Common Estate Planning Mistakes with Jim Lange, CPA/Attorney

Episode: 156
Originally Aired: January 4, 2016
Topic: Common Planning Mistakes with James Lange, CPA/Attorney

The Lange Money Hour: Where Smart Money Talks
James Lange, CPA/Attorney
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TOPICS COVERED:

Show Introduction: Avoiding Pitfalls along the Road to a Secure Retirement
Mistake One: Not Having a Well-Diversified Portfolio
Preparing for Changes in Tax and Estate Laws
When to Consider an Annuity
Premiums
Asset Allocation
The One-Minute Social Security Strategy

1. Show Introduction: Avoiding Pitfalls along the Road to a Secure Retirement

Dan Weinberg: And welcome to The Lange Money Hour. I’m Dan Weinberg, along with CPA and attorney, Jim Lange. Tonight, you’re going to learn how to avoid some predictable pitfalls along the road to a secure retirement. Over the course of the next hour, Jim will share with you the most common estate, retirement and investment planning mistakes that he sees in his practice, and he’ll tell you how to recognize them in your own planning. He’ll discuss mistakes like investing too exclusively in large companies, or having too much of your money trapped in fixed income vehicles, not updating wills, and not making the best decisions about Social Security benefits. Jim will also be talking about the latest edition of his bestselling book, Retire Secure!, which is available now. Regular listeners know that we often have guests on the program, but that is not the case this evening, so this is your chance to ask Jim your investing and retirement questions one on one. Give us a call here in the studio at (412) 333-9385, and let’s say good evening now to Jim Lange.

Jim Lange: Good evening, Dan.

Dan Weinberg: Good evening to you.

2. Mistake One: Not Having a Well-Diversified Portfolio

Jim Lange: So, the first mistake, and probably the most common mistake, that I want to talk about is almost the insistence of most clients…actually, by the time they become clients, we correct this mistake, but I’ll say most prospects do not have a well-diversified portfolio. Now, a lot of people think they have a well-diversified portfolio, or they say, “Well gee, I have some money in Charles Schwab. I have some money in TD Ameritrade. I have some money at Fidelity.” And if you actually look at what they have, it’s all large cap. Well, that’s not really a well-diversified portfolio, and the preponderance of many investors (and we’ll get to the issue of what percentage stocks and what percentage bonds), but the preponderance of most investors that I see before we start working with them is they have too much money in the very, very large companies. Now, when I say ‘large companies,’ I’m talking about companies with sales of a hundred billion dollars. When I’m talking about ‘small companies,’ I might be talking about companies that have sales of one billion dollars. So, I’m not talking about Mom and Pop grocery stores, and we’re going to examine how expensive and how much it costs in terms of lost opportunity to invest only in large companies, and I get it. You know, we’re afraid, we don’t want to make a mistake, and we’ve heard of companies that are so large that we feel more comfortable investing in them. But as I think we’re going to see when we get into the numbers, it’s not nearly as advantageous as you might think.

The other thing is, people invest too much money in growth companies. Now, what is a growth company? A growth company is a company that has a very high price-to-earnings ratio, meaning that the company is very expensive to buy relative to how much money it makes. So, think Amazon. Amazon doesn’t make much, but the stock is very expensive. The opposite would be a value company. Think the electric company. It’s a good solid earner. It doesn’t cost all that much money to buy. But it’s not all that exciting because there might not be as much upside. People are over weighted in growth, underweighted in value, just like they are over weighted in large and they are underweighted in small.

The other area that I see people being really way out of whack is, they kind of assume that there can’t be any good companies that are operated outside the United States. Now, I will concede that even American companies have worldwide distribution. To some extent, even investing in American companies, you are still investing at least some of your money in the worldwide economy. But there are a lot of good companies all over the world, and, historically, they’ve actually done a little bit better than American companies, and even if they didn’t do better, even if it was a tie, or, honestly, even if they were a little bit worse, I would still want people to have representation in companies around the world, both in the developed and the developing markets.

So, what I’d like to do is actually talk about how expensive and what the equity premiums are, and what the large cap premium and the small cap premium are. But do we have a call?

Dan Weinberg: I think we do. We have somebody who’s taken us up on that offer. We have David from Sunny, Arizona. David, are you there?

David Beeman: I’m here. Hello, Jim Lange. David Beeman, formerly from Anchorage, Alaska.

Jim Lange: Oh, I remember you well. David, if I could interrupt. Before you even start, I have a quick Alaska/David Beeman story. I don’t know if you remember this.

David Beeman: Yes, I do.

Jim Lange: All right. So, anyway, David is actually a client, and he met me through the internet, he liked what he saw on the website and we started talking over the phone, and I did some work for him and it was fine. And as an author, people are always asking me, “Well gee, Jim, are you doing book signings?” And I’m an author, and by the way, the new edition of my book, Retire Secure!, is out and you can find that at jameslange.com or at Amazon. But anyway, people are saying, “Oh, are you doing book signings?” And I’m trying to say, “Well, I’m not exactly like Jerome Bettis,” and I have done maybe ten or twenty book signings, but it’s not the kind of event that a Jerome Bettis would get. But anyway, I was going up to Anchorage. I was actually doing a bicycle ride from Fairbanks to Valdez, and I was stopping off in Anchorage, and I thought, “Well, just for the heck of it, why don’t I do a book signing in Anchorage?” So, I called the Barnes & Noble there and I said, “Hi, this is Jim Lange. I am an author, and if you are interested, I will do a book signing at your local Barnes & Noble store.” And they said, “Great!” And I said, “Out of curiosity, how many copies of my book do you have?” And they said, “Six.” And I thought, “Well, that’s pretty good. You know, Wiley did a good job with distribution. I have six books in a bookstore in Anchorage and they ordered some more in preparation for me to come,” and I had never met David, and I called him up and I said, “Hey David, guess what? I’m going to be in your neck of the woods. In fact, on this date at this time, I’m going to give a little book signing at the local Barnes & Noble, and maybe you can come and maybe you can even bring a guest.” And he said, “Great!” So, anyway, Barnes & Noble did all the advertising that they thought was appropriate, you know, this big shot author/celebrity/financial expert is going to come to Anchorage and teach all the people in Alaska about sound investing and smart taxes. Anyway, I’m going to tell you guys what a big shot I am: David did come, and he did bring a friend, and they were the only people that showed. So, now you know what a big shot I am!

Dan Weinberg: But did they buy all of the books, is the question?

Jim Lange: They did buy a book each, if I recall correctly, and in fact, David gave me a ride home, or to my hotel, because I needed a ride. I do remember that. Do you remember that, David?

David Beeman: I do. Yes, I do, and you came on the rainiest week ever. I mean, you’ll probably never come back, because it’s sunny sometimes, but it wasn’t that week.

Jim Lange: Well, actually, I mean, Alaska’s a big place, so I actually…I can’t remember how I got up there, but I went to Fairbanks and I think the weather was good there, and then I basically bicycled from Fairbanks down to Valdez, and that, I mean, it’s gorgeous. The roads are a little bit rough, but it’s gorgeous scenery.

David Beeman: Yep.

3. Preparing for Changes in Tax and Estate Laws

Jim Lange: All right, but anyway, you have a question…

David Beeman: Well, I’m glad you told that story because I was going to start out with an old Jim Lange-ism, and that is you’re really for full disclosure, so I was going to suggest to the audience that I am a client and you are a friend of mine, and so you’ve already taken care of all that!

Jim Lange: All right. Well, I agree with you. Full disclosure.

David Beeman: I actually apologize. My question was formulated before I really knew the complete content of the show, so we’re kind of switching gears. It’s something right down your alley, but it’s estate plans, so I apologize. I do agree with what you just said about stocks. I think that’s right on. But if your audience would flex with this, I’m going to ask you an estate planning question.

Jim Lange: Okay.

David Beeman: And I was going to ask, is it not difficult in your practice, knowing how to advise families, in formulating good estate plans presently when there are currently some potential significant changes coming, i.e. eliminating the stretch IRA, and with the President about to change and new lawmakers rotating, do you find it prudent to make major changes, because it appears something is about to happen? These types of proposed rule changes are likely something you have had to deal with your whole career, although eliminating the stretch IRA is likely one of the biggest game changers to your excellent estate plans. Does it not make more sense to wait until the dust settles versus developing a new revised plan that may need to be changed again in a few months? How’s that for a mouthful?

Jim Lange: Well, I think it’s a very good question, and if I could…and by the way, since I’m a lawyer, I’m allowed to take any question and then give any other answer even if it’s not to the question. But let me try to get to the essence of it, and I’m even going to slightly expand the scope of the question to say we are in, let’s say, very volatile times. You mainly were referring to tax changes that are very likely to come, and by the way, an important topic that I was going to touch on tonight anyway, so it’s very relevant. But the other changes that we are likely to see, in addition to tax changes, is we are likely to see changes in our portfolios, and one of the things when you do traditional estate planning, where you are, in effect, fixing in stone what’s going to happen at your death and at your spouse’s death, etc. is whatever you decide in terms of who is going to get what, there is a very good chance that the circumstances are going to be different than when you made that decision.

So, we’ve done, I don’t know, thousands of projections, and frankly, we’ve never been right in all these years. People had more money than we thought. People had less money than they thought. I mean, I wouldn’t have guessed that you can now protect $10.6 million from federal estate tax. So, to me, one of the big problems with estate planning is how do you plan knowing that you can have a) changes in the tax law (which is what David is alluding to, and we’ll talk about that specifically), b) changes in your portfolio, and c) changes in your own lifestyle and the lives of your family, the lives of your children, the lives of your grandchildren. These needs will likely change over time, and the traditional plans that are somewhat, I call them ‘fixed in stone,’ there’s a very good chance that that’s not going to work. So, my response to that is, let’s assume, and David referred to the ‘Leave it to Beaver’ marriage or the Cascading Beneficiary Plan, let’s assume, for discussion’s sake, that you have a traditional family, that is the original husband, original wife and the same kids and the same grandkids. So, what I’m about to say would not apply if, let’s say, your spouse has children from her marriage, and then you have children from your marriage. I’m talking about families that have children, their children are their children. That is, the husband and wife together had children, and, let’s say, those children had children. So, let’s assume that you have…and David, that’s your situation, isn’t it?

David Beeman: Yeah, ‘Leave it to Beaver’ type family, yeah, and what predicated the question is I’m working with Matt, a lawyer in your firm that’s very bright, and then I’m moving to Arizona and I’m just wrestling with whether to change my plan when I know that several changes are coming. I’m thinking about waiting.

Jim Lange: Well, I don’t want to reveal what your plan is, but let’s just say, for discussion’s sake, that your plan is similar to what we do for a lot of people. So, let’s assume, you know, you have kids and the kids are the same kids as your wife, and let’s assume that your primary goal is to take care of your wife. So, let’s start with the premise that your wife is your primary beneficiary, and, if appropriate, upon your death, all of your money (your IRAs, your Roth IRAs, your after-tax dollars, any real estate you might have), we’ll start with having your wife be the primary beneficiary. The second beneficiary might be, let’s say, kids equally, and it might be appropriate for your children or one of your children to get some money maybe after the first death. So, again, I’m not going to reveal any numbers, but just to make up a number, let’s say that you had a five million dollar estate and you died and your wife thought that all she needed was three million dollars and, at least under the current laws, I would like your wife to have the option, and the legal word is to ‘disclaim,’ or say ‘I don’t want’ a certain portion, and that would go to the next in line. Who would I recommend be next in line? Let’s say, your kids equally. Who would come after your kids? Well, it will be your grandkids, and if they are young, that money would go in a trust, and if you have IRAs and Roth IRAs, we need special language in those trusts so that when the underlying asset going into a trust is an IRA or a Roth IRA, that it has to have special language to qualify as a designated beneficiary.

So, for many people, we construct a very, very flexible type estate plan, and the important decisions of who gets what, how much should your wife keep, and which asset should she keep? Should she keep the traditional IRA? Should she keep the life insurance? Should she keep the after-tax dollars? Should she keep the real estate? We let her make that decision within nine months of your death, and that is kind of the cornerstone of what…in the literature, it is called the ‘Cascading Beneficiary Plan.’ That’s because the Wall Street Journal didn’t like what I wanted to call it, which is ‘Lange’s Cascading Beneficiary Plan.’

But anyway, building in that type of flexibility, I think, is the best you can do for the issue we have with these changes coming, and we’re always going to have changes, but you brought up one particular change. Do you want me to talk about that change?

David Beeman: Yes.

Jim Lange: Okay. So, what David is referring to is called the ‘Death of the Stretch IRA,’ and before we talk about the death, we should probably talk about the living part. So, let’s say that David wasn’t married, or let’s say that David dies and he leaves his IRA to his wife, and then his wife dies, or even on the first death…let’s assume that some IRA is going to David’s children, and let’s say, for discussion’s sake, that David’s children are roughly fifty years old when David dies, and let’s make up an even number. Let’s say that there’s a million dollars in the IRA, and let’s keep it simple as if there is one child. The stretch IRA would say that that child (who’s fifty years old, which, according to the tables, has roughly a thirty year life expectancy) would be required to take a minimum required distribution of the inherited IRA, and the way he would calculate that is he would go to Publication 590 and get a factor, which would be roughly thirty, and he would take thirty and he would divide that into one million dollars, which is a little bit less than three percent. Next year, he would take twenty-nine, divide that into the balance, and that’s how much the minimum required distribution of the inherited IRA is. Now, remember, David never paid tax on that IRA. So, when his son is taking distributions of the inherited IRA, he will have to pay tax. But what would be the worst thing that could happen? He would have to pay tax on a million dollars immediately on David’s death. That would be an income tax disaster. That would push him into the highest tax bracket. He might have to come up with $400,000 of taxes. And then, after he’s paying those taxes, the remaining money would not have any tax protection compared to the inherited IRA, where David’s son would only have to pay tax on just the amount distributed.

Now, what David’s referring to when he says ‘the death of the stretch IRA,’ is proposed legislation, it is not law now, but we believe it is coming, and we believe it is coming probably within the next couple years. The way it would work would be that a non-spouse beneficiary, so this would not affect money going to spouses, the non-spouse beneficiary would have to take, and pay income tax on, the entire IRA within five years of the death of the IRA owner. So, let’s say David dies, leaves it to his wife, his wife dies, leaves it to one child, and there’s a million dollars in an IRA. Under this proposed law, which we call the ‘death of the stretch IRA,’ that child would have to take a one million dollar distribution within five years of David’s wife’s death, and obviously, that would be a horrendous blow to his inheritance, and David, am I getting you right? What do you do now knowing that that is a likely possibility?

David Beeman: Well, I think you guys have talked about second-to-die life insurance. My wife’s got good health and mine is not as good. So, I think they look at the second spouse. I’m not sure how that works, but it just seems like it’s difficult to make that mental leap to go to second-to-die life insurance when you’ve got Lange’s Cascading Beneficiary Fund, and the stretch is still there and you said it could be a couple years coming down the pike. Well, we’re going to have a new President. We’re going to have new lawmakers. I don’t know who’s pushing this. I think it may have passed the House once, I don’t know. I really don’t know the details. But it may come down the pike. It may not.

Jim Lange: Well, that’s right, and so, here’s what I would say on a couple of those things. First, you’re right. It’s not law. So, it doesn’t make sense to change all your documents as if it was law.

David Beeman: Yeah.

Jim Lange: What’s going to happen, and you referred to second-to-die life insurance, and by the way, this is for a relatively small number of people. Second-to-die life insurance will work very well compared to leaving a very large IRA for your child or children. But you have to remember that second-to-die life insurance is a gift, and my big thing about gifts are number one, first, the first goal is always take care of the husband and the wife. So, we only even look at gifting if there is more than sufficient money to take care of husband and wife. Then, if there is, I like three types of gifts. I like just plain old ‘here’s some money. Use it for a down payment for a car or use it for a down payment for a house. Redo your kitchen.’ You know, whatever your children want. So, let’s just say general gifts. Two, I also like the gift of education in the form of 529 plans. And by the way, we just had a newsletter saying you might want to consider Roth IRAs, in effect, as an education savings account. But either one works. Let’s call it the gift of education, typically to grandchildren, and then number three is second-to-die life insurance, and I would never do a big second-to-die life insurance policy if the premium was so high that it reduced the ability for the parents to give kids on an as-needed basis, or it would hurt them so that there wouldn’t be enough money for grandchildren’s education. But if you run the numbers, and there is sufficient assets, second-to-die life insurance is actually probably a good idea even under existing law, but under the new law, it becomes very advantageous.

So, here’s what I would say in terms of what you could potentially do now if you fear this law is coming. One, and it’s probably beyond the scope of today’s talk to talk about a charitable remainder trust, which is a very cool solution, but it’s only a cool solution if they pass the law, if and when. Two, the second-to-die life insurance, again, is probably a reasonable idea now if you can afford the gift, and it becomes a great idea if they pass the law. The argument in favor of getting the insurance now is hey, it’s a good idea even if they don’t pass the law, and if we wait, we might not be in good enough health to qualify to get a favorable second-to-die premium quote. So, I don’t know if that answers your question, David.

David Beeman: It does. You did good. It’s just so hard to know when you don’t know. There’s been talk about it for some time, and I just hate to take too many actions. I mean, like, second-to-die, if they take the action, they take away the stretch, and it’s going to be five years, they’ve gotta take it out, you go buy your second-to-die life, if your health is still good. You do your charitable remainder trust. In other words, I don’t know why I’d want to do those things in advance, anticipating the laws changing. It may be changing. You would have a better feel for that than anybody. I do not.

Jim Lange: Well, I would agree with you. I would not do the charitable remainder trust unless the law actually does change. For second-to-die, I would probably only do it if it was a good idea anyway, and for many people, it really is. But I thank you for your question.

Dan Weinberg: Tonight, CPA and attorney Jim Lange is talking about some of the most common pitfalls that he sees people make in his practice. But first, we have a call on the line. By the way, if you want to call in with a question, it’s (412) 333-9385. Right now, we have Judy from Squirrel Hill. Good evening, Judy.

Judy: Hello. I have a question for Jim.

Jim Lange: Okay.

4. When to Consider an Annuity

Judy: And the question is: annuities were never on my radar, but now I’m approaching total retirement, and with the volatility in the market, at what point should someone consider an annuity?

Jim Lange: Well, first, let’s talk about what type of annuity. I suspect that you’re talking about, what I would call, a ‘commercial’ annuity, or a ‘tax-deferred’ annuity, which most “financial advisors,” well, they sell. So, why don’t we talk a little bit about that, and I will probably get in some trouble with some of the financial advisors, but I will tell you my opinion.

Judy: Okay.

Jim Lange: So, let’s say that you were to get a hundred thousand dollar annuity, and it said something like, “Well, you’re going to get a guaranteed rate of return of three or four percent, and you have a much higher upside, and then it has these special bonus features and blah, blah, blah, blah, blah, blah, blah.” And it sounds pretty good because you’re thinking, “Hey, I want to have some money in a stable market that’s going to be stable, that’s going to be guaranteed,” and let’s even assume, for discussion’s sake, that the company behind the annuity is a big company that you feel relatively confident will be there.

Judy: Right.

Jim Lange: All right. So, first, let’s look at the economics of the annuity, and here’s where I might get in some trouble from some of the financial advisors, but, again, some of these annuities, in fact, most of them, pay the advisors very, very well, and I’m licensed to sell these things, by the way. I have never sold them. They might pay an advisor maybe ten percent of the face value of the annuity. So, let’s say you buy a hundred thousand dollar annuity, and I am the one that sells it to you, then I make a $10,000 commission. All right, well, that’s very nice for me. Then, if you think about it, what does the insurance company have after they pay me a $10,000 commission? They have $90,000. And this would be my question to anybody, who would you rather invest with? A big, dumb insurance company…now, maybe they’re not all dumb, but that’s kind of the way I think about a lot of insurance companies. I’m really going to get in trouble. Now, I’m talking about advisors and insurance companies! But let’s just say an insurance company that has $90,000 to invest, and they have high costs, at best. Or would you rather have Jack Bogle invest that money at Vanguard using low-cost index funds?

Judy: Umm-hmm.

Jim Lange: Well, I think I would rather have Jack Bogle at Vanguard invest that money with low-cost index funds. Now, how about if you need some type of guarantee, like the old pension companies, you know, the old pensions would give you so much money per month for the rest of your life. If you’re looking for a certain base, and let’s assume it’s above and beyond Social Security, certainly fixed income options are a part. And the other thing that I want to mention is, there is a type of annuity that…and by the way, very few, I don’t think any of the consumer report-type writers like Jonathan Clements and Jane Bryant Quinn, they’re usually not fans of those types of annuities. But they are fans of something called an ‘immediate’ annuity, and I am also, and an immediate annuity doesn’t have all the bells and whistles of a commercial annuity. It also has far smaller costs and far less commissions for the person selling it. In fact, I think you can even get them online now, and it’s a very simple product where, let’s say, you give the annuity company a hundred thousand dollars, and depending on what the interest rate is today, and depending on how old you are, and depending on if you want it for just your life, or the life of you and your spouse, they will tell you how much money they will pay you per month.

Judy: Umm-hmm.

Jim Lange: And guys like Jonathan Clements would say it is reasonable to have a certain percentage. He would even say as high as twenty-five percent. That sounds pretty high to me, but he would say to have a certain percentage of your money with an immediate annuity, just to give you that guarantee, and if you know, just from a gut instinct, that the costs and the, let’s say, the commissions to the people selling it are significantly lower. There’s probably more money in it for your family. So, I am a fan of that type of an annuity.

Judy: And in that annuity, if you die tomorrow, would you get the rest of your money back?

Jim Lange: There’s a number of options. Let’s say it’s a single life. Let’s forget about a spouse, and let’s say that you bought it. If you did a single life with no survivorship features, poof! The hundred thousand dollars goes away. Or you could say, “Well, I want the survivor to receive payments for, let’s say, ten years.”

Judy: Umm-hmm.

Jim Lange: In which case, you would get less. That would be an option that you would take. Or you might say, “Well, I want to protect my spouse.” In which case, it pays for the remainder of both of your lives. So, there are certainly a number of options, but, in general, I don’t do a lot of immediate annuities. I do do some, but I have never done a tax-deferred or a commercial annuity, because I don’t think it’s the best thing for the client, and my and Jack Bogle’s and many other people’s big thing is we believe that all advisors should be fiduciary advisors, meaning that we not only have the moral, but we have the legal obligation to do what is in your, not our own, best interest.

Judy: Right, right. So, what I’m doing right now, actually, is when the market goes up, I’m reaping some of those returns and putting them into a TIAA, which is a fixed…but it’s kind of the same thing.

Jim Lange: Well, now, you’re talking about TIAA.

Judy: Yeah.

Jim Lange: And that, by the way, now that has its own advantages and disadvantages. One of the things I really like about TIAA (and this is usually for people in the public sector, like employees of non-profits, hospitals, universities, etc.) is if you have been in the system for a long time, the TIAA that you have, that is the fixed income portion of the portfolio. The CREF is the…

Judy: That’s the one that makes you nervous!

Jim Lange: Well, that’s the market.

Judy: Yeah, right, exactly.

Jim Lange: And the CREF actually tracks very closely to the S&P 500, and frankly, you should have both.

Judy: Yes.

Jim Lange: But what I was going to say is, the TIAA, for people who are already in the system, is paying higher than today’s interest rates.

Judy: Yeah.

Jim Lange: So, with six hundred college professors, by the way, I have never suggested any of them take one dollar out of their TIAA and give it to me to manage, even though it would be in my interest to do so, because they all need at least some fixed income, and since I can’t compete with TIAA in terms of fixed income. Now, I think I can compete with CREF in terms of the stock investments.

Judy: Umm-hmm.

Jim Lange: And by the way, mainly because CREF doesn’t do what I was just talking about in terms of diversifying. They don’t have sufficient small. They don’t have sufficient value. They don’t have sufficient international, etc. At least, most people don’t. So, therefore, TIAA is good, but particularly for the grandfathered TIAA.

Judy: Right, right, yeah.

Jim Lange: Okay?

Judy: Well, that’s good. That’s what I have, right. All right. Well, thank you very much.

Jim Lange: Well, thank you for your call.

Judy: Okay.

5. Premiums

Jim Lange: All right. So, we’re not going to quite get to the entire scope of what I was going to talk about today, but I do want to talk about these premiums because before, I said value beats growth. Well, let’s put some numbers to it. For the years between 1927 and 2013, if you were in large U.S. growth stocks, you would have done 9.44%, not quite as well in recent years, but that’s a pretty good return. On the other hand, if you were in value, that is, a stock or set of stocks that were relatively cheap compared to how much money they were making, you would have gotten 12%. So, that’s a 2.5% difference. Two-and-a-half percent from 1927 to 2013 is enormous. And that, by the way, would be called the ‘value premium,’ which is how much you could expect over the growth stock.

All right. Let’s talk about small. Between 1927 and 2013, if you were in small cap and you were in small cap value, you would have actually done 15.08%. Think about that. In large cap growth, you’re at 9.44%. At small value, you’re at 15.08%. And there’s just a huge, huge difference, and that’s one of the reasons why people should be more in value. Also, international value has outperformed U.S. large growth. Emerging market value has outperformed, and the biggest mistake that I see people make is they don’t have enough small, they don’t have enough value, they don’t have enough international, they don’t have enough emerging markets, and here’s what I would say: that if you have all these types of stocks and types of companies (and the ones that we promote, you would literally have 13,000 companies across forty countries in the world), that you will a) get a better return overall, and b) perhaps more importantly, be safer because you have so many types of investments.

Anyway, today is call day. We actually have a third call, and by the way, when I do the workshops, the questions are the most fun part for me. So, when I’m doing the radio show, the calls are great. The other thing is, I got through what I wanted, which was the most important part, which is people are underweighted in small, they are underweighted in value, underweighted in international, and underweighted in emerging markets. But why don’t we take the next call?

Dan Weinberg: All right. We’ve got Doug from Wexford. He has a question about a trust as an IRA beneficiary. Doug, good evening.

Doug: Hi Jim. Yeah, my question deals…if a trust is a beneficiary of an IRA, how is that handled for our required minimum distribution requirements? And I understand there’s a concept such as a see-through trust, but if you feel like you don’t satisfy the requirements for that, what is the RMD consequence for that, and if the deceased already was receiving required minimum distributions?

Jim Lange: Okay. Well, the first question is, who is the trust for? And if it’s private, and obviously don’t use names, but is the trust for the benefit of a minor? Is it a special needs trust?

Doug: No. It was the children of an older person, and these beneficiaries range from sixty-two to fifty.

Jim Lange: Okay. All right. First of all, it’s not all that common to have a trust as the beneficiary when the beneficiaries themselves are, let’s say, mature, responsible adults. But let’s assume, for discussion’s sake, either justifiably or not, that the IRA owner thought, “Hey, gee, you know, my kids, they might have creditors. They might go bankrupt. They might be spendthrifts. I want to make sure that that money is there, and I want that money protected for them.” If the trust is drafted correctly, the trust can be drafted in such a way that it becomes, in effect, a see-through trust. And usually, typically, if you have multiple beneficiaries, you would separate them into multiple trusts, and then each trust would have to take a minimum required distribution of the inherited IRA, just like I explained before, based on the life expectancy of that particular beneficiary. So, let’s say one was sixty and had a twenty-five year life expectancy. They would have to take four percent of the balance, assuming it is drafted properly. And by the way, that’s a big if.

Doug: Yeah, and that’s the problem. This was a living trust that was written in ’97. So, it doesn’t really seem to have that type of language in there.

Jim Lange: Well, it doesn’t really matter when it was written. I mean, if we had done it in 1997, it would be just fine.

Doug: Okay.

Jim Lange: But if it doesn’t have the right language and it’s potentially audited, then you could have a massive income tax acceleration, and the tax would either be due immediately or within five years. So, it’s a real issue, and by the way, a quick story. You know, today’s the story day. There was an article in the Wall Street Journal, and it said if the underlying asset of a trust is an IRA, that you should use something other than a trust, because it is tricky to draft the trust and the accounting is a little bit complicated. And I thought that that was terrible advice. My thinking is, no, don’t avoid a trust. If you need a trust, if you have a spendthrift, if you have a special needs, if you have the I-don’t-want-my-no-good-daughter-in-law-to-inherit-one-red-cent-of-my-money, or any other legitimate reason to have a trust, you should still have a trust. Just make sure that you go to an attorney who understands how to draft that trust and knows how to administer it after death, and that might not have happened in the past. But if you’re in, what I would call, ‘planning mode,’ as opposed to cleanup mode.

Doug: No, we’re in the beneficiary mode, so…

Jim Lange: Yeah. Cleanup mode is after death when you don’t have the right language, or whatever it is. Now, whether the particular language is appropriate, I mean, I would actually have to take a look at that. We would hope it is. There might be some wiggle room. But my big thing is, I do not fear trusts as beneficiaries of IRAs, as long as the trust is drafted properly. Now, to be fair, if there’s not a lot of money, you know, let’s say there’s a hundred thousand dollars, and there’s four grandkids, and each grandkid’s going to get $25,000, or something like that. You have to be a little bit careful that the cost of administrating the trust is reasonable compared to the amount of money in the trust. Now, by the way, the cost of drafting it isn’t that hard. It’s not that expensive. But if you’re talking about you needing a separate tax return, you needing a K-1, you’re mucking up the tax return of the beneficiary, and if you’re doing all that for $25,000, it might not be a good deal, particularly if this death of the stretch IRA passes.

Doug: Right. Now, you were saying that if it didn’t succeed in being a see-though trust, then it could be paid off in five years, or it could potentially be taxed entirely?

Jim Lange: That’s correct. Most likely, it would have to come out within five years.

Doug: Okay. Because, in this instance, the deceased was already receiving the required minimum distribution.

Jim Lange: Well, you know something? We’re going a little bit far askance from our show. I don’t mean to cut you off because I like the questions. That sounds like it’s more of a private question. I’m not trying to hurry you into the office. I’d be more than happy to take that privately. The other thing is, we only have ten more minutes, and I did promise a show on mistakes.

Doug: Okay.

Jim Lange: So, I’d like to go back to that, if possible.

Doug: Well, I appreciate all the information you provided.

Dan Weinberg: All right, well, Doug, thank you so much for your call.

Doug: Thank you. Bye-bye.

Dan Weinberg: Bye-bye.

Jim Lange: Okay. So, why don’t we go to the next issue?

6. Asset Allocation

Dan Weinberg: Okay, so we were talking about asset allocation. Should people have one asset allocation for all their money?

Jim Lange: Well, that’s also a common mistake. So, let’s just say, for discussion’s sake, you’re on top of your asset allocation. Somebody says, “Well, gee, what’s your asset allocation?” You say, “Oh, it’s 60/40.” That is 60% stocks and 40% bonds, and a lot of people think, “Well, that’s the end of the discussion.” Or even, if you’re going to be more specific, of that 60% stocks, you have so much in large growth and large value and small growth and small value international, etc. So, here’s what I would say to that. We are big proponents of what we call the DiNuzzo bucket, or stack, analysis, and we would actually have you have maybe five or six portfolios. The first portfolio would be for very short-term money and for necessities, and that money’s going to mainly be invested in cash, CDs, maturing bond ladders, something that if the market goes down, that money isn’t threatened. Then, going out a little bit further, where maybe money that you’re going to need in years, say, three to five or three to six or seven, depending on your comfort level, we will have the next bucket, or stack, and that’s going to still be a bunch of cash in CDs and fixed income, but there is going to be some equity in there. So, there’s going to be some risk, and more risk than the first bucket, but not as much risk as the next bucket. So, the next bucket will have even more risk that is a higher percentage of stocks, and then you would keep going, and the last bucket might even be money that you’re probably never going to spend, and that money would probably be invested in something that has the greatest upside potential over time. So, you might, for example, invest that money in maybe small cap value, or emerging market value, and that would be perhaps invested in Roth IRAs. So, I would say a) different types of money should be invested differently, and b) I think that you should have multiple types of portfolios within the overall portfolio.

Dan Weinberg: Now, does it make a difference if our listeners are collecting Social Security or receiving a pension?

Jim Lange: Well, sure it would. So, the question again, let’s say you have two people. They each have $500,000 of investible assets. One has a very strong Social Security and a very strong pension, and the other one does not. Well, we have to be more conservative with the client who doesn’t have a pension or Social Security because if the market goes way down, we have to make sure that there is sufficient money for him to live comfortably the rest of his life. If that same person has a pension in Social Security, we can actually afford to have more money in the market taking a greater amount of risk, knowing that the short-term money…I have clients who, between their Social Security and their pension, that covers most of their expenses. So, for somebody like that, they can invest more aggressively, get, in the long-term, a higher return for themselves and their children and grandchildren down the road, compared to somebody who doesn’t have a pension, where we have to be more conservative because no matter what (and this would go for everybody, by the way), you always want to make sure that there is enough money for both husband and wife to live very comfortably for the rest of their lives. That’s number one. That’s before kids. That’s before grandkids. You know, we’re talking food on the table, roof over your head, gas in the car, and a little bit of money for Saturday night. You always want to guarantee that. So, you can’t be wild if you don’t have Social Security or a pension.

Dan Weinberg: Okay, and does it make sense to analyze different stocks and sectors and then invest in ones that did well?

Jim Lange: Well, that’s what a lot of people do. That is, they’re really into, “Gee, I’m going to analyze, let’s say, a particular stock or even a particular type of money,” and then what happens when they actually take a look and see what happens…so, let’s say, for discussion’s sake, it is 1999, okay? In 1999, emerging markets did 66%. So, let’s say it’s December 1999, and you’re looking at your portfolio and your emerging markets did 66% and you’re going, “Wow! This is great! I should buy some more of that.” So, how do you buy more? Well, you sell what did the worst. What did the worst? In 1999, small cap and real estate did the worst. Okay, you’re going to sell your real estate, you’re going to sell your small cap, and you’re going to buy emerging markets. Well, what happened in the year 2000? The emerging markets, instead of making another 66%, they lost 30%. They were the worst performing sector. What did the best? Real estate and small cap. So, it doesn’t make sense to chase good returns. What makes more sense is to have a well-developed, well balanced portfolio, and in fact, I would actually argue that you should do the exact opposite. So, for example, at the end of 1999, what would happen is because your emerging markets did so well, you would want to actually trim that because they became too high a percentage of your portfolio. You would actually sell that and you would buy what didn’t do as well, and that’s not market timing, that is rebalancing, and it mechanically forces you to sell high and buy low, which, over time, is going to be very valuable.

Dan Weinberg: And one of the cures for that, would you say, is, perhaps, index funds, which are sort of leveling the field?

Jim Lange: Well, I don’t know if index funds are leveling the field, and this might be the last point that we’re going to have time for tonight, so why don’t we talk about, first, what an index fund is. So, now we go back to 1974, and Jack Bogle said, “Gee, let’s think about this. Half the money managers who are trying to pick the best stocks, half of them are saying buy, half of them are saying sell. There are very high fees involved, and people aren’t doing well.” So, he created a fund that, basically, to oversimplify, if you owned his fund, you would own the top five hundred stocks in the United States. The only criteria was size. Now, you would own a pro rata, and he had some formulas for buys and sells, and everybody thought he was going to lose his shirt, and they called it ‘Bogle’s Folly.’ That fund is still around today. It has a different name. It’s called the Vanguard S&P 500, and it is one of the most successful funds in history. It has $1.7 trillion invested. That is an index fund. There is more and more money, and, in my opinion, it’s a good thing for more and more money to go towards the index direction as opposed to the actively managed funds.

Dan Weinberg: Okay, and we have about a minute. Can you say anything about Social Security strategies in one minute?

7. The One-Minute Social Security Strategy

Jim Lange: Okay. The one-minute Social Security strategy is apply and suspend. So, let’s say that you have a husband and wife and they are both sixty-six years old, and let’s just use the old sexist paradigm where the husband had the higher earnings record. In general, subject to exceptions, I would want the husband to apply for Social Security and suspend collection. What does that mean? That means he doesn’t get anything. What’s the difference between that and doing nothing? By applying and suspending, that allows his wife to collect 50% of what he would have collected. That pattern goes on until they are seventy. In the meantime, he’s getting an 8% raise on his Social Security, notwithstanding the fact that his wife is collecting on his record. She gets an 8% raise, and then, no matter which one dies first, the survivor will get the higher number. There is often a difference, literally, of hundreds of thousands of dollars between getting the strategies right and getting them not right, and then, if you really want to do it right, tie that strategy into Roth IRA conversions to get a synergistic result.

END

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