Insights: quarterly newsletter from RKL Wealth Management LLC (Summer 2016)

Jul. 26, 2016 | in Newsletter

A Message to Our Clients

Contributed by: Judson S. Meinhart

“Investing should be more like watching paint dry or watching grass grow. If you want excitement, take $800 and go to Las Vegas.” – Paul Samuelson

Paul Anthony Samuelson was one of the most influential American economists of the 20th century. He earned a PhD in economics from Harvard, began his teaching career at MIT at the young age of 25, and was the first American to be recognized with a Nobel Prize in Economics in 1970. Dr. Samuelson passed away in 2009, but if he were with us today there is no doubt he would have something to say about the current state of market volatility.

It seems every quarter there is some sort of geopolitical event that drives market jitters. This quarter it was the referendum on whether the United Kingdom should leave or remain in the European Union, commonly referred to as the “Brexit” vote. As voters headed to the polls, British book maker Paddy Power (yes, it was legal in the U.K. to gamble on the Brexit vote), placed the odds of “leave” at six percent. So while the decision for the U.K. to leave the European Union did come as quite a shock, our view was that the nearly 10 percent selloff that occurred in the aftermath was overdone. This was evidenced in the 6.6 percent rally of the MSCI EAFE Index in the week following the vote. It is also interesting to note that the 1520 level touched by the MSCI EAFE in the days following the vote was not even the index’s low for the year, which was set in February when falling oil prices and China gripped the market psyche.

What does all this short-term volatility mean for you as an investor? Dr. Samuelson would say “nothing.” Later in this newsletter, take a look back at past market events and their results. The key takeaway here is that managing your wealth is less about the daily ups and downs of the markets and more about creating a plan focused on your long-term goals and working with your advisor to execute it.

This latest edition of Insights also includes an article on college savings vehicles, a follow-up piece to last month’s article on student loan debt, as well as some important updates about Charles Schwab statements. Enjoy the summer reading!

How to Save for College and Save on Taxes

By: Amy L. Strouse, CPA, a manager in RKL’s Tax Services Group

The numbers don’t lie: Higher education is expensive, and the cost keeps rising. FinAid.org predicts that the price of college will increase around eight percent each year, which means that the cost of tuition doubles every nine years.

In the face of such daunting financial figures, it’s no surprise that families and students are going into debt to finance higher education. Our financial planning experts recently outlined several factors to consider before taking out student loans. There is one surefire way to minimize the amount of loans needed to fund higher education: save ahead of time for this considerable expense.

Not only does saving now help ease the cost of college down the road, it also allows savers to reap federal, and in some cases even state, tax benefits in the meantime. Of course, all savings vehicles are not created equal, so it’s important to find the one that best aligns with your unique financial situation. Below, we highlight several of the more popular college savings tools and examine how they help families achieve their savings goals.

529 College Savings Plans

With a name derived from the governing section of the IRS code, it is no surprise that 529 plans offer savers a wide range of tax benefits when funds are used for qualified higher education expenses. Typically sponsored by a state
government or individual school, 529 plans come in two varieties: the college savings plan or prepaid tuition plans. In a 529 college savings plan, money is set aside for college in an individual investment account similar to a 401(k) plan for retirement. 529 prepaid tuition plans operate very differently, allowing savers to lock in today’s price for tuition credits for future use.

Both varieties of 529 plans offer significant tax benefits and easy-to-use features, such as:

• State and federal tax-free growth and distributions when used for qualified higher education expenses, such as tuition, room and board, books, etc.
• State tax deduction for contributions (availability may vary by jurisdiction).
• High annual and lifetime contribution limits.
• Flexibility to change beneficiaries or roll over account to another 529 plan.
• Account owner retains control of funds indefinitely; funds are never transferred directly to beneficiary.
• Gift and estate tax benefits up to $70,000 ($140,000 for married couples).
• Wide use of funds at most colleges and trade schools.
• Account is treated as parent/account owner’s asset with less impact on financial aid calculations.

Coverdell Education Savings Account (ESA)

The primary difference between a Coverdell account, formerly known as the Education IRA, and a 529 plan is that funds saved in a Coverdell account may be used for K-12 education expenses, in addition to post-secondary education. Coverdell ESAs are offered by financial institutions, not schools or state governments. Significant features of a Coverdell ESA include:

• State and federal tax-free growth and distributions when used for qualified college or K-12 expenses.
• Annual combined contribution limit of $2,000 a year per beneficiary.
• Rollovers permitted into another qualified Coverdell ESA.
• Unused funds must be distributed to the beneficiary by age 30 (except for beneficiary with special needs).
• Eligibility to open account limited to individuals with adjusted gross income of $110,000 or less ($220,000 for married filing jointly).
• Account is treated as parent/account owner’s asset with less impact on financial aid calculations.

Custodial account (UGMA/UTMA)

Custodial accounts are the original vehicle to set aside money for children under the Uniform Transfers to Minors Act (UTMA) or Uniform Gifts to Minors Act (UGMA). Unlike the more recent 529 plans or Coverdell ESAs, custodial accounts offer less tax benefits and less control over how the assets are used. Here is how custodial accounts work:

• Contributions are not tax-deductible, earnings are subject to federal income or capital gains tax and account balance may trigger “kiddie
  tax” rules.
• There may be fees associated with opening and funding an account.
• No contribution limits, but federal gift tax will be incurred at current levels.
• Assets may be used for any expense that benefits the child, education-related or not.
• Once the beneficiary turns 18, he or she takes full control of the
  account assets.
• Beneficiaries cannot be changed and accounts may not be rolled over.
• Account is treated as the child’s asset and weighs heavily in financial aid calculations.

College Savings Vehicle Comparison

SavingForCollege.com offers a helpful tool that allows savers to compare and contrast different savings vehicles according to criteria important to them.

Every dollar saved today is one less that students may have to borrow down the road, so saving for college can be an important component of a family’s financial game plan. In order to maximize the tax benefits, however, it is
important that students and families consider the implications of certain
savings vehicles or accounts. Your RKL tax professional or RKL Wealth
Management financial advisor can help you plot a tax-advantaged course to achieve your college savings goals.

Putting Brexit in Context

With the most recent global macroeconomic event referred to as the “Brexit” shocking world stock markets and sending them downward, it leaves many investors wondering things like: “Has the market changed?” “Is this time different?” “Should I sell?” The truth is, global markets rarely experience periods of extended tranquility that make investors feel safe to invest, which is kind of an oxymoron if you think about it as we get rewarded for taking risks. We don’t have to look back too far in history to see examples that feel like ages ago:

• Black Monday (1987): Not only did the U.S. markets crash, but so did many around the globe as Hong Kong, Australia, Spain, the United Kingdom and Canada had fallen 45.5 percent, 41.8 percent, 31 percent, 26.45 percent and 22.5 percent respectively.
• First Gulf War (early 90’s)
• Indian economic crisis (1991)
• Finnish banking crisis (Early 90’s)
• Swedish banking crisis (Early 90’s)
• Mexican Peso crisis (1994)
• Asian financial crisis (1997)
• Russian financial crisis (1998)
• Tech bubble bursts (2000)
• 9/11 terrorist attacks (2001)

I’ll stop here. While these events were significant global events, did any of them derail stock markets long term? No. In fact, we experienced one of the greatest bull markets in history during this time frame.

The point here is this: There will always be something going on to make investors feel unsafe or scared to invest globally. These events will sometimes have adverse impacts on stock markets in the short term. However, these events often present opportunities for long-term minded investors. Remember the fundamental trade-off of investing: You get rewarded for taking risk period. There is no free lunch. If you are waiting to feel safe to invest, you will find yourself perpetually waiting on the sidelines and missing out on returns needed for retirement. Stick to your plan, stay invested and you will thank yourself later.

Charitable Contributions from IRAs

By: Laurie M. Peer, CPA, CFP®

The Pension Protection Act of 2006 first allowed taxpayers age 70½ or older to make tax-free charitable donations directly from their IRAs. These taxpayers could exclude from gross income otherwise taxable distributions from their IRA (“qualified charitable distributions,” or QCDs), up to $100,000, that were paid directly to a qualified charity. These gifts are also known as “Charitable IRA rollovers.” The law was originally scheduled to expire in 2007, but was extended periodically through 2014 by subsequent legislation, and finally made permanent by the Protect Americans from Tax Hikes (PATH) Act of 2015.

How QCDs work for 2016

You must be 70½ or older in order to make QCDs. You direct your IRA trustee to make a distribution directly from your IRA (other than SEP and SIMPLE IRAs) to a qualified charity. The distribution must be one that would otherwise be taxable to you. You can exclude up to $100,000 of QCDs from your gross income in 2016. If you file a joint return, your spouse can exclude an additional $100,000 of QCDs in 2016. It is important to note that you can’t also deduct a QCD as a charitable contribution on your federal income tax return – that would be double-dipping.

QCDs count toward satisfying any required minimum distributions (RMDs) that you would otherwise have to receive from your IRA, just as if you had received an actual distribution from the plan. However, distributions that you actually receive from your IRA (including RMDs) that you subsequently transfer to a charity cannot qualify as QCDs.

Here are two examples to demonstrate how to maximize the benefit of QCDs:

1. Assume that your RMD for 2016, which you are required to take no later than December 31, 2016, is $25,000. You receive a $5,000 cash distribution from your IRA in February 2016, which you then contribute to Charity A. In June 2016, you also make a $15,000 QCD to Charity A. You must include the $5,000 cash distribution in your 2016 gross income, but you may be entitled to a charitable deduction if you itemize your deductions. You exclude the $15,000 of QCDs from your 2016 gross income. Your $5,000 cash distribution plus your $15,000
   QCD satisfy $20,000 of your $25,000 RMD for 2016. You’ll need to withdraw another $5,000 no later than December 31, 2016, to avoid a penalty.
2. Assume you turned 70½ in 2015. You must take your first RMD (for 2015) no later than April 1, 2016. You must take your second RMD (for 2016) no later than December 31, 2016. Assume each RMD is $25,000. You don’t take any cash distributions from your IRA in 2015 or 2016. On March 31, 2016, you make a $25,000 QCD to Charity B. Because the QCD is made prior to April 1, it satisfies your $25,000 RMD for 2015. On December 31, 2016, you make a $75,000 QCD to Charity C. Because the QCD is made by December 31, it satisfies your $25,000 RMD for 2016. You can exclude the $100,000 of QCDs from your 2016 gross income.

As indicated above, a QCD must be an otherwise taxable distribution from your IRA. If you have made nondeductible contributions, then normally each distribution carries with it a pro-rata amount of taxable and nontaxable dollars. However, a special rule applies to QCDs; the pro-rata rule is ignored and your taxable dollars are treated as distributed first. If you have multiple IRAs, QCDs are aggregated when calculating the taxable and nontaxable portion of a distribution from any one IRA. RMDs are calculated separately for each IRA you own, but may be taken from any of your IRAs.

Keep in mind that QCDs cannot be made to a private foundation, donor-advised fund or supporting organization (as described in IRC Section 509(a)(3)), nor can the gift be made in exchange for a charitable gift annuity or to a charitable remainder trust.

Why are QCDs important?

Without this special rule, taking a distribution from your IRA and donating the proceeds to a charity would be a bit more cumbersome, and possibly more expensive. You would need to request a distribution from the IRA, and then make the contribution to the charity. You would receive a corresponding income tax deduction for the charitable contribution, but the additional tax from the distribution may be more than the charitable deduction, due to the limits that apply to charitable contributions under IRS Code Section 170. QCDs avoid all this by providing an exclusion from income for the amount paid directly from your IRA to the charity. You don’t report the IRA distribution in your gross income, and you don’t take a deduction for the QCD. The exclusion from gross income for QCDs also provides a tax-effective way for taxpayers who don’t itemize deductions to make charitable contributions.

Charles Schwab Client Statements

Based on Charles Schwab’s client feedback and industry standards, Schwab will now issue monthly statements only for accounts that have a qualifying transaction—such as a deposit or a withdrawal—within the reporting month. This practice will begin with July statements, which are delivered in August.

All accounts will continue to receive quarterly statements as usual, regardless of their activity level. Below you will find a chart outlining which activities will generate monthly statements, and which will not.

Other items to note about this change:

• This change will apply to eStatements, paper statements and bundled statements.
• Clients who receive bundled statements will only see balances for accounts that have qualifying activity.
• The majority of accounts associated with advisors tend to have qualifying activity, thus this change will impact only a small percentage of accounts each month.

If you would like to continue to receive monthly statements regardless of activity, Schwab must process your request two business days prior to the end of the statement month. Depending on the volume of requests, yours may not be processed immediately.

Activity that generates monthly statements:

• Bond interest payments
• Checks issued or deposited
• Commission credits
• EFT or MoneyLink activity
• Journal entries between accounts
• New account (funded or securities deposited)
• Price corrections
• Reorganizations
• Schwab One transactions, such as checks, VISA transactions, adjustments to interest
• Stock dividends
• Trades settling in the month the statement is generated
• Transactions related to Bank Sweep feature (not including interest)

Activity that does NOT generate monthly statements:

• Journal entries within the same account (from Type 1 to Type 2, for example)
• Money market dividends (manual or automated)
• Schwab One interest
• Interest on Deposit Accounts held through the Bank Sweep feature
• Trading activity where the trades settle in the next month

Reminder: Our Team Approach to Client Service

RKL Wealth Management prides itself on client service excellence. Whether you need to solve financial challenges, plan for education savings and retirement, make critical estate decisions or manage risk, RKLWM can help lay the groundwork for a secure financial future. Our team approach to service means we leverage the specialized knowledge and wide range of expertise of our advisors and operations specialists to meet your unique needs.

Should another RKL Wealth Management team member or advisor contact you, please do not be alarmed. It is our highest priority to keep your personal information private and held in the strictest confidence. Although every account has a lead advisor, RKLWM taps into the specialties and insights of each team member – whether it be operations, cost basis or financial plans – to maximize client benefit. It’s just another way we strive to help you invest in something greater.