Estate planning: Documents (like a will and power of attorney), beneficiary designations (reviewed every other year)
  • Insurance: Life, long-term disability, homeowners or renters, umbrella liability, auto, etc. (reviewed every other year)
  • Taxes: Check in on your relationship with your CPA, revisit any parts of our tax-return review that warrant it, and several more tax-related topics:
  • Tax strategies for an unusually high or low-income year: IPO years (high income/tax rate!) or sabbatical/layoff years (low income/low tax rate!) give us fleeting opportunities: charitable donations, Roth conversions, selling investments at a gain, etc.
  • Charitable giving: How much you are giving vs. how much you want to give, how you’re donating the money (credit card, stock, directly to charity vs. Donor Advised Fund, etc.)
  • Net Worth: Change from last year, explanation for change, and whether that change is acceptable or you need to change something
  • Account consolidation: Opportunities to simplify your financial life by reducing the number of accounts you have—either bank accounts or investment accounts

#3 Review Investments

Accounts We Invest for You

We can do the most for the investments we manage for you. We look at:

  • Your Investment Policy Statement (a document that states what we’re investing for and the high-level strategy for investing). Does it need to change due to changes in your life?
  • Your actual investment portfolio. How closely is your portfolio abiding by the strategy in the IPS? Has it veered away from it? What changes do we need to make to bring your portfolio back to target?
  • How much cash is in your portfolio (more of an issue for clients living on their portfolios). Do we need to generate more?
  • Special investments you own, like company stock or other concentrated stock positions. How concentrated are you?

We send this review to you several days before the meeting, with a video explaining our review and any changes we recommend.

Why do we do this part ahead of time? Because usually you just want to know that we’re paying attention to it and to know generally what’s going on in your portfolio. Beyond that, we’ve usually found that clients don’t have many questions. So, I’d rather use the meeting time for you to talk, instead of me droning on about your investments.

Accounts We Don’t Invest for You

We don’t (usually because we can’t) manage certain accounts for you, for example, 401(k)s, HSAs, education 529 accounts, and company stock plans. We do, however, still make sure they’re invested appropriately for you:

  • Are your investments low-cost enough?
  • Is the account invested with an appropriate balance of stocks and bonds (i.e., your “asset allocation”)? Do you need instructions for how to “rebalance” it?

If it’s an HSA, we look to see if you have been withdrawing money from it to pay medical bills. Yes, I know that’s the whole purpose of this account, but usually clients are better off using it as a retirement account that they don’t touch for many years.

And sometimes clients have “play” accounts: accounts that they invest on their own, usually in individual stocks, crypto, or other “gambles.” The only thing we monitor here is the size of the account. Has it grown to be too large a part of your total investment portfolio?

#4 My “Woo” Preparation

All the prep I just described is essential. There is no Annual Renewal Meeting without it. And by itself, it’s enough! You can have a good, even great, meeting with it.

I have found two practices that make me even better at running an Annual Renewal Meeting:

#1 Five to ten minutes of savanasa-like rest after reviewing all these details. Savasana (translated as “corpse pose”) is the final pose of any physical yoga practice. It looks a lot like just lying there, eyes closed. ‘Cause it is. It is an opportunity for your body to integrate all the benefits of the physical practice you just finished.

As a financial planner, I take a similar short period of quiet and reflection (I might even close my eyes!) after all the heavy Brain Work. And this savasana helps me just sit with all that information, integrating it at some unconscious level. I have found that I emerge from the savasana with a better understanding of what is truly the most important thing for you.

#2 Five-minute meditation right before the meeting. This tames the Monkey Mind a bit. With a calmer mind, I can simply be more present with you. I am more likely to truly “hear” you.

Told you…kinda woo.

The Actual Client Experience: What Happens in The Meeting

So far, I’ve told you nothing about your experience in this Annual Renewal Meeting. It’s been all “me me me.”

What do you experience, as a client? Behold:

Before the Meeting

We ask you to give us some information:

  1. Fill out a questionnaire
    You can see our questionnaire here. (We have a slightly different questionnaire for our clients who are living off their investments.)
  2. Provide a recent paystub
  3. Make sure that all your financial accounts are up to date in our financial planning software

We can still have a useful meeting even if you provide us with nothing (I know because this has happened not a few times). It’s just more useful when we get more input from you.

You should also receive an email with a short video review of your investments (as described above) in the week prior to the meeting.

During the Meeting

Here’s what we talk about in the meeting itself:

Check-in

Yeah, yeah, there are always the basic conversational pleasantries that make the world go round. I genuinely enjoy seeing dogs and cats and babies and seeing what you’re eating for lunch and hearing about your latest vacation or even the latest chaos at work.

This usually leads pretty quickly and naturally into you talking about what’s on your mind and heart, which will end up being the focus of the meeting.

strengths, opportunities, and priorities

We like to lay out early in the meeting our high-level assessment of your finances: 

  • Strengths: from a good savings rate to a lot of flexibility in your investment portfolio to demonstrated grit in your career or personal life
  • Opportunities for improvement: Could your cash cushion be usefully higher? Do you still need to get your estate planning documents drafted?
  • Priorities: Of all the parts of your financial life, what are the few that we think best deserve your time today and your work in the near future?
Review the last year

We review your answers to these three questions, which we asked in the client questionnaire:

  1. Tell us about one thing you’ve done in the last year that you’re proud of.
  2. Tell us about one thing you’ve spent money on in the last year that brought you joy.
  3. Tell us about one organization or person you gave money or other resources to that made you happy!

This discussion helps reinforce how to use money to bring joy and meaning to your life. Sounds pretty helpful for making financial decisions moving forward, eh?

This personally is one of my favorite parts of the meeting: it’s a celebration.

Review net worth

Net worth is one of the few metrics we track every year. We want to know how it’s changing and why. Did the stock market help or hurt? Did you save a lot? Spend a lot?

Over time, we generally like to see it go up. But not always! Depends on your plan.

Review goals

We review your goals (which we record in your Written Plan):

  • Have you accomplished a goal? (always fun to check those off)
  • What progress have you made towards existing goals?
  • Do you have new goals?
  • Have the priorities of your goals changed?
  • Are some goals not really important to you anymore?

This is not a complex process. It is, however, incredibly valuable. This part of the meeting, using the Written Plan as guide, provides a simple structure to make sure we’re still making financial decisions “in the right direction.”

What you want to talk about

Although I’m dedicating only a few sentences to it here, this is perhaps the most robust part of the. meeting. Depending on what you want to talk about, we can go deep technically and emotionally. We want you leaving the meeting with a deeper understanding of what you need to do and why.

What we want to talk about

This is the stuff that we prepared ahead of time.

Wrap up

We’ve just spent two hours talking about a lot of things; you’re not going to take all that with you. This wrap-up helps cement in both our minds the parts that you will carry with you.

We do three things:

  1. Schedule the next meeting. (It’s comforting to everyone to know this is on the calendar!)
  2. Agree to the work we each have to do after the meeting.
  3. “What are you taking away from our conversation today?” Your reflection here is another favorite part of the meeting for me. It’s such a satisfying window into your brain and heart.

After the Meeting

We send you an email, listing the tasks that we agreed to in the meeting, and provide full notes from the meeting.

I hope seeing “behind the curtains” of our Annual Renewal Meeting (the what, why, and how) gives you a better appreciation for the practicalities of working with us. Armed with such information, may your search for a financial planner be more informed and more confident!

Would you like the comfort and confidence that comes with such a thorough annual focus on your life and finances? Reach out and schedule a free consultation or send us an email.

Sign up for Flow’s twice-monthly blog email to stay on top of our blog posts and videos.

Disclaimer: This article is provided for educational, general information, and illustration purposes only. Nothing contained in the material constitutes tax advice, a recommendation for purchase or sale of any security, or investment advisory services. We encourage you to consult a financial planner, accountant, and/or legal counsel for advice specific to your situation. Reproduction of this material is prohibited without written permission from Flow Financial Planning, LLC, and all rights are reserved. Read the full Disclaimer.

Meg’s Musings: On Being a Financial Planner

Block Women is to the left of the image with a black background cutout overlayed a brown wood wall.

Back from several days in San Francisco—celebrating my wedding anniversary, admiring a friend’s potato-shaped dog, meeting with a handful of clients, enjoying the hell out of San Francisco, and generally “checking out” from the daily grind—it’s prime time for another edition of Meg’s Musings.

Technical, Behavioral…and Bureaucratic

In my profession, “real” financial planners know that in order to serve our clients well, we need two kinds of knowledge:

Technical. This is what almost all our education and training is targeted at. How does the tax code work? How much insurance of what kind do you need? Etc. Those letters after my name (CFP®, RICP®)? Those are almost entirely indicative of technical knowledge. You want facts? I got yer facts. Right here.

Behavioral. This is a more recent entrant into the canon of Good Financial Planning, but it’s a growing focus, and at least my entire professional community is on board. This is the work of acknowledging clients’ emotions, and using emotions and behavior to improve their lives and finances. (I also, as it turns out, have letters for this domain of knowledge! I just don’t usually use them. But if you like, you can imagine RLP® after my name. That stands for Registered Life Planner®.)

The longer I practice, and more time the federal government, state governments, and corporations have to “improve” things, the more I believe a third knowledge category deserves acknowledgment:

Bureaucratic. This is the category of knowledge that we must bring to bear when we actually want to implement all the strategic and tactical decisions my clients and I make. And I think it gets more obvious and important every year.

A fantastic example is the knowledge required to roll over an old 401(k). Most clients understand the technical and behavioral merits of doing this. But Oh. My. God. Have you tried to roll a 401(k) to another account at all recently? If you have, maybe you already know what I’m about to say. If you haven’t, just ask your friendly local financial planner.

From inefficient processes (“Really? You have to mail me a check? And then I have to turn around and mail that self-same check to the new 401(k) company?”) to outright mistakes (“What do you mean you deposited my old Roth 401(k) money into my new pre-tax 401(k)?”), it can be a nightmare. I have an entire blog post dedicated to avoiding common 401(k) rollover mistakes.

After years of observing and helping clients roll old 401(k)s into new 401(k)s or IRAs, we’ve accumulated quite a list of tips and tricks to help it happen, perhaps not quickly, but successfully and without giant mistakes.

That is, in my opinion, a tremendous value we financial planners can offer to clients, who might otherwise:

  • Not do it at all. Like the client who left their old 401(k) alone for over 10 years, resulting in the money getting sent to the state’s unclaimed property division, whence it is proving extremely difficult to extract it, or
  • Do it and something ends up wrong. Like the client whose after-tax/Roth money was deposited in the new 401(k)’s pre-tax account. Don’t worry, we resolved that. or
  • Do it, push through all the hurdles, actually do it correctly, but be uncertain and stressed out along the way.

Prior to “retiring” (to be a stay-at-home dad) back in 2016, my husband had worked for several years (as a software programmer) at a company that produced security software. He used to characterize his job—at first jokingly, and increasingly cynically over time—as writing code to undo the effects of the shitty code that other people had already written. Yes…there’s obvious value in undoing badness, but damn, wouldn’t it just be better if the shitty code never existed?

In that same spirit, this Bureaucratic Knowledge is one of those incredibly useful things we financial planners provide…that I really wish we didn’t have to. It’s just getting us back to Net Zero. It’s just undoing the negative value that institutions have created. It’s not creating positive value. But I’m at least glad that we have the expertise to help clients navigate the bureaucratic BS more successfully and less stressfully.

Clarity on what you truly want is a magic unlock. It’s worth (constantly) working on.

As I mentioned at the top, I recently spent several days in San Francisco, where I used to live, pre-children.

I still love San Francisco. I love walking its streets. I love taking MUNI and BART. I love the food (I packed two loaves of Acme bread in my suitcase to take home). I love the staircases and public parks.

And during many of my visits since moving out almost 15 years ago, I used to yearn to live there again. During this recent visit, I found myself enjoying all that San Francisco has to offer, but without that yearning.

I was trying to figure out why my reaction to San Francisco was so purely appreciative this time, not tinged with yearning. It seems linked to another experience I’ve had recently: on various occasions walking around downtown Bellingham (where I live) with either my mom or a daughter, I’ve observed myself feeling deeply contented. So deep and thorough was this contentment that it felt heavy, tangible.

I think I can attribute these pleasures to two things:

  • Getting older. I turned 48 earlier this year. Being that 80-year-old woman rocking on the front porch who doesn’t give one sh*t what other people think? #goals I have a working hypothesis that women, much as we are born with all the eggs we’re ever going to have, we are also born with all the f*cks we’re ever going to have. And, as with eggs, we shed those f*cks steadily over our lifetime until arriving at a point when we, ta da! have no more f*cks to give.
  • Working explicitly, for years now, to clarify what I truly value, and taking explicit steps to use my time and money to support those things. You know, the answer to, “If I were to die tomorrow, what would I regret that I never did?” And it doesn’t hurt (from this perspective, at least) that I had to deal with a diagnosis of and treatment for Stage 0 breast cancer starting in August 2023; that has a way of focusing one’s attention. 😑

(Yes, I’m also affluent, healthy, lucky, etc. And there are plenty of people who are all those things…and also unhappy.)

In the past few years, I’ve really started prioritizing What Truly Matters to Me over the usual stuff that it’s so easy to fall into. That has meant I finally took my daughters (and my husband) to a long-yearned-for trip to London and Paris. I planned a lot for it. I saved for it over a year or two. I arranged work so that I could really be present on my travel and not constantly peeping back into work. And it. was. amazing. Everything I expected and more.

I better carved time out of my calendar to attend my kids’ track and cross-country meets and other school events. To start working with a personal trainer. I’ve spent more of my money getting together with my brother’s family because his daughter is the only cousin my kids have, and they get along so well.

I’ve started caring less (I still care…just less) about how my business stacks up against other people’s businesses. I decided that my focus was going to be making enough money, serving my clients well, and enjoying the work as best I could (i.e., paying to outsource or delegate the work I didn’t).

All that is great! But what are the flip-side implications of prioritizing all those things? It means that I simply can’t afford to live in San Francisco right now. I’d have to change how I run my business or my family life in major ways in order to do so. I think that used to make me sad. But I think it used to make me sad because I it felt like giving something up without acknowledging what I was prioritizing or gaining in return.

And while San Francisco is a great city, and I certainly wouldn’t sneeze at the idea of living there again, living in a great city like that isn’t in my top 5 right now. The work I’ve done to figure out what my top 5 is has been long and difficult and, ultimately, has made me a much more content person.

(Disclaimer: Contentedness of course subject to change at a moment’s notice, but I am optimistic I’m on the right path.)

Perspectives on the Financial Planning Profession. We’re Out There!

While I was in San Francisco, I met up with a few clients to just Talk Life (okay, and the occasional options-exercise strategy).

I met one client for lunch at Duboce Park Café on an unimpeachably beautiful day. I’ve been working with him for…Oh, I could look this up, but it’s probably two or three years. (Hey, there, guy! Yep, I’m talking about you.)

While I’m going to paraphrase tremendously here, he observed that he doesn’t hear any of his friends or colleagues talk about their financial advisors in a way that sounds anything like his relationship with me. He also recounted a conversation he had with a friend who asked him if he was still going to therapy, and he responded, Well, kind of. “What do you mean, kind of?” I meet with my financial planner every few months. “????”

As much as I preen at being viewed as The Only Emotionally Aware Financial Planner In the World, I will share with you what I shared with him: More of us are out there! I might be rare in a gigantic financial services industry, in my efforts to center the work on The Human instead of on The Money, in my efforts to continually dig into what my clients want their lives to look like and then to make financial decisions that support that life and set of values. But I’m definitely not alone.

In just the 8.5 years since I’ve been running my firm, I’ve noticed an absolute explosion of interest in, attention to, and training and content to support advisors becoming more human-centric, more emotionally attuned, more aware of the impact of behavior on financial outcomes, etc.

But I also recognize that I’m at a slight advantage over my client in knowing the financial planning landscape, being a financial planner and all. For Regular Schmoes out there, looking for a financial planner, I imagine that for every exposure they get to a planner like me, they get 1000 exposures to advisors from the likes of <insert name of gigantic financial institution here>. And while I have never worked at said gigantic financial institutions and don’t closely know advisors who do, I’m just gonna go ahead and bet that the vast majority of them—perhaps through no fault of their own—have a more money-centric approach to financial planning.

If you’ve never experienced the kind of financial planning that I (or my close colleagues) practice, it’s probably impossible to imagine if you’re accustomed to the service at Big Name financial companies.

Maybe I am, maybe I’m not the right financial planner for you, but I’m happy to connect you with other financial planners who operate in a human-centric way. Reach out and schedule a free consultation or send us an email.

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Disclaimer: This article is provided for educational, general information, and illustration purposes only. Nothing contained in the material constitutes tax advice, a recommendation for purchase or sale of any security, or investment advisory services. We encourage you to consult a financial planner, accountant, and/or legal counsel for advice specific to your situation. Reproduction of this material is prohibited without written permission from Flow Financial Planning, LLC, and all rights are reserved. Read the full Disclaimer.

More Strategies to Save You Taxes In Case the Tax Cuts and Jobs Act Expires in 2026

A shadowy Block Woman views a yellow ball labeled with red initials TCJA almost fully hidden below the horizon of a blue and green sea.

Big tax changes are a’ comin’. Maybe. In our last blog post, I discussed one big strategy to take advantage of the possible expiration of the Tax Cut and Jobs Act: the fabled Roth conversion.

The TCJA went into effect on January 1, 2018. All of the TCJA’s changes to tax law will expire at the end of 2025—and tax rates and other rules go back to the pre-2018 levels—unless Congress renews it.

In this blog post, let’s cover a few more strategies that might end up being really helpful to have done if the TCJA does indeed expire. But remember, because we don’t know whether the TCJA tax laws will expire or be renewed, you only want to make moves now if you’ll still be okay regardless of whether Congress renews it or lets it expire. Don’t go bettin’ the farm on Congress doing or not doing something.

And as with the previous blog post, it’s going to be Very Helpful to have a competent CPA on your team to help model the tax impact of any of these strategies.

Exercising Non-Qualified Stock Options (NSOs)

Remember how (and if you don’t, go back and reread our last blog post) I recommended that you consider converting pre-tax money in your IRAs or 401(k)s to a Roth account, because tax rates are low now compared to what they will be if the TCJA expires? And we want to incur taxable income when tax rates are lower?

Well, the exact same logic applies to the idea of exercising non-qualified stock options (NSOs).

When you exercise an NSO, you immediately owe income tax on the “spread” between the exercise price and the value of the stock.

Let’s say you exercise one NSO at a strike price of $1 with a share price of $10 (be that the price on the stock market for a public company, or the 409(a) value for a private company). That gives you $9 of taxable income.

Most people aren’t thinking about just one option. So, let’s think about 10,000 NSOs. In the exact price scenario above, you’d immediately have $90,000 of taxable income.

Behold the tax brackets and tax rates below, which is what they are now, and what they will be if the TCJA expires. Imagine that you’re single and your salary + bonus is $500k/year. If you exercise NSOs now, that generates an extra $90k of taxable income, all of that will be taxed at 35%. If you exercise post-TCJA expiration, then a little of that $90k will be taxed at 33%, a little at 35%, and most of it at 39.6%. Which, let’s review, is higher than 35%.

If you look long enough at the chart below, you can see that in some income scenarios, you’ll actually have a lower top tax rate post-TCJA than now. You’d need to run the numbers for your own specific situation to make sure.

Source: fpPathfinder®

Consider doing this: Exercise NSOs now, especially in private companies, if it would generate taxable income in a lower tax bracket than post-TCJA expiration. If you have NSOs in a public company, I’m usually of the opinion that you shouldn’t exercise NSOs until you’re ready to exercise and immediately sell, and that having the right amount of leverage is a good tool for determining when to do that. That’s probably still more important than gaming tax rates.

Exercising Incentive Stock Options (ISOs)

Surprisingly, most people I talk with who have ISOs seem to know about Alternative Minimum Tax. (Someone out there has been doing some good employee education!) The understanding sometimes stops right there: this tax exists, it’s related to ISOs, and, uh…tax bad?

For a short primer/reminder on AMT, read this blog post, the section entitled “Mistake #3: Forgetting about Alternative Minimum Tax on ISOs,” from our friends at McCarthy Tax.

What’s important in this blog post here is that the likelihood of having to pay AMT when you exercise ISOs will go up dramatically if the TCJA expires. You can usually exercise some ISOs without triggering AMT because there’s an “exemption” amount of AMT income before the tax kicks in.

Let’s say you exercise one ISO at a strike price of $1 with a share price of $10. That gives you $9 of AMT-eligible income. That income will likely not be subject to any tax because it’s below the exemption threshold.

At the other extreme, let’s say you exercise 100,000 such options, for $900,000 of AMT-eligible income (and then you hold the shares for at least a year). Yeah, you’re likely going to have to pay AMT.

You want to be pretty clear on where the tipping point is from “I don’t owe AMT” to “I owe AMT.”

That tipping point is determined in large part by what the AMT exemption amount is. The higher the exemption amount, the less likely you will have to pay AMT on your ISO exercises. You can see in the table below that right now, you can incur $133k of AMT-eligible income (as a couple; $85k as a single person) before triggering the tax. That threshold will drop meaningfully if TCJA expires: drop by roughly $29k for married couples filing jointly and roughly $19k for people filing taxes as Single.

Source: fpPathfinder®

Okay, what are you supposed to do with those numbers? Let’s continue with the example just above.

You can incur roughly $19k more AMT-eligible income now than you would be able to under the rules if TCJA weren’t in effect (all else held equal in your tax situation). So, with $9 of AMT-eligible income per option exercised, you could exercise roughly 2000 more ISOs now without triggering the Alternative Minimum Tax bill, than if you were exercising under tax rules without the TCJA in effect.

So, yes, you still have to pay the exercise price on that extra 2000 options (i.e., $2000, in this example), but you don’t have to pay anything more in taxes. Pretty sweet, eh?

Consider doing this: If you’re sitting on some exercisable ISOs (most likely that means they’re vested, but it could also mean you have early exercise/83(b) exercise available to you for unvested options), exercise ISOs now, up to the currently-higher AMT exemption limit.

Yes, you’re still putting your exercise price money at risk…but you’re not putting any money at risk paying taxes. You have up until the end of the year to do this. And then again in 2025.

[Note: Paying AMT isn’t the end of the world. If you pay it, you now have an AMT credit in your tax return, and if you make sure to carry it forward onto all subsequent tax returns, you have a chance of using that credit up in future years, thereby “getting back” any excess tax you paid in your AMT year. But, you know, it’s still nice to avoid paying it in the first place, as receiving the credit back isn’t guaranteed and also $1 now is better than $1 in 5 years. If you want to learn more about the AMT credit, see this blog post, the section “Mistake #4: Forgetting about the AMT Tax Credit”]

Increase your ability to exercise ISOs without AMT by increasing your ordinary income.

The higher your ordinary income, the higher your AMT income can be before triggering the tax. (This fact is independent of this TCJA discussion.) And increasing your ordinary income—by pulling future income into this year or 2025—might be a reasonable strategy to pursue in and of itself because your tax rates might be lower now than later.

What are some strategies for increasing your ordinary income?

In the tech world, it’s usually if you have non-qualified stock options to exercise. As discussed above, the spread between the strike price and share price is taxable ordinary income in the year you do the exercise. So, exercise more NSOs. Pay taxes on those (maybe at a lower tax rate than you’ll have in the future?) and then exercise even more ISOs without triggering AMT.

If you have any self-employment income or any other income whose timing you have control over, you could also consider accelerating income earlier rather than in later years.

Delay charitable contributions

The primary reason you should donate to charity is that you want to give money to a deserving cause or person. If you want to keep on keeping on in your annual charitable contributions, I APPLAUD YOU.

But if you’re already going to donate, you might as well make it as tax efficient as possible, eh?

There are two reasons that delaying charitable contributions might save you taxes:

#1 You save more when tax brackets are higher. If you are currently at a 37% tax bracket (the highest current tax rate) for every dollar you donate to charity (and itemize on your taxes), you save 37¢, which means it costs you 63¢ to donate that dollar. If you are at a 39.6% tax bracket (the highest rate in a post-TCJA world), you save 39.6¢ for every dollar you donate to charity, which means it costs you 0.604¢ to donate that dollar to charity.

Purely from that perspective, it makes sense to donate money in years when you’re in a higher tax bracket.

If you think tax brackets could rise in 2026, maybe it’d behoove you to delay charitable giving until 2026, when you could “bunch” charitable contributions from 2024, 2025, and 2026 into 2026. That way you’d get the benefit of bunching (a strategy that can be useful no matter what the tax-rate regime) and you’d be saving taxes at higher tax rates.

I wrote a series of blog posts about creating my family’s charitable giving plan, and it covers tactics we employed to make it more tax efficient, like donating “appreciated securities” instead of cash and the just-mentioned “bunching” of multiple years’ worth of donations into one year.

#2 You’re more likely to itemize—and actually get tax benefits—if TCJA expires. Also changing if TCJA expires is the standard exemption: it’d go down a lot:

Source: fpPathfinder®

You also will be allowed to itemize much more of what are often people’s two biggest expenses: mortgage interest and state and local taxes.

Right now, you can itemize interest on mortgages only up to $750k. That’d change to $1M. (And in places like the Bay Area and NYC, it’s reeaaaaallll easy to get a mortgage that big.)

Secondly, right now you can deduct only $10k of your state and local taxes (known as SALT). Again, if you live in California or NYC, your state and local taxes are likely way more than that.

Thirdly, and probably less impactfully, is that you could once again deduct the fees associated with using an investment advisor. (Thought I’d throw that in there for, you know, self-promotion’s sake.)

Source: fpPathfinder®

So, now you have a lower standard deduction and you’re being allowed to itemize more things, meaning it’s easier to get to the point where it’s worthwhile to itemize deductions because they exceed the standard deduction.

Consider doing this: Delay your charitable contributions to 2026. Between potentially higher income tax rates at that point, and the increased ease of itemizing deductions over taking the standard deduction, this could save you meaningfully in taxes.

Please return to my first comment in this section: the primary reason to donate money is to help people or causes, not to save in taxes.

If you're high net worth, get more assets out of your estate.

There’s too much to think about here, for this one blog post. I would absolutely encourage you to talk about this with your estate planning attorney (and/or your financial planner) .

What’s going on? When you die, any money in your estate above a certain threshold will be subject to a federal estate tax of up to 40%. (Look here for details. Some states also have estate/death/inheritance taxes, but we’re not discussing those.) Right now, that exemption is $13,610,000 per person. If TCJA expires, it’ll drop back down to what is currently estimated at $6,810,000.

Source: fpPathfinder®

Which means that if you have $10M now and die, your estate won’t have to pay any estate taxes and your heirs get all your money. If you were to die in a TCJA-expired world, $3,900,000 of your estate would be subject to estate tax, and your heirs would lose a lot of money to estate taxes.

Maybe you don’t have $10M now. But, you do have $5M, and if you live another 20+ years, and that money is invested and grows, you will have a bunch of money when you die. And then your heirs could still miss out on a lot of money because of estate taxes.

In either case, the overarching strategy being widely discussed now is to move money out of your estate now, when you have that big ol’ $13,610,000 lifetime exemption available to you. You can move your money out of your estate in a variety of ways, from plain vanilla (like funding your child’s 529 college savings account) to more complicated (like family limited partnerships and Nevada Asset Protection Trusts…no, I don’t actually know how these work, I’ve simply spoken with estate planning attorneys who do).

There is so much more to this discussion. Way more information is necessary from attorneys far more knowledgeable than I. This mention is only an amuse-bouche.

The benefits of moving money out of your estate now are the more obvious: Possibly saving your heirs a lot of estate tax.

In my opinion, there are a couple of major downsides to moving money out of your estate now:

  • Complexity: Your financial situation is almost certainly going to get more complex, with more accounts or legal structures to keep track of, and possibly changes to how you access your money/get income. Simplicity is worth fighting for.

  • Reduced access/flexibility: Your access to your money is almost certainly going to be more constrained, and possibly just outright reduced. Moving money out of your estate more or less means that it’s no longer yours to control and use as you want.

    I believe that the younger you are, the more important this is to consider. With so many years of life ahead of you, life is nothing but Uncertainty. Flexibility is a powerful tool in such circumstances.

    As one of my favorite estate planning attorneys observed, you might want to retain all your money unencumbered because, who knows! You might want to emigrate to a different country, buy your own baseball team, start a business, or start a foundation. And who knows what kind of adult your three year old is going to turn into in another two decades.

If you’re 80 and have 10, maybe 20 years left, this decision is one thing. But if you’re 40 and have two young kids and have half a century of life unfolding in front of you? Putting any of your money out of your control is, in my opinion, a risky gambit.

To boot, who knows what estate rules will be when you eventually die (hopefully, decades from now, by which time Congress will likely have changed the rules another 10 times)?

Consider doing this: Talk with an estate planning attorney who is familiar with the strategies necessary to move money out of your estate. But do this well before the end of 2025, because they are going to be slammed by then! It’d be like trying to hire a CPA in March to do your taxes by April 15. By which I mean: Good luck with that, yo.

Blog posts like this actually make me a bit anxious. There’s so much finicky stuff to keep on top of! I can only imagine how thinking about this must affect people who aren’t financial planners.

Just try to keep in mind that these strategies are not the essence of personal finance. The essence of personal finance is: spend less, save more, and don’t do anything stupid (according to Dick Wagner). If you’re not doing those things yet, focus your effort there first!

Would you like to work with a financial planner who can help proactively identify opportunities like this and then figure out whether they’re useful for you and your finances? Reach out and schedule a free consultation or send us an email.

Sign up for Flow’s twice-monthly blog email to stay on top of our blog posts and videos.

Disclaimer: This article is provided for educational, general information, and illustration purposes only. Nothing contained in the material constitutes tax advice, a recommendation for purchase or sale of any security, or investment advisory services. We encourage you to consult a financial planner, accountant, and/or legal counsel for advice specific to your situation. Reproduction of this material is prohibited without written permission from Flow Financial Planning, LLC, and all rights are reserved. Read the full Disclaimer.

Should you do a Roth conversion before the (possible) expiration of TCJA in 2026?

A shadowy Block Woman views a yellow ball labeled with red initials TCJA partially below the horizon of a blue and green sea.

As you might know, there’s a huge, all-encompassing change to tax law potentially coming up at the end of 2025. If it happens, you will almost certainly be big-time impacted.

What is that all-encompassing change to tax law? It’s the expiration of the Tax Cut and Jobs Act, which went into effect on January 1, 2018. All of the changes the TCJA ushered in will expire at the end of 2025—and tax rates and other rules therefore go back to the pre-2018 levels—unless Congress renews it.

It’s anybody’s guess whether Congress will renew it.

There are many provisions in the TCJA that really benefit our clients. If you, like our clients, are in tech, make good money and/or have good wealth, and have various forms of equity compensation, you probably benefit, too.

So, it behooves us to look at what tax rules are in effect now that potentially will disappear come 2026, and ask ourselves:

Should we take advantage of TCJA tax rules while they still definitely exist (because they might not exist come 2026)?

Consider these strategies this year and next.

Given the “maybe?” nature of all of this, you don’t want to do anything that you’ll regret if the tax laws stay the same. So, you’re looking for strategies that will serve you well—or at least not hurt you—regardless of what happens tax-wise.

This is, may I remind you, the nature of almost all of personal financial planning: You’re making decisions based on what you think or hope will happen in the future, not on what you know will happen in the future.

How do you still make good decisions in an environment of such irreducible uncertainty? For each choice available to you, you need to think about all the possible outcomes of making that choice. If any of those outcomes is simply unacceptable, then that choice isn’t right for you.

If some outcomes are better or worse than others, but none of them would be catastrophically bad for you (financially or emotionally), then it could be a reasonable choice to make.

For example, let’s say you work at a pre-IPO company. You have stock options. You could exercise them now, paying not only the exercise cost but also the associated tax bill. You can’t know what will happen to the company, and more specifically, the stock, in the future. Let’s say the stock does poorly and you lose all that money.

  • If that means you’d lose your emergency fund and throw your retirement plans off track, then that’s not a reasonable choice.
  • If that instead means you can’t take that One Vacation, but you’re more or less okay with missing it, then okay! Go forth and take that risk.

Below I discuss one strategy to consider before the TCJA expires (maybe): Roth conversions (and the corollary: contributing Roth instead of pre-tax). Later this month, I’ll publish another blog with the other strategies I think are worth considering:

  • Exercising ISOs
  • Delaying charitable contributions
  • All sorts of potentially very complicated stuff to reduce the size of your estate (for those of you who already have millions of dollars)

I’m covering only those strategies that I think are most likely to affect our clients (and therefore you, if you’re like our clients). The changes made by the TCJA are vast and beyond the scope of this blog post.

If you want to know more about the whole TCJA “thing,” you can find articles that are broader in scope from the likes of Schwab or Forbes or any number of financial advisory firms focused on other clientele.

Why talk about this now?

The changes may or may not happen, and making giant decisions based on a possibility is often a bad idea.

But we’re talking about it now for a few reasons:

  • There are some potentially powerful strategies you can use for 2024 and 2025 that will lose their power come 2026, if TCJA expires.
  • If you need to involve an estate planning attorney in any work, they’re gonna be slammed come the latter half of 2025. Best to reach out to them ASAP.
  • Even if it were entirely rational to wait for a while to discuss any of this stuff, you’re going to start seeing some “sky is falling” headlines, if you haven’t already. So, let’s discuss this in a useful manner before the headlines hijack your brain.

Roth conversions: Convert pre-tax IRA or 401(k) dollars to Roth

Why do we care about pre-tax and Roth?

Some background and edumuhcation about Pre-tax vs. Roth

Let me ask you a question: Would you rather save pre-tax when your tax rates are high or low?

The answer is High. If your tax rate is 39%, every dollar saved pre-tax saves you 39¢ in taxes. If your tax rate is 25%, every dollar saved pretax saves you 25¢. Saving 39¢ is better.

Now, would you rather save after-tax (i.e., to a Roth account) when tax rates are high or low?

The answer is Low. At a 39% tax rate, you pay 39¢ in taxes for every dollar you save to a Roth account. At a 25% tax rate, you pay 25¢ for every dollar you save to a Roth account. Paying 25¢ is better.

That’s a useful, but simplistic, way of thinking about the pre-tax vs. Roth/after-tax question. For a bit more nuance:

When you take money out of pre-tax accounts (typically IRAs or 401(k)s) in retirement:

  • You will need to pay income tax on all of that money.
  • That income can also increase other costs, like Medicare Parts B and D premium and the taxability of your Social Security retirement income.
  • All money in a pre-tax IRA or 401(k) is subject to Required Minimum Distributions, meaning that you must take money out of those accounts starting at what is now age 73.

Sounds kinda crappy. Why would we put money into a pre-tax account? Why, to save money on taxes now, of course.

By contrast, Roth accounts are tax-free, and any money in those accounts can stay in there for your whole life, you never have to take the money out, and if you do, it’s not subject to taxes and won’t raise your taxable income in a way that will impact Medicare premiums, etc. But you don’t get any tax breaks now for any contributions or conversions into Roth accounts.

[Note: The “Roth vs Pre-tax” discussion is a multi-layered one. Some considerations are technical (comparing current tax rates with expected future tax rates). Some are emotional (I, for example, would rather just bulk up tax-free assets while I’m young and have strong earning power). This TCJA-inspired consideration has to fit into the larger Roth vs. Pre-Tax discussion, which is, alas! outside the scope of this blog post.]

Why now is such a good time to consider Roth conversions

I wrote a whole blog post about Roth conversions a little while ago. (If you think you want to do a Roth conversion, I highly recommend you read the whole thing. Oh, and work with a CPA to model the tax impact.)

In that post, I pronounced that one good opportunity for doing Roth conversions is when “You bet the federal government will raise tax rates.” Well….?! That’s precisely what we’re talking about here!

If TCJA expires, here’s how tax rates and tax brackets would change. Observe that not only do tax rates go up, but higher tax rates apply to lower bands of income, meaning that your tax bill could go up double-whammy style.

Source: fpPathfinder®

We already consider Roth conversions for clients who are having an unusually low-income year, clients who are taking a sabbatical, going back to school, got laid off and can’t find a job, etc.

Because of this TCJA thing, even if this is a totally “normal” income year, you should still look at doing Roth conversions. These might end up being anomalously low tax rates anyways, simply because of federal tax policy.

Keep in mind that doing a Roth conversion means you are volunteering to pay taxes before you have to. You could just wait for another several decades to pay taxes on this money. But you’re making a bet that by paying taxes now, you’ll pay less (over your lifetime) than if you pay taxes later. (So much delayed gratification energy going on here, it hurts.)

It’s always possible you could convert the pre-tax money, and the tax rates don’t go up. Lord knows there have been bountiful predictions for decades now that tax rates will (“have to!”) go up…predictions that have yet to come true.

Consider doing this: Ask your CPA to model for you how much you can convert from pre-tax to Roth (in your IRA or 401(k)) and still stay within the same tax bracket, or even one tax bracket up, along with the tax bill you’d incur in both cases. If you want to convert, remember you have to do so by year’s end. You can even convert some this year and some again next year.

Remember, you want to have cash or taxable investments to pay the extra taxes. You do not want to withhold any money from the IRA in order to pay the taxes.

Contribute Roth instead of pre-tax

Many of our clients have $100ks or over $1M in pre-tax accounts (IRAs or 401(k)s). That is a lot of money to consider converting. (In reality, it probably makes sense to convert only some of it.)

By contrast, annual contribution limits to all these retirement accounts are way way lower: $23,000 for 401(k)s and $7k for IRAs (plus some catchup for people 50 years old and up). So, “pre-tax vs. Roth contribution” can be a much smaller-scale decision.

It’s still worthwhile considering, however! And maybe, behaviorally speaking, it’s a lot easier to contribute Roth (and not reduce your tax bill) than it is to convert to Roth (and intentionally increase your tax bill, possibly by a lot). Progress, not perfection, people!

Many of you likely have access to, and perhaps are even saving to, after-tax contributions to your 401(k) (aka, mega backdoor Roth). In that case, you’re already getting lots of after-tax/tax-free money into your retirement portfolio. Maybe that takes the pressure off shifting even more money into that tax-free status.

Consider doing this: Saving to your 401(k) Roth instead of pre-tax, for the rest of this year and in 2025. You could switch back to saving pre-tax if TCJA expires and tax rates jump up.

It’s hard to figure out how all this affects you!

I don’t know if you’ve noticed this, but our federal tax code is complicated. Like, really, really complicated. And getting more so every year. (Be sure to give your friendly local CPA a sympathetic glance, and maybe a cookie, next time you see them.)

The tax code is so intricate and interrelated that you can’t ever glibly proclaim that the change of <this one thing> will affect your taxes <in this specific way>. You need tax software because you need to effectively process your entire tax return in order to get a reliable answer about any single thing. It’s an unfortunate reality.

For example, if you live in California and have a mortgage and earn a lot of money, the higher tax rates will hurt you, but your ability to deduct more of your mortgage and more of your state income taxes (as illustrated below) will help you.

Source: fpPathfinder®

To make good decisions confidently, you need to work with a tax professional who has software that can model your entire tax situation under TCJA tax rules vs. your tax situation if TCJA expires.

Alright, friends and strangers. See you in the next blog, for more discussions of strategies you should start considering before the end of this tax year. Tootles.

Would you like to work with a thinking partner who can help you to discover and define your goals, and use that to help make your best financial decisions? Reach out and schedule a free consultation or send us an email.

Sign up for Flow’s twice-monthly blog email to stay on top of our blog posts and videos.

Disclaimer: This article is provided for educational, general information, and illustration purposes only. Nothing contained in the material constitutes tax advice, a recommendation for purchase or sale of any security, or investment advisory services. We encourage you to consult a financial planner, accountant, and/or legal counsel for advice specific to your situation. Reproduction of this material is prohibited without written permission from Flow Financial Planning, LLC, and all rights are reserved. Read the full Disclaimer.

Look out for These Mistakes in Your Estate Plan.

Block Woman stands in front of a white sheet of paper with the title written in old script that says Last Will and Testimont. The letter i in misspelled Testimont is crossed through in red and a letter a is written above.

You have money? You need an estate plan.
You have children? You need an estate plan.
You have a body? You need an estate plan.

Many of our clients don’t have estate planning documents when they come to us. If a client has no estate plan—or an outdated one—we recommend they work with an estate planning attorney to create one. Then, after the attorney has drafted a set of documents and implementation advice for our clients, we review it all.

And sometimes (not often; turns out estate planning attorneys are generally pretty good at their jobs! how nice) we find either mistakes or “sub-optimal” bits.

This blog post is not advice on “what your estate plan should say.” That’s better written by an estate planning attorney. This blog post describes those mistakes and sub-optimal bits that we come across most often. I hope you can use our experience to help avoid making the same mistakes in your own estate plan.

The mistakes we see clients (unwittingly) make

I am not an estate planning attorney.

More importantly, our clients are not estate planning attorneys. Which means that they generally don’t know how to read, understand, or interpret a lot of the documentation that is written for them. (Certain lawyer clients notwithstanding…) They might understand the words, but not the implications for them or their family.

The estate planning attorney is, obviously, the expert on the law. But not usually on the client.

So, between the client, the attorney (the expert on the law), and me (the expert on the rest of the client’s life and finances), I think we ultimately do a pretty good job of getting the clients an estate plan that serves them and their family and their values really well.

Here are the mistakes we’ve helped clients correct over the years:

A plan exists…but it’s not yours.

You might think that if you don’t have estate planning documents or you haven’t set your beneficiaries on your life insurance policy or 401(k), you don’t have an estate plan.

Wrong.

You have a plan. But it’s the state’s plan for you. Not one of your own design. There are all sorts of state-level and federal-level laws that will dictate what happens to you and your stuff and your children in the event of your death or incapacity.

If you don’t draft estate planning documents and designate beneficiaries and fund your trust, etc. etc. etc., you are tacitly saying, “Okay, state, you make all the decisions on my behalf!”

You don’t have all the necessary documents.

This is kind of a subset of the above mistake. You have parts of your plan, but not all the parts.

In practice, we’ve never found this to be a problem with clients who engage an attorney directly to work with. We’ve found this only when clients use their workplace legal benefits or some other service here an attorney isn’t personally guiding the conversation.

We have one client who “got their estate planning documents done” via their workplace benefits…and it contained only a will. No powers of attorney. No living will. No healthcare proxy.

Do you have all the appropriate documents for your situation? The standard suite of documents is, well, pretty standard:

  • Will. If you are a parent, you absolutely need a will…to name the person who will take care of your child if you die. (Everyone else needs a will, too. It’s just that having a kid is the thing that finally persuades people to do the work.)
  • General durable power of attorney (for financial decisions)
  • Healthcare power of attorney (for healthcare decisions)
  • Living will/advance medical directive. What healthcare decisions should be made if you’re unable to make them?
  • HIPAA release. Who should have access to your healthcare information?
  • Maybe a trust
Your estate planning attorney should know what kind of documents are appropriate for your financial and family situation and in your specific state. For example, whether or not you should have a trust depends on your personal financial situation and the state you’re in. In Virginia, my husband and I had revocable living trusts. In Washington, we don’t.

All sorts of beneficiary “gotchas.”

Designating a beneficiary on an IRA, a 401(k), a life insurance policy, or a variety of other accounts is about the easiest way to make sure a certain person gets your money when you die. (On taxable accounts, it’s usually set up as a “Transfer on Death” designation, as opposed to a “beneficiary” per se.)

While they’re usually very easy to set up, there are a ton of ways that your beneficiary designations can go wrong.

If you don’t know how to correctly designate your beneficiaries, ask your attorney.

You don’t have a beneficiary set up on every account and policy.

The “easiest” way to go wrong when it comes to designating beneficiaries is simply that you haven’t designated a beneficiary for each account. And, if we’re going to gild the lily a bit, each account should also likely have a secondary or contingent beneficiary, just in case the first one dies before you do.

You’re married, but someone or something other than your spouse is the beneficiary, especially on retirement accounts.

Let’s say you have set beneficiaries on all your accounts. If you’re legally married, but your spouse isn’t listed as a beneficiary, that’s going to catch our eye.

Spouses get better treatment than anyone or anything else on many accounts: IRAs, 401(k)s, 403(b)s, and HSAs in particular. Life insurance benefits and taxable accounts can more reasonably be designated to go somewhere else, especially if you also have a trust (which could be the proper beneficiary).

If you check your beneficiaries and your spouse isn’t the beneficiary, just confirm with your attorney that this is in fact the right way to go, both in terms of “how do I minimize taxes?” and also “who do I want to end up with all my money?”

Your IRA/401(k) leaves some money to a charity and some money to a human.

The tax treatment of the money in your IRA/401(k) differs depending on who inherits it when you die: your spouse gets different rules than your child would, and both of those sets of rules differ from the rules governing a charitable beneficiary.

If you have both a human and charity as a beneficiary on an IRA, then the rules assigned to the charity might negatively impact how your human heir inherits the money, too.

The solution? It’s probably better to have two IRAs, one leaving money to the charity, and the other leaving money to your favorite humans. This way, the human gets the most tax-favorable distribution rules when they inherit your money.

Your minor children are designated as beneficiaries.

If your child is younger than 18 years old, designating them as a beneficiary can cause problems. They have to be adults to directly receive that money.

This isn’t necessarily a catastrophe. But you do want to consult first with your attorney to ensure that you want that money going as directly as possible to your child. (Maybe it’s better going into a trust managed on behalf of your child, for example?)

Then, assuming this is indeed the plan, you should consult with the custodian where you hold your account or policy (like Schwab or Transamerica) to ask how the beneficiary needs to be written so that someone you trust can serve as custodian of that money on behalf of your child until they’re 18.

Your Beneficiaries No Longer Make Sense.

Have you gotten divorced? Have you had a child? Have you drafted a trust? Have you gotten married? Have your children become adults?

All of these are reasons why your existing beneficiaries might no longer make sense. You will likely pick up on this yourself if you simply take the time to look at your beneficiaries.

Your will leaves money to a charity.

Why is this a problem? Well, maybe it’s not.

But if you have money in a traditional, pre-tax IRA/401(k) as well as money that passes through a will, it’s likely that leaving money to the charity from your IRA/401(k)—and leaving your other assets to human beneficiaries—is much more tax efficient.

Charities won’t have to pay taxes on the money in your pre-tax IRA/401(k). Human beneficiaries will. And taxable assets get a “step up” in basis upon your death, usually resulting in vastly lower tax bill for your human heir than they’d have to pay if they inherited the same amount of money through a pre-tax IRA/401(k).

You accidentally disinherit future children.

If your will, trust, or any beneficiary designations name your existing child by name and have no mention of the possibility for future children, then you risk disinheriting children you might have in the future.

Most documents I’ve ever seen say something like “My current child, Kim, and any future issue.” But sometimes documents simply say “My child, Kim.” Full stop. Be aware!

You name a contradictory hodgepodge of people for different roles in your estate plan.

Your estate plan might end up naming a lot of people for different roles: an executor for your will, an agent for your healthcare power of attorney, for your general durable power of attorney, a guardian for your kid, a trustee of your trust, etc. And all of these people should also have backups.

It can get confusing. So, make a list of all the different people and make sure they make sense together. Do you want the same person with general durable power of attorney and healthcare power of attorney and guardian for your kid? Or do you want to separate some of those powers?

Double check the names you’ve listed against your actual desires. Sometimes we just get confused and end up mistakenly listing the wrong person in the wrong place.

You will lose access to your child’s healthcare information when they turn 18.

One thing that many parents don’t think about is that, when their kids turn 18, the kids are no longer minors, and the parent no longer has a default legal right to their medical info. If you want to make sure you can get information about your child’s health while they’re, say, off at college, make sure you have a HIPAA release for your child.

You have a trust, but you haven’t “funded” it yet.

Many of our clients have revocable living trusts as part of their estate plan. The trust, basically, describes a set of rules that dictate how everything “inside” the trust will get handled. Trusts can be great in that they organize all your assets under a single set of rules, and they keep your estate information private upon your death. (Information about anything that passes through your will is publicly available.)

The catch is: You have to put stuff inside the trust in order for those rules to be useful. If there’s nothing inside the trust, the rules don’t apply to anything.

This is called “funding” your trust.

Your attorney most likely will give you a list of instructions for how to do that. We see these most commonly:

  • If you own a home, you can assign the deed for your house to your trust (from your name). Your attorney can help you do that.
  • If you own taxable investment accounts, you should be able to “retitle” the account so that it is owned by your trust, no longer by you. (Retirement accounts like IRAs and 401(k)s are owned individually by you. They don’t and cannot get retitled to the trust.)
  • Some accounts that are owned by you can’t be retitled. The institutions that host the accounts don’t allow it. We see this most often with bank accounts. Check with your attorney if this is okay, but the most common workaround is to simply designate the trust as a “Transfer Upon Death” or traditional beneficiary for the account. The trust won’t own it during your life, but as soon as you die, the money gets shoved into your trust and the rules apply.

You let your kids have unfettered access to all your money too young.

Many of our clients have minor children (many are just wee babies!). These same clients currently have or will likely have a lot of money over the ensuing years (especially if we consider life insurance death benefits).

Our clients’ wills or their trusts talk about what will happen to that money when they die. Usually, our clients want that money going to their kids. Very natural.

What we expect to see in the estate planning documents is language like this: After your death, the money will be kept in a trust. While the money is in the trust, the trustee of that trust will distribute money from the trust to pay normal expenses for the child. At the age of 25, the child can get access to one-third of the entire amount of the trust. At the age of 30, the child can get access to half of the entire amount of the trust at the age. And at the age of 35, the child can get access to all the money that remains in the trust.

(This isn’t how the trust document actually words it. It is a legal document after all. But that’s the meaning.)

Why do it this way? While the child is young, and obviously unable to manage their own money, the trustee manages everything on the child’s behalf. The child doesn’t get their first exposure to Big Money until age 25, by which age they’ve hopefully learned a bit about prudent money management. But if not, they can only “squander” one-third of the inheritance. They learn a little something through that process, and five years later, they get another lump sum of money. Hopefully by then they’re a little wiser. Rinse and repeat by age 35.

We’ve seen estate plans that (unwittingly!) give the child full, unfettered access to 100% of the money as soon as they turn 18. Yikes! I don’t know about you, but I’m fairly sure me coming into $4M at the age of 18 would not have been a good idea. And I don’t intend to leave money like that to my children if I die while they’re still relatively young.

So, think about how you’d want your child to inherit your money. All at once? In stages? At what age(s)? Make that clear to your attorney.

Prioritize doing your estate planning with a good human attorney over doing it cheaply.

Many of the mistakes, omissions, and oversights I mention above have come from clients who did their estate planning via a low-cost, tech-first, low-touch, online solution. It turns out, estate planning is complicated! Not necessarily because we’re using complicated solutions, but because the law changes over time and your values and emotions and lives are complicated.

So, for my clients (and for myself), I lean heavily in the direction of engaging an actual human attorney 1-on-1 to do your estate planning work with you. Maybe for particularly simple situations, the high-tech/low-touch tools make sense? But it seems penny wise, pound foolish to me. You’re not paying for an estate plan every year. Hopefully you can afford to do it thoroughly, because you only have to update it every few years.

Here are some thoughts from estate planning attorney, Alan D. Khalfin, Managing Partner at Vaksman Khalfin, PC, with whom I’ve had many illuminating conversations over the years.

While DIY estate planning might save a few bucks upfront, it often ends up costing families more in the long run due to administrative and tax issues. This is because DIY plans are not tailored to specific asset, tax, and family dynamics, nor do they contemplate the numerous contingencies that may arise. Each client’s situation is unique, with specific nuances that need to be addressed, even if not overly complex.

In my trust administration and probate practice, I’ve seen firsthand the dangers of DIY estate planning materialize. Significant issues and unnecessary complexities often arise from inadequately prepared documents, many of which require court involvement to resolve. This can be costly and time-consuming, far exceeding the initial savings from using an online platform. Working with an attorney from the beginning can help prevent these pitfalls and ensure a smoother process during a difficult time.

It’s simply impossible for online services to provide the counseling required for tailored estate planning that works as intended. Counseling is essential during all phases of the engagement, including design, drafting, execution, and funding. And as life and assets evolve after the estate plan is in place, it’s important to address questions and changes with an experienced firm that has a relationship with you and knows your situation. While some online services offer “attorney advice” for an additional fee, it’s typically from a different attorney each time who doesn’t know your situation or the estate plan already in place. And given the compensation these services offer their attorneys, the chances of getting quality advice are slim.

Another practical consideration: if things go awry and a mistake was made by an attorney, the heirs can pursue that attorney’s legal malpractice insurance to make them whole. This is not possible with an online service, which is not a law firm and does not carry legal malpractice insurance. And of course, with an online service, the heirs have nobody to turn for assistance when incapacity and death occur.

Frankly, the only situations where I can condone DIY estate planning are: 1) if the client simply can’t afford the fees an attorney charges and would otherwise have no estate plan; 2) a temporary will, POA, and healthcare directive needed immediately for health or travel reasons, with the intent of doing a full estate plan with an attorney when able; and 3) POA and healthcare directive for young adults with no assets who aren’t ready for a full estate plan.

Revisit your estate planning when…

When should you go back to your attorney and ask them to review or replace your estate plan? Simply put, when something big changes in your life:

  1. You get married (or divorced)
  2. You have a child (or your child turns 18)
  3. Your wealth grows by a lot (especially if it’s “overnight,” by way of inheritance or IPO)

The simple passage of time is a good reason to revisit your plan. Maybe nothing needs to change. But 10 years can create a lot of change, cumulatively, which you’re not particularly aware of. Kind of like someone losing weight, a few pounds a month. Nothing looks different day to day…but if you see that person for the first time after a couple years, whoa!

Not to mention that changes in the law can render estate plans or certain provisions in estate planning documents wrong or useless.

Do you want to work with a financial planner who will connect you with an estate planning attorney and help ensure that your estate plan serves your finances, your life, and your family? Reach out and schedule a free consultation or send us an email.

Sign up for Flow’s twice-monthly blog email to stay on top of our blog posts and videos.

Disclaimer: This article is provided for educational, general information, and illustration purposes only. Nothing contained in the material constitutes tax advice, a recommendation for purchase or sale of any security, or investment advisory services. We encourage you to consult a financial planner, accountant, and/or legal counsel for advice specific to your situation. Reproduction of this material is prohibited without written permission from Flow Financial Planning, LLC, and all rights are reserved. Read the full Disclaimer.

Should You Participate in an Exchange Fund with Your Big Pile of Company Stock?

Block Woman peers over the edge of a clear blender, looking down on an ice cube and the stainless steel blender blade.

Do you have too much of your company stock? Today let’s talk about one specific solution to that “concentration risk”: the exchange fund. (Really, I talk, you listen. Juuuuust the way I like it.) 

Many people seem to think that exchange funds are another one of those “rich, sophisticated people who know how to work the system” tools. So much cool. So much smart. So much brag-worthy. In my opinion, however, in general, you’d be well served by staying away.

I recently went through this analysis with a client, who’d been invited to join an exchange fund and was wondering if she should. (Yes, you have to be invited to participate.) I hereby share the results of that analysis with you, in case you are tempted to join an exchange fund.

Much of what I know about exchange funds comes from my favorite book about equity compensation: Managing Concentrated Stock Wealth. The author, Tim Kochis, is kinda the godfather of equity-comp planning. The first time I ever heard him speak, I remember walking away with this single impression: Almost all the time, the best solution is to sell it, pay the taxes, and move on. So, be aware that that is the attitude I bring with me to all discussions about company stock. Any reason to vary from that approach is gonna have to be Pretty Damn Persuasive.

What is an Exchange Fund?

Let’s just consult Investopedia for its definition:

An exchange fund, also known as a swap fund, is an arrangement between concentrated shareholders of different companies that pools shares and allows an investor to exchange their large holding of a single stock for units in the entire pool’s portfolio. Exchange funds provide investors with an easy way to diversify their holdings while deferring taxes from capital gains.

After you keep your money in the exchange fund for at least seven years, you can “redeem” your shares in the fund (this has no tax impact). Now you own a collection of shares of the individual companies that were represented in the exchange fund. You can choose to sell those shares (or not). At the moment of sale, you will pay long-term capital gains taxes on the gains, i.e., the value of the shares over your original cost basis. That’s what the above definition means by “deferring taxes.”

An example:

  1. Your investment portfolio is $3M. $2M (67%) of that is Airbnb stock. You acquired this stock by exercising ISOs way long ago, and so your cost basis in that stock is only $20k.
  2. You are invited to participate in an exchange fund and to reduce your concentration in Airbnb, you accept.
  3. You move all $2M (for simplicity’s sake) into the fund. This happens with no tax consequences. Now, instead of owning $2M of Airbnb, you have $2M of a mix of Airbnb, Meta, Datadog, Fastly, Amazon, Microsoft, Tesla, Nvidia, etc. (all the other stocks that were invited to join the fund). You have moved from ownership of a single stock to (indirect) ownership of many stocks, without incurring any tax bill.
  4. In seven years, you redeem your shares in the exchange fund and now own stock in all those companies (Airbnb, Meta, etc.). All that stock is worth $3M.
  5. You choose to sell all that stock and now you owe taxes: The taxable gain is $3M- $20k = $2.98M. You pay long-term capital gains tax on that $2.98M.
[Added 10/4/2024 for clarity’s sake:] Please note that you don’t have to sell the company stock after seven years. That’s just the earliest that you can.

Why Would You Consider Using an Exchange Fund?

Because taxes suck.

I mean, I’m not one of those types who think taxation is theft. I very much like my paved roads and national parks and national defense and public schools and feeding the hungry. But I know as well as anyone that paying taxes is painful.

Having a lot of your money in a single stock creates a concentration risk. The opposite of concentration is diversification: having a little bit of your money in a lot of stocks (or, more broadly, in a lot of investments, including bonds and, for some people, real estate and commodities and precious metals, to name a few). You get easy diversification when you invest in something like a Total US Stock Market fund or a target-date fund.

If you sell your company stock in order to reduce your concentration and invest the proceeds in a diversified portfolio, you’re gonna have to pay taxes on the gains in the stock you sell. (Notice I said gains; you don’t have to pay taxes on the total value of the stock, only on the growth it has experienced since you acquired it.)

Exchange funds promise that diversification without the tax hit.

Ooooh, that sounds niiiice.

What’s the catch?

Cons of Exchange Funds

Oh, my friend, the catch is big. And multi-faceted. Let us count the ways this can bite you in the butt.

Your money is locked up for seven years.

I’ve already mentioned the seven-year holding requirement in order to get these tax benefits. You might be able to get your money out earlier (check the terms of the exchange fund), but if you do, you won’t get the tax-deferral benefits. The seven year holding period is actually a legal requirement.

Why is this lockup a potential problem?

Well, there’s the obvious “But what if I need the money?” problem. For my client who inspired this blog post, this wasn’t a problem: she has plenty of money outside this company stock and shouldn’t need the company stock money for many years.

Then there’s the not-so-obvious “If the performance of the fund starts to tank, I can’t do anything about it” problem. You gotta leave your money in, watching helplessly as your investment falls in value. And considering that exchange funds are often created after a huge run up in a particular industry’s stocks, it can easily happen that you put the stock into the fund at or near the top…and then watch the stock prices run down. 

[Added 10/4/2024 for clarity’s sake:] Even if you were invested in typical stock funds, it’s not as if I’d recommend selling out of them as soon as the market starts to go down. There’s a reason why the saying is “Buy Low, Sell High” and not vice-versa. If you’re invested in the stock market, you have to be okay with the “down” part.

If your stock is Qualified Small Business Stock (QSBS), you already have the best tax benefit!

[Added 11/13/2024] If you acquired your company stock while the company was still small/early stage, it’s quite possible that your stock is considered Qualified Small Business Stock (QSBS). Why do you care? Because if it is QSBS, you can sell it, at a gain, and not owe any federal capital gains taxes on some to all of those gains. (It’s possible you can avoid state taxes, too, but that is, naturally, state-specific.)

If you can sell stock at a gain without paying taxes (or by paying far less in taxes), your tax need for an exchange fund might be eliminated. So, if you want to participate in an exchange fund, please first make sure that the shares you’ve contributing to the fund aren’t QSBS.

Some of your money is probably invested in crappy real estate.

Twenty percent of an exchange fund must be invested in “illiquid” investments. Usually, this means real estate. So when you participate in an exchange fund, yes, you own a portion of Airbnb, Meta, Datadog, Fastly, Amazon, Microsoft, Tesla, Nvidia, etc. You also own a portion of a real estate investment that the managers of the exchange fund pick.

Here to comment on said real estate investment, Mr. Kochis:

Excellent real estate opportunities can be packaged and sold on their own merits. Real estate used to meet a tax requirement for the packaging of some other main event is not likely to be the kind of with the very best investment characteristics.

In other words, you’re likely not getting the crème de la crème real estate in the fund. Probably not even the plain old crème. And yet 20% of your investment in the fund now depends on that real estate investment’s performance. Not ideal. [Added 10/4/2024 for clarity:] But, you know, check out what this 20% actually is in the exchange fund you’re looking at. I’m not opining on any specific fund.

They’re expensive.

Historically it has been white-shoe firms like Goldman Sachs and Eaton Vance who have offered exchange funds. The fees have been hefty. It’s not surprising to find an annual cost of 2% of your share of the fund. Have $1M in the fund? You’re paying $20,000 each year.

That said, Cache, a much newer company, charges a much-lower fee: 0.50% – 0.95%.

Not-so-diversified diversification

Exchange fund managers try to get stock into the fund (by invitation) in order to recreate/track a diversified market index. That’s the whole point after all: Diversification! (without a tax bill)

Alas, this promise of diversification often doesn’t turn into actual, meaningful diversification.

Again, Kochis writes:

The opportunistic timing of the creation of exchange funds can diminish true diversification even more. These funds are especially likely to be brought to potential investors when a particular market sector has recently enjoyed exceptional growth. [Sound like the tech industry, anyone?] Such growth often leads to many newly wealthy investors looking for ways to manage their new problems—far too much of a single holding in proportion to the rest of their portfolio. They are often found in the same industry or market sector at the same time making for a rather dubious attempt to minimize the downside risks of market exposure for a closely correlated position. This is especially problematic since investors in exchange funds are precluded for 7 years from taking any other action on the stock they contribute.

Traditionally exchange funds have usually tried to track the S&P 500 (which as of earlier this year, was 40% in the tech industry). Cache tries to create a fund that tracks the Nasdaq 100 (when I looked, it was 62% in the tech industry).

So, yes, you diversify away from the risk of your one company. That is valuable! But you’re still wildly exposed to the vagaries of one industry: tech. You own little of US companies in other industries, and probably very little to no international stock, bonds, smaller companies, etc.

Some offerings are very new.

Call me a luddite (I prefer “realistic based on experience”), but at this point I instinctively distrust fintech offerings that haven’t been around for probably at least a decade. I have been burned by a sexy new fintech startup—and have seen many people be burned by others—as the companies “pivot” to find a business model that is actually sustainable. That pivot often completely undermines the value to the early adopters. I daren’t name names for fear of crossing some unknown-to-me legal line, but if you harken back over the last five years, I’m sure you can think of a fintech tool that ended up really damaging some people’s finances and lives.

As much as I instinctively turn up my nose at Goldman Sachs, at least they’ve been offering exchange funds for years and years. I don’t have personal (direct or indirect through my clients) experience working with Cache, but it was founded in early 2022, and frankly that alone is enough for me to be wary of them.

Exchange funds are hugely complicated tools and tech has a history of flouting either the letter of the law or the spirit of best practices (tidily summarized in the euphemistic phrase “disrupting the industry”). Occasionally, yes, the tech folk get punished for it. Much more often, however, the end consumer is the one who suffers.

Your taxes aren’t eliminated, just delayed.

This isn’t a con per se, but it can still hurt you if you think (incorrectly) that exchange funds allow you to avoid taxes. And I fear many people do.

Even if you use an exchange fund and get some level of diversification, when you sell (after at least seven years), you still owe taxes on the gains in the fund. There is value to tax-deferral, for sure! That’s why so many of you likely contribute to your 401(k) pre-tax. But the tax bill is still gonna be there, and, if the exchange fund hasn’t lost a lot of money, the bill is still gonna be big.

When Are Exchange Funds Most Likely to Be Useful for You?

After reading this far, you might wonder, as did my client, “Who, then, would actually benefit from using an exchange fund?”

As best I can tell, you’re most likely to benefit if you’re in the following situation:

  • You’re currently in a high-tax situation (because of your income and/or state), and it’s possible you’ll be in a much-lower tax situation in seven years (because it’s at that point that the taxes will be calculated).
  • Your stock has very low cost basis. That means your gain is large, and the tax bill upon sale will be large. By contrast, if your company stock is all from vested RSUs, it’s probable that your cost basis is actually pretty high (because you paid taxes on the RSU shares when they vested, setting the cost basis equal to the value of the stock on the day of vest), meaning the gain is small. In that case, just selling the stock would actually not create that big a tax bill.
  • You have lots of broadly diversified investments outside the concentrated stock so that the inability to access the money for seven years isn’t a big deal, and the continued lack of broad diversification in the fund isn’t that big a risk to your total portfolio. This is more “you can afford for the exchange fund to go poorly” and less “the exchange fund will actually help you.”

the snark

As I’ve already mentioned, you have to be invited to join an exchange fund. That makes sense, because the managers are trying to construct a fund that tracks a certain market index (ex., the S&P 500). They can’t just take all comers.

You also need to be an Accredited Investor or maybe even a Qualified Purchaser in order to participate. That means that you have to have a certain (high) minimum household income or household net worth.

As you might imagine, this creates a sense of exclusivity, of elitism that can be very tempting.

Kochis writes:

On rare occasions you may have a client who prefers the exclusivity of an exchange fund, despite all its limitations, or one who finds the seven-year lock-up helpful for reasons unrelated to investment optimization [ex., they want an excuse to not give money to family].

Heh. Well, the world takes all kinds. And there probably are some cases where these considerations are important enough. Though, if they are, I’d suggest you might benefit more from some personal or family therapy.

One of the basic rules of investing is: Don’t invest in anything you don’t understand.

As you now perhaps understand, exchange funds can be wildly difficult to understand (well). So, either avoid exchange funds, acquire the knowledge yourself to analyze the opportunity (but lord, why would you spend your one wild and precious life doing that??), or work with a financial professional who already has the knowledge (not only of exchange funds, but also the knowledge of you and your goals).

If you want help thinking through all the complicated “but maybe they’re good?” financial opportunities in your life, from someone who knows you and cares about you, reach out and schedule a free consultation or send us an email.

Sign up for Flow’s twice-monthly blog email to stay on top of our blog posts and videos.

Disclaimer: This article is provided for educational, general information, and illustration purposes only. Nothing contained in the material constitutes tax advice, a recommendation for purchase or sale of any security, or investment advisory services. We encourage you to consult a financial planner, accountant, and/or legal counsel for advice specific to your situation. Reproduction of this material is prohibited without written permission from Flow Financial Planning, LLC, and all rights are reserved. Read the full Disclaimer.

Focus on these Few, Important Parts of Your Auto Insurance

Block Woman stands in focus in the background with two blurry red cars in the foreground that have crashed into each other.

My husband pointed me to this recent, kinda insane Twitter thread about auto insurance: 

It tells story after story of people doing or saying “dumb” things about auto insurance.

You get enough such stories strung together and you start to realize, “This isn’t the consumer’s fault. It might be their problem, but it’s (often) not their fault. They’re not doing these ‘dumb’ things because they’re dumb or subject to magical thinking. The system is simply too complicated to understand (alongside the umpteen other systems they need to understand…oh yeah and don’t forget their job and family obligations).”

That plus the fact that some clients have been goggle-eyed at the increase in their auto insurance premiums and, lo’, this blog post was born.

We are not insurance agents or brokers (originally typed as “borkers,” and let me tell you, that almost stayed) here at Flow. Such people have already written lots of articles across the internet that explain every aspect of auto insurance. I’m not interested in recreating that. (You should absolutely work with an auto insurance agent or broker in order to fully understand your coverage.)

I’m coming from a perspective of knowing enough about auto insurance and having worked with many a client to figure out the most appropriate coverage for their total financial picture. I have learned what to focus on…and what to safely ignore.

Auto insurance policies can provide a lot of different kinds of coverage. I don’t care about most of them. They’re nice-to-haves.

I want to discuss the short list of items in an auto insurance policy that we review on our clients’ policies—and that you therefore might focus your energies on. We believe they are the most likely to protect you against catastrophic (or even just really painful) financial damage, while keeping premiums as low as possible.

Liability Coverage

When I look at my auto insurance policy, this is formally called “Bodily injury and property damage Liability.” It covers your legal liability when your accident injures another person or damages someone’s property, i.e., when you’re sued by the person you hit.

Now, if you get an Umbrella Liability coverage—which we generally recommend to our clients—you’ll likely need to max out this coverage anyways. But even in the absence of that requirement, this is probably The Most Important Part of your auto insurance.

Why? Because it protects against the most catastrophic financial costs: being sued. While the cost of repairing or replacing your car is bounded (by the value of the car or a replacement car, more or less), people can sue you for any amount they want.

We generally recommend our clients max out their liability coverage.

Deductibles

Setting deductibles too low is probably the most common mistake we find amongst our clients. They’ve set their deductibles to, say, $250 when they could be much higher (usually $1000 is the highest available).

Why do I recommend they raise their deductibles? Because it will lower their premium.

What makes that an acceptable trade-off? The fact that they have plenty of cash to pay that extra $750 if they submit a claim. If you don’t have much cash lying around to pay the possible bill yourself, then yes, you should probably keep your deductible low. In my opinion, deductibles should be set in coordination with your cash emergency fund: the bigger your cash cushion, the higher you can afford to set your deductible.

This logic applies to both Comprehensive (covers the cost of repairing damage to your car by an event other than a car collision, such as theft or vandalism) and Collision (covers the cost of repairing damage if your car overturns or if it hits another car or object) deductibles.

Underinsured/Uninsured Motorist Coverage

That Twitter thread mentioned at the start features a “Plaintiff’s personal injury litigator” who says he recommends to all his friends and family that they get lots of underinsured/uninsured motorist coverage.

Anywhere from 5% to 25% of drivers are uninsured, depending on the state.

Which really really sucks when they hit you. Their lack of insurance, it turns out, ain’t payin’ any of your bills.

There are two parts of this coverage:

  • Underinsured Motorist Bodily Injury: This covers costs for damages you (and a few other related people…see your insurance policy for details) incur, including medical expenses and lost wages.
  • Underinsured Motorist Property Damage: This covers the cost of repairing your car. If your car is a beater 👋, then it’s not very worthwhile.

We generally recommend our clients pay for underinsured motorist coverage and tailor the “property” damage coverage to the value of their car.

So, take a look-see at your auto insurance and make sure that you at least have these three categories of your policy set appropriately for your situation, okay? 

And yes, your premiums have probably gone up and they’re probably high…and there’s probably nothing for it but to pay the bill.

That or trade in your vehicle for a 20-year old Toyota Sienna that’s worth about $13 and move out of California. See? Easy!

If you want to work with a financial planner who will take a look at all parts of your financial situation, reach out and schedule a free consultation or send us an email.

Sign up for Flow’s twice-monthly blog email to stay on top of our blog posts and videos.

Disclaimer: This article is provided for educational, general information, and illustration purposes only. Nothing contained in the material constitutes tax advice, a recommendation for purchase or sale of any security, or investment advisory services. We encourage you to consult a financial planner, accountant, and/or legal counsel for advice specific to your situation. Reproduction of this material is prohibited without written permission from Flow Financial Planning, LLC, and all rights are reserved. Read the full Disclaimer.

How Much Can You Safely Spend from Your Investments?…for the Young and Financially Independent

Block Woman stands at the start of a blurry game board of Life.

You have millions of dollars. You’re 40ish years old. You’re financially independent. At least, you think you are. But that all depends on not taking too much money out of your investment portfolio. So, how much can you spend and still be “safe”?

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