Press Room: Financial & Estate Planning

Practical Finance: Rules of Thumb to Forget. Number Four….



You have no doubt heard this rule of thumb if you pay any attention to personal finance publications: Experts recommend setting aside three to six months’ worth of expenses in a savings account as a buffer against spiraling into debt should a disaster occur.

This is a great example of a good idea reduced to unfortunate over-simplification.

The idea of being prepared to cover unexpected expenses such as sudden car repairs, medical emergencies or job loss is undoubtedly a sound foundational principle. So, where’s the over-simplification?  Simplified to this: Every family’s situation is different, so the rule of thumb that says the correct prescription is three to six months’ worth of routine expenses is a shortcut that you might just as well dismiss.

Let’s re-invent a way to think about this important question in a more deliberate manner. If we break this down, it should become easier to make a bit more sense out of how to think about this financial issue in a sound way. Here’s an acronym that might be helpful: “SAVES”

  • S – SAGS & SWELLS HAPPEN. Be realistic when forecasting predictable outflows. In our 48 years of working with families, we’ve found that when we ask people what it takes for them to support their lifestyle in terms of average monthly outlays, a high majority underestimate the actual number on their first attempt. Why? Each expense is not month to month. Plot your spending on a graph — the line likely has many sags and swells. We refer to this as the “Battle of the Bulge”. When forecasting outlays, it is easy to forget about those “bulges” in outlays that are predictable, even though not monthly. Property taxes come due at the end of every year. Many insurance outlays tend to be annual in nature. Vacations and travel may be concentrated in certain months of the year. Most families have higher health care costs in the early part of the year when deductibles and out-of-pocket insurance limits reset.
  • A – ACCIDENTS HAPPEN. Most of us understand the meaning of the words, “… an accident waiting to happen!” In assessing your possible need for sudden cash infusions, think of yourself as an insurance company underwriter trying to anticipate what could go wrong. Your nickname may be “Tightwad”, referring to the guy or gal driving vehicles that are 10+ years old with more than 100,000 miles. If so, your risk of needing to pay for unexpected repairs, or to confront a sudden situation calling for a vehicle replacement is higher compared to a family driving only late model cars that remain covered by a warranty. If you are a homeowner, your exposure to a variety of repair expenses is decidedly higher than that of a lessee where such exposures belong to the landlord. Either way – tightwad or homeowner – you probably should calculate your cash reserve higher than your counterpart.
  • V – VARIATIONS MATTER. Think about the variability of your cash inflow sources month to month. The leading breadwinner in some families may work in a field where income can be high, but subject to considerable variation on a month-to-month basis. Many positions in sales which pay some component of compensation on commissions are like this. You may calculate that you have a low risk to require cash supplementation on an annual forecast, but find that some months can look much different than others. Just like expenses vary each month, the primary paycheck can vary. Paychecks that are highly variable generally favor a greater emergency cash reserve.
  • E – EARNINGS SOURCES COUNT. Determining an emergency cash reserve starts by comparing predictable expenses to predictable cash sources. Two paychecks mean more flexibility than one. Some households operate on a monthly basis where the take-home paycheck money from one or both contributors is fully spoken for in covering normal bills. In the event of a job loss, there’s clearly a difference in possible need for a cash infusion if one paycheck covers everything compared to the situation where both paychecks are being used. But in either situation, it is fair to say that two-income households can generally tolerate a somewhat lower emergency cash reserve compared to a single-income household.
  • S – SURPLUS COUNTS. Your monthly and annual expected cash generation surplus matters. A household that is regularly saving excess monthly cash flow [over and above pre-tax savings like 401(k) contributions] and adding it to investment accounts may be able to operate on relatively low emergency cash reserves. Why? In the event of unexpected needs, it may be relatively easy to discontinue that savings outflow temporarily, and if required, to even borrow on a short-term basis against investment accounts. When cash flow is restored, repaying such loans in relatively quick fashion from excess monthly cash flows should be relatively painless.

The main take-away: Determining the right emergency reserve for your own situation depends on your unique variables. Imagine the peace of mind that can come from a more deliberate and thoughtful approach to this important area where one size does not fit all.

Practical Finance: Rules of Thumb to Forget. Number Three….



If you read or follow personal finance publications and blogs, you’ve undoubtedly seen some headlines to articles or posts that read like these from the past year or two:

  • “More evidence that it’s very hard to ‘beat the market’ over time, 95% of finance professionals can’t do it”
  • “Why Active Managers Still Underperform”
  • “Active Managers are Losers”

A conclusion or rule of thumb follows: “You’d be a fool to invest in any fund other than the lowest cost index fund.”

These headlines would not appear with such frequency without some statistical support for the proposition they espouse. Indeed, Standard & Poor’s updates and publishes a regular scorecard[i] of their S&P Indices versus Active Fund Managers. These scorecards typically indicate that between 80-85% of Active Managers underperform an index, such as the S&P 500, over meaningful periods of time, like 5 years. Standard & Poor’s includes more than 10,000 funds in the comparison. So, on the surface, the conclusion that there is simply no merit in using an active manager might not seem ridiculous. In our 48 years of working with clients, however, our experience tells us that this is one of those areas where the biggest challenge to solid reasoning is what we “know” to be true that is not.

Given the data, what is wrong with the reasoning that one should eschew any and all active management? We’ve learned from our experience in actually investing money for families that there are two key elements to reaching a sound conclusion about this question.

First, it is important to put raw statistics into perspective and understand the almost inevitability of the numerical result in a scorecard like that prepared by Standard & Poor’s. When you stir 10,000+ fund portfolios into the stew, it is to be expected that their aggregate holdings will look pretty much like the market itself, which is also what the S&P 500 Index approximates. The resulting average return of the 10,000 funds (before considering fees) of a large group of funds ends up being about the same as the S&P 500. It really could not be any different mathematically. Since all of the funds charge a fee, the average fund would thus have to deliver a return that underperforms the S&P 500 Index, which has no fees. So, there is really nothing at all surprising in the numerical outcome that the majority would underperform, once fees are subtracted.

Second, but perhaps most important, many of the so-called “active managers” might better be labeled “closet indexers”. Finance professionals use a term, “Active Share”, to calculate the proportion of stock holdings in a manager’s portfolio that differs from the benchmark index. Without going into all of the detail here, suffice it to say that over the past 4 decades, the number of fund managers who build portfolios that do not differ materially from the index has increased (low Active Share measure). A study by professors at Yale University[ii] noted that the percentage of fund assets with Active Share greater than 80% went down from 58% in 1980 to 28% by the year 2003. It may be even lower today. Why does this matter to you as an investor? Here’s why: the most credible academic research suggests that the minority of funds which DO out-perform the market are the ones with very high Active Share scores. (By the way, that does not mean that a high Active Share measurement ensures out-performance, because the worst performers also typically have high Active Share calculations.) Active Share is very valuable in identifying and excluding closet indexers, which is extremely important because their active management fees virtually guarantee they will underperform the index. Stated well by our Chief Investment Officer, Ryan Patterson, CFA, CFP®, “If there is any “Rule of Thumb” here, it might more properly be stated: You’d be wise to avoid a closet-index fund.”

So, what is the sound conclusion? We believe that the key is to avoid “mantras” that take on the level of a religious fervor. Rather, recognize that two things can be true, side-by-side:

  1. Passive indexing strategies have a proper and worthwhile place in that they provide a very high likelihood of obtaining the return for the market segment you might desire at an extremely low cost, and typically with high tax efficiency.
  1. Active investing strategies can indeed enhance portfolio construction and produce excess returns. It becomes a bit easier to identify those fund managers who have demonstrated consistency in such superior results if you use techniques like Active Share measurement (it is not the only tool, of course) to exclude the closet indexers from consideration.




Practical Finance: Rules of Thumb to Forget. Number Two….



This one seems to hit the personal finance columns and blogs with regularity when December rolls around. We are referring to those pieces with year-end tax advice that almost always mention the advantage of taking steps to defer taxes to future years. There are typically a number of reasons cited. You may be in a lower tax bracket in future years. Actual tax rates may be lower in future years. Postponing tax allows you to earn interest on the government’s share of the money. You can pay the future taxes with cheaper (inflated) dollars.

These supposed benefits of deferring taxes have become one of those almost sacred rules of thumb. In fact, a few of our CPAs on the L&W team recall that “Defer, Defer, Defer!” became almost a mantra when we were taking our income tax courses in college.

One thing has become crystal clear to our team after almost 50 years of helping families with their wealth management needs. There are important exceptions to every rule, and this “rule” of deferring tax is certainly one of those that should not be accepted without question. The simple fact is that deferring taxes is not always the best plan. A couple of pretty common fact patterns that we encounter with clients can help illustrate this point.

  • Postponing recognition of capital gains on investments is one application of this rule of thumb. Our Chief Investment Officer, Ryan Patterson, CFA, CFP, commented at a recent Investment Committee meeting, “What most people forget is that under our very ‘non-simple’ tax system, long-term capital gains have their own graduated rate schedule, with rates ranging from 0% to 23.8%, depending on amount. Deferring gain recognition typically has marginal impact on portfolio returns, and may result in taxes at higher rates later. Care and planning are required in timing decisions.”
  • Accumulating excessive balances in tax-deferred retirement accounts will likely dictate distributions of ordinary income when Required Minimum Distribution rules take effect at age 70-1/2. The result of excessive tax-deferred build-up may be unbalanced Net Worth Statements where all accessible assets are in accounts that trigger taxable income when accessed. Added to Social Security and other income, this income can hit marginal tax brackets higher than those applicable during the working years. Heidi Davis, CPA/PFS, CFP, former chair of our Wealth Planning Committee, adds, “… often, these required distributions can push retired investors into high-income premium categories for their Medicare coverage.”
  • Deferral of excessive money into tax-deferred accounts also means a sacrifice in flexibility. Access to these monies before age 59-1/2 is generally punitive. Also, these assets cannot be pledged as collateral in financing transactions.

These three examples by no means exhaust the subject. There are others we could discuss with more time. But once again, these three are a reminder not to lean too heavily on rules of thumb such as “Defer, Defer, Defer!” The better approach is to be thoughtful about decisions like this and seek help from a qualified advisor, one functioning under the fiduciary business model, who is obligated to act in your best interest and provide non-conflicted advice.

Practical Finance: Rules of Thumb to Forget. Number One….



If you saw the movie, The Big Short, you may remember a quote attributed to Mark Twain near the beginning of the show: “It ain’t what you don’t know that gets you into trouble. It’s what you know for sure that just ain’t so.”

After 47 years of advising clients, we notice that some of these rules of thumb which circulate in the world of personal finance have amazing staying power, even when they have little relevance to a family’s actual circumstances. Recently our firm’s Wealth Planning Committee, conducted an informal poll among our Wealth Advisors to ascertain which of these seem most widely embraced. Phillip Hamman, CFP, CFA who chairs the committee said, “We reached a pretty good consensus on a “Top Five” — no small feat considering the diversity of our group that includes CPAs, JDs, and other credentialled professionals from multiple backgrounds.” We’ll touch on number one in today’s post.

NUMBER ONE: Your invested asset allocation should relate inversely to your age. There are several iterations to this one, but the most popular version is, “Your allocation to stock market investments should be equal to 100 minus your age (40% equities at age 60, 30% equities at 70, and so on)”. This describes a glide path of declining exposure to stock investments as you age during retirement.

All rules of thumb are not bad, since they can help simplify things that are complex. However, this is one that is ready to be retired itself. The original underlying premise of this rule of thumb is based on a mathematical truth – the older you are, the less time you have remaining to recover from a bear market in stocks.  While true, age is only one factor that enters into the asset allocation decision. This rule of thumb overlooks all the interrelated personal financial planning factors that can make a difference in comparing one family’s situation with another’s.

There is actually a great deal of academic research on this subject of setting appropriate asset allocation as circumstances evolve during one’s lifetime, and particularly during the retirement years. It is important to realize that allocation policy and time horizons can span generations and the tax treatment of different types of investment accounts figures into final decisions.

Perhaps a couple of practical examples will illustrate the more obvious point on the pitfalls that can lead to oversimplifying a complex question.

  • Example One: You are retiring early at an age like 55. The rule of thumb noted above might suggest 45% in stocks with the remainder in conservative investments. However, assume you are setting allocation for investments in an IRA Rollover account that will likely sit untouched until you begin Required Minimum Distributions at age 70-1/2, because you have other identified sources of early retirement cash flow. In such a case, you have a lengthy time horizon and an allocation of 45% to stocks is very likely overly-conservative for such a pool of money.
  • Example Two: You consider yourself “mid-career” with 20 years remaining to retirement. Considering time-horizon alone, your allocation to stocks under the Age 100 and similar rules of thumb would suggest heavy allocation (some even 100%) to stock investments. However, you contemplate college expenditures for children in the next five years and also aspire to purchase a vacation home soon to enjoy during the early years of empty nesting. These diverse objectives which will affect the drawdown of your assets might certainly dictate some reasonable measure of conservative assets.

Rules of Thumb may be a good starting point for examination of particular financial issues. But take care, as they can often be clever oversimplifications.

Practical Finance: The Ideal Retirement? Survey Says…



Regardless of your age, you may know the popular game show, Family Feud. The original game airs in syndication and has regained popularity through current programming but the premise remains the same.Two families competed to name the most popular responses to survey questions in order to win cash and prizes. After the competing guesses were recorded, the host introduced the correct response by saying, “Survey says…”

A Senior Living Community provider recently released their survey[i] of 2,000 Americans on the subject of how to define the “ideal retirement”. The answers from the national survey are interesting, even though they might contrast significantly with your responses.

Q:  What is the right age to retire? Survey says: Age 60. The answers varied based on the ages of those responding. Boomers answered with an average age of 64, while Millennials answered with an average age of 56. Maintaining lifestyle in a retirement starting at age 56 is a considerably greater financial challenge than starting at 64.

Q:  More than 1 in 5 Americans desire to retire and live abroad. What is their top choice for a country to live in? Survey says: Italy. Apparently, the draw of the Tuscan wine country is powerful. Those who pursue this course learn that the legal and paperwork requirements for Americans to live abroad can be challenging and require planning.

Q:  Name the top 5 cities Americans prefer as a retirement location. Survey says: (this might be surprising, but in order…) – Miami, San Diego, Denver, New York, and Orlando. We know from much experience with this question that these particular cities are not on the list for many of our Linscomb & Williams clients. Whatever your personal leanings, however, retirement location is an important variable in your financial plan. Miami is 24% more expensive than Houston for example[ii]. San Diego is 41% higher, Denver 27%, and New York is double. Only Orlando is reasonably close, but is still about 7% more expensive. Clearly, when planning the ideal retirement, WHERE you intend to retire can have as much or more financial significance than WHEN you desire to retire.

Q:  How much in savings would be ideal by the time you retire? And how much do you realistically expect to have? Survey says: To supplement Social Security and pensions an ideal savings target would be $610,000. Unfortunately, the second half of the question on expected savings leaves a big gap: $276,000. This is less than half of what would be desirable.

In an unrelated survey[iii] conducted for the Certified Financial Planner Board of Standards, Inc. (CFP Board) by Heart + Mind Strategies of 1,000 voters on election day 2018, there were a couple of important insights which bear upon this last question.

  • 60% of the respondents indicate they expect to work with an advisor for planning their retirement needs.
  • However, 23% intend to wait until just 3 to 5 years before retirement to engage a professional financial planner.
  • 82% want someone who can provide a comprehensive plan that takes their holistic financial situation into consideration.
  • 79% believe their financial advisor should always work in their best interest (the “fiduciary” business model).

In our nearly 50 years of helping clients plan their own “ideal retirement”, we think there are several key elements that transcend the various visions of what might be ideal:

  1. If you don’t have a well-conceived plan for your ideal retirement, the best time to start working on it is today. Unless you are willing to do considerable homework on your own, seek the help of a qualified professional financial planner sooner rather than later.
  2. Choose a planner who is well experienced and qualified. Credentials can be important indicators. Look for the key 4: CFP® certification, CPA, Chartered Financial Analyst® credential, and/or JD (Juris Doctor).
  3. Choose a planner who commits in writing to always interact with you, as a fiduciary, with a legal obligation to work in your best interest.





Practical Finance: Thinking About Hurricanes (and Bear Markets)



Having our headquarters on the gulf coast of southeast Texas, most of us at Linscomb & Williams are plenty familiar with how it feels to live in an area that is threatened with a significant hurricane about once every 10 years. Some in our L&W family are familiar in a completely personal way with these risks, having been flooded out of their homes in Hurricane Harvey.

Despite our personal memory of experiencing these risks, none of our L&W family has decided to sell their home and move away from Houston. We got into some discussion about this during a recent staff luncheon and attempted to answer the question: Why? Why stay in Houston despite knowing that it is not a question of “if” but “when” the next significant hurricane will impact our area?

A few common answers came out of that luncheon conversation:

  • “The risk is worth the award. 99% of the time you have a nice house in a nice location close to some of the greatest people in the country.”
  • “If you were born here, you are just used to it.”
  • “I could live somewhere else and face earthquakes or wild fires. Hurricane threats are a small price to pay to live in a place like Houston with a great economy.”

Maybe this is instructive in framing how we should think about the possible impact of a bear market on our portfolios. A bear market decline in the stock market is the financial equivalent of a hurricane.

The odds of facing a bear market if you are an investor in stocks is similar to your risk of living through a hurricane in Houston. There is no “if”, just “when”. You are likely to see one about every 10 years. A bear market in stocks (a decline of 20% or more) may well do some damage to your portfolio in the short term, but history shows that you will likely recover.

Bear markets are part and parcel of the risk of being an investor in the stock market. And the rewards in the long-term from being invested in quality stocks are well worth planning for this risk. Compared to the returns likely from more conservative investments (bonds or cash), your long-term returns on stocks will probably outpace inflation.

You plan for the risks of a hurricane by doing sensible things like building your home on a solid foundation above the flood plain, owning a back-up generator, and stocking up with emergency food and water supplies. Smart stock market investors make sure they own the stocks of high quality companies that will bounce back when the storm passes. They generally have enough diversification in their asset allocation to ensure that everything they own is not down in price at the same time. They keep enough emergency cash on hand to ensure they are not forced to sell their stocks at the wrong time.

We’ve observed that bear markets seem most fearful to newly-retired investors who are unaccustomed in their new chapter of life (no regular paycheck) to observing a decline in portfolio value. For the same reason we in Houston are more fearful about earthquakes if we move to Los Angeles, the new retiree fears the bear market because he or she has not lived through one to enjoy the recovery on the other side.

“If you want to see the sunshine, you have to weather the storm.” – Author Frank

Life After Marriage


Life After Marriage

Q: Why is financial management potentially a challenge for new widows and divorcees?

It may come as no surprise, but there is a gender gap in family financial planning.  Since 2000, Prudential has conducted a continually updated biennial study on Financial Experience & Behaviors Among Women, which surveys women’s attitudes, behaviors and financial knowledge, as well as their financial goals and confidence in meeting those goals.  Though counter to our modern cultural discourse, the most recently published update to the survey continues to reveal that a minority of married women judge themselves to be “taking the lead” or “taking control” of family financial planning decisions.  Such a tilt in favor of ceding the financial leadership to a male partner could leave a significant body of married women feeling unprepared if they find themselves suddenly single.  Considering life expectancy differences between men and women, as well as divorce statistics, the simple fact is that a large number of married women will face financial management responsibility alone at a later point in their life, when divorced, or widowed.

Q: When you say “financial management”, are you referring to investment decisions?

That is part of it, but for many women, the challenges may be more basic.  We’ve lived through a lot of these situations in our firm’s 47-year history.  Consider a woman who has chosen to remain relatively non-engaged in the family’s financial management and suddenly loses her husband to premature death.  She may be facing the sudden reality that the mortgage payments are overdue because her late husband was the one tending to these bill-paying chores.  Or it could be the challenge of needing to make quarterly estimated tax payments and not being familiar with the rules and deadlines.  There may be pressing cash needs to deal with hospital and funeral bills, while the filing of insurance claims can be an unfamiliar and intimidating process.  In some cases, many of the financial asset accounts are titled in her late husband’s name, so bank and brokerage firms may restrict access to accounts until the legal estate process is completed.

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Juggling the Retirement Pieces


Juggling the Retirement Pieces

Q: When we discuss “juggling the retirement pieces”, what is the point?

That is an observation that comes out of multiple observations over our 47-year history from working with client families who face the transition from their previous life of living on a regular paycheck to a new life of creating their own paycheck.  In many cases, if not most cases, there are decisions to be made regarding how to create the cash needed to maintain the family’s lifestyle in retirement.  Most of the time, there are numerous alternative sources for cash.  Today’s retirees are not “living their grandfather’s retirement” where there was nothing much to think about beyond being sure the pension check and Social Security payment made it to the bank for deposit before the bills came due.

Q: Are you saying that you cannot simply plan retirement cash flow by using the rules of thumb we have from history?

The answer would be “Correct”.  But Warren Buffett put that far better than we could when asked about how he’d become rich.  His answer was, “If past history was all that is needed to play the game of money, the richest people would be librarians.”  Those rules of thumb are not 100% wrong, but the main danger is that they are over-simplifications.

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Where Are We Headed in 2018?


2017: A Tough Act to Follow…
Where Are Markets Headed in 2018?

Q: We’ve just closed out a pretty remarkable year for investors in 2017. Where is our Investment Committee’s thinking? Will this continue?

You’ve posed the most frequent question we get from clients. This question was being asked even before the end of 2017, because this strong up move in the financial markets has been in place, virtually uninterrupted since early 2016. We are close to the two-year mark of this upward advance. The U.S. market returned almost 22% last year (S&P 500 Stock Index). Foreign stock markets, in the aggregate (excluding the U.S.) did even better, surpassing 27%. Even dull and boring bonds had a nice year, producing a solid inflation-beating return of more than 3% with little volatility. It’s hard to remember a year when portfolios moved ahead “hitting on all cylinders.”

Q: That is good perspective. Does that mean we have concluded the party is about over?

The short answer: not necessarily. We get this question from clients and friends for a few reasons. One reason often behind the question: this bull market has extended longer than average in terms of time and advance. That said, it does not represent the all-time record. The answer to your question has to be more than some simplistic appeal to “reversion to the mean.” Yes, the U.S. market has attained record levels of price appreciation when you look at popular benchmarks, but that is only part of the story. It is equally true that we are in an economy where the corporate profits encompassed within the U.S. stock indices are also at record levels, and that is before counting the positive effects of the recent tax changes. What we tell clients is that you must put this question in some sort of frame to have a sensible perspective. The “frame” on one side is a U.S. economy that appears to be in steady growth mode with no serious signs of impending recession risk. The other side of that frame is that U.S. stocks, while not a bargain, are nonetheless selling at reasonable price multiples relative to expected earnings. There are a number of ways to measure valuations. Our team looks at several different metrics and compares them to historical averages, different periods in history, and makes adjustments for the current economic environment. In that sense, we believe U.S. equity markets are fairly valued.

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Tax Cuts & Jobs Act: A Few Initial Takeaways and Key Changes to Consider

TAX CUTS and JOBS ACT: A Few Initial Takeaways and Key Changes to Consider

Congress and the President successfully passed new tax legislation, known as the Tax Cuts and Jobs Act (TCJA). The TCJA impacts individuals, as well as businesses large and small. It’s very early in the process, and many of the details are still being sorted out. The IRS will undertake the process of working through the particulars, and they’ll ultimately issue final regulations, which will certainly help clarify planning opportunities. How the changes will impact individuals and businesses is difficult to say, as each particular circumstance is unique.

There are a few clear winners from the TCJA. Corporations stand to benefit from a materially lower income tax rate. Businesses that distribute “pass through” income to their owners are favored. In fact, possibly some of the biggest planning conversations ahead will revolve around business entity selection or related topics. Larger estates will also benefit, given an increase in the exemption amount that can pass to one’s heirs free of the death tax.

For many individuals, the direct benefits of the TCJA are a bit more complicated and dependent on one’s situation. Though there has been plenty of political “hype” in all the discussion, we do agree that all individuals are likely to be indirect beneficiaries of the new law, as corporations and businesses employ some of their tax savings in ways that foster long-term economic growth – more on that below.

Regrettably, the new law does significantly reduce some popular deductions for individuals, including state and local income taxes, sales taxes and property taxes. Thus, for individuals with relatively large itemized deductions, there is a chance they could see taxes increase, in spite of lower tax rates.

Also, despite the perpetual political promise of “simplification”, the tax code will remain as complicated as ever. Thus, planning will remain highly essential, especially considering all of the different effective dates and sunset provisions included in the new law (see chart below). It is also a bit disappointing that provisions like the individual Alternative Minimum Tax (AMT) did not get the axe entirely, but at least there was improvement.

Additionally, with respect to estate planning, it’s important to note that the higher exemption amounts are not permanent. Therefore, there’s at least a decent chance that today’s lower exemption amounts will return. You might recall it wasn’t all that long ago that the exemption amount was less than $1 million, impacting a much higher percentage of individuals. And, even if your estate is well under the new exemption level, there are many reasons, outside of tax considerations, to properly plan your estate.

In general, the new tax legislation has been well received by financial markets. The reduction in the statutory corporate tax rate to 21% makes the United States’ corporate tax structure much more competitive globally. The previous rate of 35% was one of the highest in the developed world. Now, not all large U.S. based companies have been paying the full freight, but still, their effective tax rate is expected to drop between 5 – 6 percentage points, which Wall Street analysts estimate could add about $10 per share to S&P 500 earnings. This improves after-tax earnings and improves free cash available to businesses to reinvest and distribute to shareholders.

Small and mid-size companies – which are not typically included in the S&P 500 – could experience an even greater relative improvement. Exactly how companies plan to use this new windfall is not completely predictable, but it is likely that some of it will be used for accelerated business investment, new hiring, and higher worker pay. Anecdotally, we have already seen a number of one-time bonuses paid out to employees across various industries.

Another, and perhaps underappreciated, aspect of the legislation is the shift to what is referred to as a territorial tax system. After an initial repatriation charge on cash held overseas, companies will henceforth be allowed to return international earnings back to the United States tax free. This is most important to technology, healthcare, and pharmaceutical companies which tend to have the most money held outside of the United States. It wouldn’t surprise us to see an increase in mergers and acquisitions, stock buybacks, and dividends from these sectors.

Let’s discuss and make observations on a few of the details, good and bad… let’s start with the good:

  • There are still seven tax-brackets for individuals, but the highest tax rate as well as intermediate rates are now lower than before. The highest rate has dropped from 39.6% to 37%.
  • The standard deduction is now higher for both individuals and married taxpayers. One of the most visible and talked about changes is the increase in the standard deduction from $6,500 to $12,000 for individuals and from $13,000 to $24,000 for married couples.
  • 529 Education Fund savers can now use up to $10,000 per student per year for public, private or religious elementary or secondary schools, where previously these could only be used for traditional college costs. The $10,000 limitation does not apply for post-secondary school expenses.
  • Charitable contributions are still available as an itemized deduction, and the AGI threshold for cash gifts to charity increases from 50% to 60%.
  • For individuals age 70 ½ or older, qualified charitable distributions (QCDs) from retirement accounts are still available up to $100,000. Note that QCDs are an above the line deduction for tax purposes, as opposed to an itemized deduction.
  • Medical expenses in excess of 7.5% of adjusted gross income are deductible. In the past, the AGI threshold was 10%. (This is a temporary change, for the 2017 and 2018 tax years only).
  • The “Pease” limitation, aka the 3% phase-out for itemized deductions above a certain income threshold, have been suspended for 2018-2025. This provides significant relief to taxpayers with higher incomes who previously were losing as much as 80% of the benefit from their itemized deductions.
  • Favorable tax rates for long-term capital gains and qualified dividends were unaffected, and tax rates will generally remain subject to a maximum rate of 15% or 20% on higher amounts.
  • Proposed legislation requiring investors to sell their oldest, and likely most highly appreciated, shares first did not make it into the final law. Despite much discussion, the 3.8% Medicare Surtax applied to investment income above certain thresholds did not get eliminated.
  • Owners of pass-through businesses will be allowed a 20% deduction for qualified business income from a partnership, S-corporation and sole proprietorship. This is for income below certain thresholds ($315,000 for Married Filing Jointly and $157,000 for Individual filers).
  • The Alternative Minimum Tax (AMT) system is still in place. However, since it raises the income exemption levels to $70,300 for individuals and $109,400 for married filing jointly, fewer people will be impacted by the tax. (Previously, these exemptions were $54,300 and $84,500 respectively.) This is welcome news for many.
  • The Gift & Estate Tax exemption doubles to $10,980,000 per person, and $21,960,000 per married couple. This change eliminates estate tax considerations for a whole new level of taxpayers. The rate for estate taxes remains at 40%, but the higher exemption amounts are scheduled to sunset after 2025.
  • Section 179 changed so that businesses can deduct a higher portion of capital investment as a current expense. This amount increased to $1 million from $500,000, while increasing the cost of property subject to the phase-out to $2.5 million from $2.0 million.

And now, the not so good news…

  • Not as prominent in discussions as the Standard Deduction is that the Personal Exemption, currently $4,050 per person, is eliminated.
  • For alimony paid after December 31, 2018, payments are not deductible by the payer spouse, nor is it includible as income by the payee spouse. This only affects divorces that are finalized beginning in 2019 and will not impact existing alimony arrangements.
  • Regarding itemized deductions, there are many changes. Perhaps the most notable being:
    • State and local income taxes, property taxes and sales taxes are limited to $10,000 (combined).
    • Mortgage interest deductions are capped at interest on $750,000 of acquisition indebtedness for a primary residence and second home (combined) for loans established after December 15, 2017. Debt incurred before this date is “grandfathered” under old rules.
    • Interest on HELOC loans is no longer deductible, unless specifically used for home improvement.
    • Miscellaneous itemized deductions subject to a 2% floor have been eliminated.
  • College Athletic Fund Contributions to athletic funds in exchange for preferred event seating will no longer be deductible.
  • Net operating losses (NOLs) are now limited to 80% of taxable income, and the two year-carryback provision, which allowed losses to be calculated against prior year returns, has been eliminated. However, taxpayers can now carry forward NOLs indefinitely instead of the prior limit of 20-years.

There are many additional changes in the TCJA not addressed in this relatively short piece. Thus, we highly recommend visiting with your CPA or other tax advisor as to how these and other changes may impact you personally. And, keep in mind, that the new rules take effect and potentially sunset at different times, making long-term planning difficult at best.

We’re in the very early stages of the game with these new rules, so much is still to be seen. That being said, it’s clear that tax planning and modeling will remain an essential part of any personal financial discussion. This relates to both decisions around personal income and business tax planning, as well as estate tax planning.

To conclude, please keep in mind that this is only a brief summary. It’s a bit staggering that we’ve already seen summaries on the new tax law that are in excess of 150 pages in length. There are many changes and certainly many nuances with the tax code to consider. Again, we highly recommend visiting with your CPA or other tax advisor to ensure you have a good understanding of how the new law will impact you personally.