Market Concentration in the Fall of COVID

by Jason Vaurio, Senior Investment Research Analyst

At the height of the COVID-19 market meltdown it would have seemed farfetched to say that the S&P 500 Index would be sitting with just under 10% gains for the year at the end of August. Surely we must have found a vaccine and administered it to the global populous with impossible efficacy and speed! It turns out a miracle cure or vaccine wasn’t the shot in the arm required for the S&P to rebound to new highs; all it took was an aggressive Fed, significant fiscal stimulus and the largest tech companies in the world to continue their dominance in the market. Though if we peel back a layer, we’ll find that the market’s reliance on tech growth is strikingly similar to that of the dot-com craze of the late 1990s/early 2000s.

The five largest publicly-traded companies in the world, measured by market cap, are: Facebook, Apple, Amazon, Microsoft and Alphabet (Google) aka “FAAMG.” At the beginning of the year these tech giants accounted for 16.7% of the market-cap weighted S&P 500 Index. Today that number stands at 23.9%. After free-falling with the rest of the stock market in the first month of the shutdown, tech stocks have ascended with exceptional velocity.

The S&P 500 Index is now up +9.7% year-to-date. The largest components of the index, FAAMG, have gained +56% year-to-date through August, propping up the performance of the broader market. Excluding these five companies from the index, the S&P would have returned a paltry 0.9%.

This market bifurcation can be explained, in part, by the COVID-19 shutdown and focus on social distancing. With brick & mortar stores effectively shut down in the spring and summer months, consumers directed their spending to online retailers. Businesses and employees were more likely to purchase additional hardware and software that would lessen the burden on a work-from-home labor force. All of these behaviors helped large tech companies capture an extra slice of the pie. But the amount of market concentration and large valuations of these tech mega caps should be cause for some concern.

Since the end of 2019 the FAAMG have added $2.7 trillion to their collective market cap – eight months to add $2.7 trillion. To put this breathtaking growth into context, in the five years prior to 2020 these titans of tech grew by a combined $3.2 trillion. The 10 largest components (including FAAMG) of the S&P 500 now account for 29% of the index’s total market cap, eclipsing the 26% concentration at the height of the dot-com bubble. The big five tech companies have the same amount of influence on the S&P 500 as the bottom 370 stocks in the index.

When the S&P 500’s performance is fueled by a handful of large stocks, the overall index return can mask the underperformance of the other ~495 stocks in the index. This is referred to as “narrow” market breadth and increases the concentration risk of the index. If (or when) those few names begin to lose their momentum, the broader index is more susceptible to large downturns. This scenario played a role in the dot-com crash.

Though the FAAMGs continue to grow their revenues and generate cash, stock returns are ultimately based on how much investors are willing to pay for that stream of cash flows. Price-to-earnings, price-to-book and price-to-sales ratios continue to stretch beyond near and long-term averages. This is especially evident in technology stocks; the S&P Information Technology Sector Index currently trades at 34.5x earnings, well above its 20-year average of 25.2x. On average, the FAAMG stocks are priced at 60.3x earnings.

While it’s natural to see parallels between the present day market and the tech-fueled delirium of the dot-com bubble, there are stark differences from 20 years ago. These are not unprofitable “.com”-suffixed companies fresh off their IPOs. The tech companies driving performance today are profitable, growing businesses with revenue streams diversified across tech segments (retail, communication, internet advertising, business software, etc.). These contemporary colossi of computing are responsible for bringing smartphones and tablets into our everyday lives and the network effect has helped them develop a stranglehold on internet advertising and cloud-based storage. The sustained low interest rate environment has minimized borrowing costs and spurred massive investments into their business operations.

It is always important to remember that starting valuation is an important determinant of future returns. Current elevated valuations negatively affect forward-looking risk/reward expectations. Investors often have a tendency to extrapolate recent trends too far into the future and any disruption to these trends can induce a downturn in stocks. A well-diversified portfolio that includes a combination of global equities and safer assets such as bonds is recommended to help withstand a potential market correction.

The information in this presentation is for educational and illustrative purposes only and does not constitute investment, tax or legal advice. The opinions expressed are those of Oxford Financial Group, Ltd. The opinions are as of the date of publication and are subject to change due to changes in the market or economic conditions and may not necessarily come to pass. Oxford Financial Group, Ltd. is a Registered Investment Advisor (RIA) registered with the Securities and Exchange Commission and is headquartered in Carmel, Indiana. Registration does not imply a certain level of skill or training. For more information about our firm, or to receive a copy of our disclosure Form ADV and Privacy Policy call 800.722.2289 or contact us at info@ofgltd.com. OFG-2009-3

Sprints, Marathons and Hurdles: Estate Planning Techniques for 2020

In our article, The 2020 Estate Planning Trifecta, we discussed the perfect storm of elements that should drive clients to consider estate planning strategies, to wit:

1. Historically low interest rates
2. Highly favorable tax laws
3. Volatility in the valuation of not only marketable securities, but also many closely held businesses

In this second article of our series, we dig deeper into key 2020 planning strategies, as well as the practical considerations that should shape our thinking today. Planning in our current environment should focus on: avoiding the burn of a sprint, good planning is a marathon and low hurdles are easier to jump.

Sprint – A run over a short distance in a limited period of time.
The current tax law provides for all-time high estate/gift and GST exemptions of $11,580,000. All wealth in excess of these amounts will at some point be subject to wealth transfer tax, currently at the rate of 40%. However, the period to use these high exemptions is time-stamped with a sunset date of 2025 at the latest and could be reduced earlier (perhaps as early as 2021) under a potential Biden administration and a change of control in the Senate. As such, a common theme for exemption planning in 2020 is “Use It or Lose It.”

We are fortunate to have a historical perspective from 2012, when it was highly speculated the exemption amounts would fall off the fiscal cliff. Families who took a wait and see approach were left doing Hail Mary planning without time to tailor trust documents to their unique situation. The available margin of our estate planning brethren was nearly zero, and many assembly-line trust documents were generated out of sheer necessity.

We find ourselves in a time that may feel like impending 2012 deja vu, and families who procrastinate planning until the end of 2020 may feel the burn of the sprint.

Marathon – A lasting effort highly rewarded by endurance.
Sound planning and creating a thoughtful trust structure is the proverbial “marathon, not a sprint.” The rewards for this effort are many, including:

  • The thoughtful selection of trustees and other fiduciaries
  • Maximizing options to enhance flexibility
  • Consideration of appropriate distributions for current descendants and generational lines
  • Enhancing provisions that maximize tax advantages
  • Creating entities that may entitle some assets to valuation discounts prior to a gift
  • Ensuring sufficient time to avoid certain IRS risks associated with some strategies
  • Determining the optimal state trust situs for particular goals and objective
  • Selecting the optimal assets for trust funding, including time to consider and structure gifts of business interest and other non-marketable securities

For those who may be ‘on pause’ at the notion of moving remaining exemption amounts off their balance sheets, several types of trusts are uniquely tailored to:

  1. Enhance flexibility
  2. Provide some contingent access to the trust income

A Spousal Lifetime Access Trust (SLAT) is a trust that is created by one spouse for the benefit of the other spouse, as well as children and potentially grandchildren and beyond. By including the spouse as a beneficiary, the marital unit can maintain access to trust income and assets if circumstances later require. The spouse’s interest may cease upon divorce, or may continue. The beneficiary spouse may also hold a Limited Power of Appointment to redirect the trust assets at his/her passing to adapt for any changing family dynamics. See the April 2019 e.Insight, The Adaptable Spousal Lifetime Access Trust.

Another type of trust, sometimes referred to as a Contingent Access Trust (CAT), can give an independent Trust Protector the power to add beneficiaries from a class which could include a current or future spouse, or even the grantor provided the trust is created in a jurisdiction whose trust laws include the appropriate statutes. A CAT can be ideal for a currently single individual, or a couple who may be concerned about the impact of divorce or the death of the beneficiary spouse.

A few significant notes to self:

  1. A trust need not be funded immediately. It can be structured now, and then funded at a later date when there is more clarity around potential political shifts or proposed changes to tax laws.
  2. Families who already have irrevocable trusts should review them with their advisors to see if the provisions currently meet (or can be modified to meet) the goals of the family, thereby avoiding the added complexity and administration of additional trusts.

By starting early to structure a new trust or modify an existing trust, families can run the first leg of the marathon now and enjoy the fruits of thoughtful planning for generations to come.

Hurdle – The act of clearing an obstacle to be successful.
An estate freezing strategy is designed to freeze the taxable value of an asset, allowing future growth to occur outside of the taxable estate. Many estate freezing strategies require a certain amount of trust income or assets to be paid back to the grantor. This amount is referred to as the ‘hurdle rate,’ and is defined by the IRS as either the applicable federal rate or the Section 7520 rate.

Essentially, hurdle rates are wealth that must be paid back into the grantor’s taxable estate. Thus, the lower the hurdle rate, the greater the amount of appreciation that remains in trust, free of wealth transfer tax.

The historically low hurdle rates in the current environment are barely a speed bump.

Key Estate Planning Techniques for 2020
In order to utilize the exemption amounts, something must be gifted. However, a “gift” need not necessarily be an outright gift of assets to a trust, such as the gift to a SLAT as described above. The following are additional strategies to utilize the current exemptions and transfer wealth to heirs.

Sale Strategies
A common strategy to freeze the value of assets in the taxable estate is a sale to an irrevocable grantor trust. Such a trust may be referred to broadly as a ‘Defective Grantor Trust’ or ‘Irrevocable Grantor Trust.’ A SLAT is a type of such a trust.

The trust is created and funded with seed capital, which is a gift to the trust. Thus, a ‘third party’ is created. When properly structured, the trust becomes a legitimate borrower, which can later purchase assets from the grantor. However, unlike a sale to a traditional third party, whereupon capital gains are recognized, the trust is designed to utilize provisions in the income tax code which render it a “grantor trust.”

What is the significance? The trust is then deemed one-in-the-same with the grantor for income tax purposes and there is no recognition of gain upon the sale of assets to such a trust.

Further, by complying with the provisions of the Gift and Estate Tax Code, the trust is structured as an irrevocable trust. Hence, when successful, the non-appreciating note is in the Grantor’s estate and the appreciating assets are held in the trust, free of wealth transfer tax on future appreciation.

The Grantor, in return for this sale of assets, takes back a promissory note from the new Trust. In the present environment, a nine-year interest-only note with balloon principal payment would require a minimum AFR of .41% for August, 2020.

Forgiveness of Promissory Notes
Note forgiveness is a gift. When properly structured, it is a gift that utilizes exemption. In the case of the sale of assets to an irrevocable grantor trust, the value of the trust is improved by no longer owing this debt to grantor.

The ability to structure such a sale in return for a note affords the grantor some ‘wait and see’ margin. The note can be held for its full term, or, if the political tides shift to the blue and a reduction in exemptions is deemed inevitable, the grantor may forgive the note at that time, thereby utilizing gift and estate tax exemption.

Grantor Retained Annuity Trusts (GRATs)
A GRAT is similar to a sales strategy. However, the annual payments required to be paid to the grantor are structured as annuity payments. The hurdle rate is the section 7520 rate, which is .4% for August, 2020. All appreciation over and above this historically low rate accrues to the benefit of the trust beneficiaries.

Longer term GRATs (for example, terms of 5 to 15 years) provide an opportunity to lock in the low hurdle rate for a more substantial period. Because the grantor must outlive the GRAT to avoid assets being pulled back into their estate, longer term GRATs are beneficial for clients with lower mortality risk, and are also well-aligned with assets that provide higher cash flow such as higher dividend yielding stocks and certain business interests. Another way to potentially minimize the mortality risk is to play into it. A 99 year GRAT may, especially if the 7520 rate increases, not require that all of the assets be pulled back into the Grantor’s estate at passing; thus leaving some assets to pass to the remainder beneficiaries transfer tax free.

Lastly, GRATs can be structured with either, (1) a gift component in order to utilize gift and estate tax exemption, or (2) as a zeroed-out gift, which would be beneficial as a freezing strategy for families that have already used their full exemptions.

Conclusion
As noted, thoughtful estate planning is a marathon. For many affluent families, the use of their full estate/gift and GST exemptions is just the start. Estate freezing strategies and enhancing trust structures should continue to be explored as long as assets are appreciating and there is remaining estate tax exposure.

As always, a review of your entire balance sheet will enable a full analysis of the pros and cons of each potential strategy. Your Oxford team will collaborate with your other trusted advisors to evaluate these potential strategies in light of your family’s unique situation.

Oxford Financial Group, Ltd. is an investment adviser registered with the U.S Securities and Exchange Commission. Registration does not imply a certain level of skill or training. More information about Oxford Financial Group Ltd.’s investment advisory services can be found in its Form ADV Part 2, which is available upon request.

The opinions expressed are those of Oxford Financial Group Ltd.’s Investment Team. The opinions referenced are as of the date of the publication and are subject to change due to changes in the market or economic conditions may not necessarily come to pass. The information in this presentation is for educational purposes only and does not constitute investment, tax or legal advice. Tax and legal counsel should be engaged before taking any action. Forward-looking statements cannot be guaranteed. OFG-2008-11

Certified Financial Planners™ (CFP®) are licensed by the CFP® Board to use the CFP® mark. CFP® certification requirements include: Bachelor’s degree from an accredited college or university, completion of the financial planning education requirements set by the CFP® Board (www.cfp.net), successful completion of the CFP® Certification Exam, comprised of two three-hour sessions, experience requirement: 6,000 hours of professional experience related to the financial planning process, or 4,000 hours of Apprenticeship experience that meets additional requirements, successfully pass the Candidate Fitness Standards and background check, agree annually to be bound by CFP® Board’s Standards of Professional Conduct and complete 30 hours of continuing education every two years, including two hours on the Code of Ethics and Standards of Professional Conduct.

The Personal Financial Specialist™ (PFS™) designation is awarded by the American Institute of Certified Public Accountants (AICPA) to candidates who display their expertise in the field of financial planning. Candidates must be a member of the AICPA, hold an unrevoked CPA certificate issued by a state authority, and have at least two years of teaching or business experience (3,000 hours equivalent) in personal financial planning within the five-year period preceding the data of the CPA/PFS application. Candidates must have 75 hours of personal financial planning education within the five-year period preceding the date of the PFS application, and pass a final examination. The designation requires 60 hours of continuing education every three years.

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Planning for the Shifting Sands of Taxes

Last week, Joe Biden introduced his comprehensive economic plan, including his “Buy American” plan. In response to questions regarding how to pay for the new programs, reference was made back to tax proposals previously announced earlier in his campaign. Some proposals are simply a reversal of some of the provisions enacted by the Tax Cuts and Jobs Act of 2017. Others are new and will impact both individual and corporate taxpayers.

While Biden’s proposal is centrist relative to the high-profile progressives (Senators Warren and Sanders), it will bring meaningful change to the tax code and headwinds for investors.

The tax provisions previously enacted under the Tax Cuts and Jobs Act of 2017 and relating to individual taxpayers came with an expiration date of December 31, 2025. As it relates to estate planning with the increased exemptions, many individuals are in the process of implementing trust strategies to take advantage of the increased exemptions before they return to lower levels. The timeline for completing this planning may be accelerated depending on the outcome of not only the Presidential election, but also by control of the House and Senate. Nevertheless, we believe it is a good idea to complete the execution and funding of trusts by year-end to assure that the full benefit of the increased gift and estate as well as generation skipping exemptions can be utilized.

The more significant impact of the Biden Plan are the items that are not simply a rollback of the Tax Cuts and Jobs Act of 2017 provisions, but are provisions that have not been planned for and that implement new tax rates. The bulk of these proposed changes target higher-income taxpayers.

For business owner clients, whether operated as a C Corp or Pass-Through Entity, the potential income tax changes have the potential to significantly alter income and business valuations. Business owners considering a possible sale of their business could see after-tax proceeds reduced by nearly 50% if the increased capital gains tax rate were to be implemented.

From an economic perspective, we believe Q2 is likely to be the bottom for most indicators. From here we expect significant improvement, which will be meaningful on a percentage basis, though still well below full output/employment. With the looming election there will be substantial pressure on Congress to continue providing enhanced unemployment benefits (which are set to expire July 31) and corporate support. Congress is in recess until July 20 so we expect a flurry of activity around month end.

Corporate profits have been elevated in recent years and our current expectations are that these would decline independent of the fall election. If the Biden Plan is implemented, this would put further pressure on profit margins. A recent Goldman Sachs analysis estimated the increase in corporate tax rates would reduce Earnings Per Share (EPS) for S&P companies by 12%.

As we look ahead to the fall, we envision a couple of factors that may contribute to heightened volatility. The first would be a rising probability of a Democratic Senate alongside a President Biden. Currently they need to pick up three seats to reach 50, and a Democratic Vice President would be the tie-breaking vote. This presumes the two independent Senators (Bernie Sanders, Vermont & Angus King, Maine) continue to caucus with Democrats. The second is potential policy responses from the Trump administration in an effort to shore up support through the fall, which could include particularly aggressive trade actions and rhetoric.

The chart below highlights the historical average annual return under various political regimes. It is notable that some degree of balance is a good thing and market concerns about a Democratic Congress are valid.

A Democratic sweep could be a headwind for equities, particularly in sectors expected to face increasing regulation. These could include for-profit education, for-profit prisons, defense and aerospace and energy. Conversely, Democratic control of the “power of the purse” would benefit infrastructure programs, renewable energy, and absent a “public option,” a number of healthcare companies could benefit from additional spending if we see an expansion of the Affordable Care Act.

Another area that will surely be impacted by the election is US trade policy. In recent years many CEOs and CFOs have lamented the tremendous uncertainty on this issue. Clarity around the path forward, even in the face of a more restrictive regulatory regime, should lead to an uptick in corporate investment.

Independent of the election results, we expect Congress and the Federal Reserve to be active in supporting the US economy well into 2021.

In anticipation of continued market volatility, Oxford has been evaluating all facets of our portfolios, but with a particular focus on real assets and assessing how tax rates would impact our fixed income allocations, particularly within niche segments of the municipal bond market. As always, our managers are making decisions on a company-by-company basis to assess how these changes might impact cash flows and the shifting range of outcomes from current market prices.

Engaging Your Oxford Team
In the upcoming weeks and months, we will explore strategies to consider throughout the remainder of the year to minimize the potential negative tax impact for individuals and business owners that may result if the Biden Plan were implemented. These may include considerations of strategically recognizing capital gains, exploring tax-loss harvesting opportunities to offset gains, planning considerations around adjusted gross income, the impact on deal structure for business owners considering a partial or full exit strategy as well as estate planning strategies to fully capitalize on gift and estate and generation-skipping exemptions.

There are a number of variables that must fall into place before implementation of Joe Biden’s tax policies would occur. Besides his election as President, the most important may be the control of the Senate. Regardless of the election outcomes, your Oxford team is positioned to ensure that our affluent family clients continue to develop well thought out wealth enhancement strategies and implement them timely and efficiently. Consultation with your Oxford team and an analysis of the possible impact of any tax policy, regardless of the candidate, will allow your full team of advisors to identify the optimal solutions for your family.

The information in this presentation is for educational and illustrative purposes only and does not constitute investment, tax or legal advice. The opinions expressed are those of Oxford Financial Group, Ltd. The opinions are as of the date of publication and are subject to change due to changes in the market or economic conditions and may not necessarily come to pass. Oxford Financial Group, Ltd. is a Registered Investment Advisor (RIA) registered with the Securities and Exchange Commission and is headquartered in Carmel, Indiana. Registration does not imply a certain level of skill or training. For more information about our firm, or to receive a copy of our disclosure Form ADV and Privacy Policy call 800.722.2289 or contact us at info@ofgltd.com OFG-2007-07

The Financial Landscape – June 2020

Global Macro Environment

Green Shoots Appearing in the Global Economy
The global economy has received encouraging news of late that could signal a bounce back. First let’s begin with the US. Friday’s jobs report indicated the economy may be able to pull out of the downturn faster than expected. Data showed the economy defied expectations as payrolls rose by 2.5 million in May.The unemployment rate declined from 14.7% to 13.3%, which is still a staggering absolute number, but much better than consensus views. The underemployment rate (U‐6 rate) is currently 21.2% vs. the previous 22.8%. On the downside, the permanent jobs lost number continued to rise and stands at 2.3 million. Even amidst this encouraging report, high unemployment should not be discounted as a headwind for normalization. The Institute of Supply Management (ISM) Manufacturing Purchasing Managers Index (PMI) improved month‐over‐month to 43.1 in May from 41.5 in April. The ISM Non‐Manufacturing PMI also rose month‐over‐month to 45.5 in May from 41.8 in April, a hopeful sign the sudden shock to the US economy from COVID‐19 is beginning to abate. The April reading ended 122 consecutive months of expansion for services‐related activity. Another expansion record was broken as the National Bureau of Economic Research (NBER) declared the US entered into a recession in February. The expansion, which began in June 2009 and lasted 128 months, was the longest on record.

In Europe, countries are re‐opening and implementing more stimulus measures, which are making their way to the data. Business climate and economic sentiment for May both improved from rock‐bottom levels seen the past two months. The IHS Markit Eurozone PMI Composite Output Index, which includes manufacturing and services, bounced back in May to 31.9 from the series low of 13.6 in April. Three of the four biggest economies all posted three month highs beginning with Italy (33.9), France (32.1) and Spain (29.2), while Germany (32.3) hit a two month high.

China continues to stand out as the only country operating in expansion territory. Easing of restrictions for business operations is helping lead new orders higher and client demand is improving. If global demand continues to improve, the economy in China could recover to the pre‐virus levels quicker than anticipated. However, geopolitics could be a major headwind. Tensions with the US include Hong Kong, Huawei and the World Health Organization.

Next Generation European Union Proposal
The European Commission has announced a recovery program of 750 billion euros (about $847 billion) to support its member states and those economies hit hardest by COVID‐19. This recovery program, along with a 1.1 trillion euros budget proposal over the next seven years, is being led by Germany, which is typically reluctant to support fiscal transfer programs. The European Central Bank also announced the expansion of its bond‐buying program beyond $1.5 trillion, putting the central bank’s stimulus effort on par with the Federal Reserve.

Market Observations

US Equities
US equities continued to rise in May as the S&P 500 gained (+4.8%), which puts the rally for the index from the March 23 lows at (+36.6%). Positive sentiment around the US economy re‐opening continues to power the market with support of massive intervention by the Federal Reserve. Businesses are eager to get back and demand is picking up among the US consumer. Growth stocks continue to outperform on the back of lower real rates as large cap growth (+6.7%) outperformed large cap value (+3.4%). Small cap (+6.5%) outperformed large cap (+5.3%) in May, but the spread year to date (+11.0%) still favors large corporations. However, this trend could reverse as the economy re‐opens. All S&P 500 sectors had positive performance in May as information technology (+7.1%) led while consumer staples (1.5%) lagged.

International Equities
Developed international equities were up (+4.4%) at the end of May, while emerging markets finished slightly positive at (+0.8%). The German market had strong performance for the month (+12.4%) on the hope the global economy continues to show signs of improvement.

Fixed Income
The 10‐year treasury yield reversed course in May and rose to 0.7% from 0.6% in April. Yields on the longer end of the curve, 10 to 30 year, have shown a slow steepening trend. The most probable cause of this is the optimism around the economic re‐opening. The Bloomberg Barclays US Aggregate Index rose (+0.5%) during the month. The municipal market had strong performance in May as the Bloomberg Barclays Municipal Aa+ 1‐ 10 Year index rose (+2.6%). The finances of states and local municipalities across the country will be a key data point in assessing the impact of the quarantine on tax revenues.

Real Assets
Real assets continued to deliver positive returns in May. Master Limited Partnerships (+9.0%) had the strongest performance followed by natural resources (+3.7%) and real estate (+0.2%). Oil (+88.1%) registered its best month on record as demand expectations increased and further supply adjustments were made by OPEC and non‐OPEC producers.

This commentary represents the consensus of the Oxford Investment Fellows as of 6.11.20, is subject to change at any time due to market or economic conditions or other factors and offers generalized research, not personalized investment advice. This commentary offers generalized research, not personalized investment advice. Statistical data is derived from third party sources believed to be reliable and has not been independently verified by Oxford. Content is for informational purposes only and does not constitute a complete description of our investment services or performance. Nothing in this commentary should be interpreted to state or imply that past results are an indication of future investment returns. All investments involve risk and unless otherwise stated, are not guaranteed. Be sure to consult with an investment and tax professional before implementing any investment strategy. Oxford Financial Group, Ltd. is a Registered Investment Advisor (RIA) registered with the Securities and Exchange Commission and is headquartered in Carmel, Indiana. Registration does not imply a certain level of skill or training. For more information about our firm, or to receive a copy of our disclosure Form ADV and Privacy Policy call 800.722.2289 or contact us at info@ofgltd.com. OFG-2006-39

The 2020 Estate Planning Trifecta

At times, the extremes of a negative event are matched by the extremes of a positive planning opportunity, and such is the case with our current market, economic and tax law environment. While 2020 has been a year of unprecedented set-backs, in the world of estate planning we have the veritable trifecta of positive planning opportunities: historically low interest rates; suppressed asset valuations as a result of market and economic influences; and a variety of favorable laws and authority for ‘estate freezing’ strategies.

In this three part series, we will first discuss the scope of the current planning opportunity and the ‘why’ behind it. In our second and third articles, we will dive deeper into the specific strategies that we believe provide optimal results in the current environment, both for overall federal estate tax planning and for charitable planning strategies.

The Estate Freeze
Broadly speaking, estate freezing strategies are designed to freeze the taxable value of an asset in the grantor’s estate. All future appreciation after the strategy is implemented goes either into a trust for intended remainder beneficiaries or directly to the beneficiary outright. The former strategy, utilizing a trust, is generally preferred for its superior asset protection benefits, as well as the opportunity to design a trust for ongoing multi-generational tax benefits.

The specific strategies by which to accomplish an estate freeze are numerous and each strategy has inherent pros and cons. However, in terms of the foundational requirements and factors that lead to optimal success, there are several ‘absolutes’ for each strategy.

Absolute One – Each Family’s Strategy Has a Unique Fingerprint
As most affluent families are aware, the current Gift/Estate and Generation Skipping Tax exemptions for 2020 are $11,580,000. All wealth in excess of this exemption amount is, at some point, taxed at the rate of 40%. For many affluent families, it is imperative to be as strategic as possible to get the maximum benefit of these lifetime exemptions.

Poorly planned gifts and non-strategic use of the exemptions can result in reverse estate planning, where wealth that was successfully transitioned out of the grantor’s taxable estate gets shifted back onto the grantor’s balance sheet. To avoid this result, practitioners are challenged to find the most optimal strategies to maximize the use of the exemption in a thoughtful and tailored way for each and every family.

Absolute Two – Hurdle Rates
Many estate freezing strategies require a certain amount of income to be paid back to the grantor over the course of the planning technique. The amount to be paid back to the grantor is referred to as a hurdle rate and is dictated by the IRS for each particular strategy.

There are two main ways to construct a freezing strategy:

  1. Utilizing gifting techniques
  2. Utilizing sale strategies

For gifting techniques (other than a simple outright gift), the required payments back to the grantor are defined as annuity payments and the hurdle rate is based upon the IRS published Section 7520 rate. For a sale strategy, the IRS requires that the interest payments back to the grantor must be, at a minimum, the published Applicable Federal Rates, or AFRs.

Recalling that the goal of a freezing strategy is to minimize the amount of wealth that must be poured back into the grantor’s taxable estate, low interest rates provide the ideal environment to maximize the positive impact of these strategies. In fact, there is a 100% correlation between declining interest rates and an increase in the success of a freezing strategy.

For June 2020, the hurdle rate for an annuity-based strategy is 0.6%. All appreciation over and above this historically low rate accrues to the benefit of the grantor’s heirs or other trust beneficiaries. A 9-year interest-only balloon note, resulting from a sale-based strategy, would require a minimum AFR of only 0.43%.

In other words, the required income/wealth to be paid back into the grantor’s taxable estate is at an all-time historical low under either scenario.

Absolute Three – Passing Muster with the IRS
Many techniques are directly governed by statutory authority within the Internal Revenue Code. Currently, our laws are extremely favorable to several strategies, as will be further discussed in this series. These strategies, however, are vulnerable to political whim and potential changes in our Internal Revenue Code in the coming months.

One of the more publicized pending changes to our tax laws includes the December 2025 sunset of the currently increased federal estate tax exemption, although the increased exemption could be reduced by earlier legislative action.

In addition, the statutory authority supporting many estate freezing strategies is also subject to legislative challenge. While the ‘practitioner’s toolbox’ is currently full of favorable laws and legislation, many challenges to these strategies have been the subject of political platforms going into the coming 2020 elections.

Absolute Four – A Freeze is Ideal for ‘Appreciating’ Assets
The greater the appreciation of the asset after the strategy is implemented, the greater the positive impact. It is the appreciation that a freezing strategy is designed to protect from the 40% gift/estate tax. The earlier these strategies are implemented, ahead of a full valuation rebound, the greater the positive impact.

As such, when an asset value is suppressed by a variety of macro- or micro-economic influences, we believe this presents an optimal time to implement a freezing strategy. It is no coincidence we are discussing this issue at a time when broad market values have not fully rebounded to their highs earlier in the year. Further, many business owners may find the impact of COVID-19 on their business will result in a suppressed valuation in the months and quarters that lay ahead.

Herein lies the intersection of the world of estate planning with the world of investment management. Collaboration is a necessity in order to determine the optimal time to implement a freezing strategy. It is an ideal time to speak with your planning and investment management teams to glean when this type of strategy is most suitable for your family.

Engaging Your Planning Team
As values experience a rebound, our Oxford team is positioned to ensure that our affluent families retain the value of their rebound appreciation, rather than sharing it in a 60/40 split with the Internal Revenue Service (IRS). Consultation with your Oxford team and a full analysis of the pros and cons of each potential strategy will allow your full team of advisors to identify the optimal solution for your family.

In the upcoming articles in this series, we will discuss the techniques and tangible means by which you and your Oxford team can partake of these extremely positive planning opportunities.

 

The information in this presentation is for educational and illustrative purposes only and does not constitute investment, tax or legal advice. The opinions expressed are those of Oxford Financial Group, Ltd. The opinions are as of the date of publication and are subject to change due to changes in the market or economic conditions and may not necessarily come to pass. Forward looking statements cannot be guaranteed. Oxford Financial Group, Ltd. is a Registered Investment Advisor (RIA) registered with the Securities and Exchange Commission and is headquartered in Carmel, Indiana. Registration does not imply a certain level of skill or training. For more information about our firm, or to receive a copy of our disclosure Form ADV and Privacy Policy call 800.722.2289 or contact us at info@ofgltd.com. OFG-20-11

The Financial Landscape – May 2020

Global Macro Environment

Global Economies in Free Fall
Economic lockdowns across the world and a plunge in consumer confidence is taking a major toll on the US and global economies. The US economy shrank -4.8% in the first quarter and the second quarter number is almost certain to be much worse. Consumer spending fell 7.5% in March, the steepest monthly decline in records tracing back to 1959. Household incomes fell 2%. New unemployment claims are at unprecedented levels, in the last six weeks claims reached over 30M for the week ending April 25. While initial job losses were concentrated in the retail and hospitality sectors in the states most affected early on, recent job losses have been much more widespread. Suppliers and other industries across the nation are adding heavily to an underemployment rate (the U-6 rate) which now stands at 22.8% and has more than erased the 22M jobs created in the longest employment boom in US history. The Institute of Supply Management (ISM) Manufacturing Purchasing Managers Index (PMI) for April came in at 41.5, down from 49.1 in March, the largest one month decline since September 2008. The ISM Non-Manufacturing PMI printed its lowest reading since the index was initiated at 41.8. The contraction ended 122 consecutive months of growth.

In Europe, economic activity contracted -3.8% in the first quarter, the biggest contraction on record for the bloc, as shutdowns and social distancing policies remain in place. Sweden, the lone outlier, is taking a different approach by not completely shutting down their economy and asking people at risk to shelter in place. This attempted balanced approach between economic and health concerns should be monitored by other countries around the globe. The IHS Markit Eurozone PMI Composite Output Index, which includes manufacturing and services, fell to a new series low in April of 13.6, down from March’s previous record lowof 29.7.

Data in China continues to show improvement in economic activity. Both PMI readings (Manufacturing/Non-Manufacturing) were in expansion territory. Activity in China may be picking up locally, but the global economy is still shut down which is a headwind for this prominent export nation.

Conclusion: The global economy is on track to suffer its worst contraction since the Great Depression era. The consensus appears to be that until there is a medical solution to COVID-19, it seems implausible for the global economy to get back to normal.

Governments Continue to Pull Stimulus Levers
Governments around the globe are doing their fair share to support lending and provide economic relief. The US government is set to borrow a record $2.99 trillion in the second quarter, dwarfing the borrowed height of the 2008 financial crisis by more than a factor of five. In addition to the CARES Act, the $484 billion relief package for small businesses, hospitals and testing was approved. Germany, a country known for fiscal discipline, has declared stimulus measures totaling 12% of their GDP. China has recently declared a larger fiscal package than the one announced in 2008. There is no doubt policymakers are communicating that aggressive action will be taken to support the economy and the eventual recovery.

Source: BCA Research; Strategas

Market Observations

US Equities
What a difference a month makes. US equities had their best month since 1987 as the S&P 500 was up (+12.8%) in April. At the end of the month, US equities had rallied (+30.2%) since the March 23 lows. The disparity between stock market and economic data has been puzzling, but massive intervention by the Federal Reserve has no doubt buoyed market prices and valuations. Large cap growth (+14.8%) outperformed large cap value (+11.2%) as the large technology companies continued their leadership. At the end of the month, the top five stocks in the S&P 500 were about 21% of the index. In sector performance, energy (+30.8%) rebounded from extreme selling pressure in March, despite volatility in the futures market. Utilities (+3.2%) and consumer staples (+7.0%) lagged for the month of April.

International Equities
Developed international equities were up (+6.5%) at the end of April, while emerging markets finished higher at (+9.2%). The growth outperformance relative to value story continued overseas as developed growth returned (+7.4%) vs. value (+5.2%), and emerging growth returned (+9.8%) vs. value (+8.5%).

Fixed Income
The 10-year treasury yield continued to slide in April from 0.7% to 0.6%. The Bloomberg Barclays US Aggregate Index rose (+1.8%) during the month. The municipal market has been an interesting area to watch during COVID-19 as financial stress continues to elevate across states. Economic stoppage, tax-filing deferrals and a severe decrease in revenue sectors such as airports, hospitals and universities will all weigh on municipal finances. All of this resulted in a robust and popular financial aid response by the federal government. However, investors are still taking a wait-and-see approach to this market as the Bloomberg Barclays Municipal Aa+ 1-10 Year Index was flat for the month (+0.0%).

Real Assets
Real assets reversed course in April and significantly outperformed global equities driven by strong performance in Master Limited Partnerships (+49.6%). Natural resources (+13.8%) and real estate (+7.1%) also had a positive month. Storage capacity for crude oil disappeared at a rapid pace and caused oil prices to make history as the price for oil to be delivered in May fell below zero, the first ever negative contract.

 

This commentary represents the consensus of the Oxford Investment Fellows as of 5.11.20, is subject to change at any time due to market or economic conditions or other factors and offers generalized research, not personalized investment advice. This commentary offers generalized research, not personalized investment advice. Statistical data is derived from third party sources believed to be reliable and has not been independently verified by Oxford. Content is for informational purposes only and does not constitute a complete description of our investment services or performance. Nothing in this commentary should be interpreted to state or imply that past results are an indication of future investment returns. All investments involve risk and unless otherwise stated, are not guaranteed. Be sure to consult with an investment and tax professional before implementing any investment strategy. Oxford Financial Group, Ltd. is a Registered Investment Advisor (RIA) registered with the Securities and Exchange Commission and is headquartered in Carmel, Indiana. Registration does not imply a certain level of skill or training. For more information about our firm, or to receive a copy of our disclosure Form ADV and Privacy Policy call 800.722.2289 or contact us info@ofgltd.com.

Where Does It Stop?

We are now six weeks and over 30 million new unemployment claims into the US fallout from the coronavirus pandemic. Despite significant drops in new applications over the last three weeks, new claims for the week ending April 25 were still five times that of the worst week for new unemployment claims during the Great Recession of 2008-2009, as can be seen in the chart below. Worse yet, as eye-popping as the latest figures from the Labor Department are, they still don’t fully capture the extent of the layoffs due to the persistent lag in the processing of new claims and the reality that the Labor Department statistics may well be significantly understating the actual number of new unemployment claims due to the unprecedented level of new claims overwhelming unemployment offices and staff.

While initial job losses were concentrated in the retail and hospitality sectors in the states most affected early on, recent job losses have been much more widespread. Suppliers and other industries across the nation are adding heavily to an unemployment rate which now stands at 21% and has more than erased the 22 million jobs created in the longest employment boom in US history. Worse yet, it is estimated that over 95% of these job losses have come from the private sector, with public sector employment remaining relatively stable thus far. With wide-ranging forecasts of up to an additional 5-10 million new unemployment claims expected in May, it now seems entirely probable that, depending on the success of state efforts to reopen the economy, the US unemployment rate will reach or exceed the peak rate of the Great Depression.

With the global economy collapsing at a pace not seen since World War II, the CARES Act, passed by Congress and signed into law on March 27, 2020, provided $2.2 trillion in economic relief for the American economy. It also sought to address the reality that newly unemployed workers needed money quickly to continue paying bills and to avoid the hole that the larger economy has fallen into from getting deeper and more difficult to crawl out of. While individual states manage their own unemployment insurance programs and set the level of benefits and eligibility rules, they are also now responsible for administering new federal emergency relief benefits that provide payments for an additional 13 weeks of coverage, cover previously ineligible workers like part-timers and freelancers and add $600 to the regular weekly unemployment benefit.

While historically unprecedented in scale, and nearly three times the size of the Great Recession’s $831 billion 2009 Recovery Act, the realization that the CARES Act would be insufficient came quickly. Just two weeks ago, less than 30 days after the signing of the CARES Act, an additional $484 billion relief package was approved, consisting of loans to small businesses, additional funding for COVID-19 testing and aid to hospitals, to further support and expand the Cares Act. Of the $484 billion, $321 billion is earmarked to replenish the original small business loan and grant program from the CARES Act. Even with the additional small business funds being made available last week, the continued flood of new loan applications is expected to exhaust the additional relief funds by the end of this week as more that 60% of the new relief funds were allocated in the first five days of eligibility.

While governments across the globe, both local and national, are struggling with when and how to walk the tightrope of re-opening economies, it’s not just government, but individual businesses that will need to convince employees and consumers that it’s safe to return. As several US states began relaxing restrictions May 1, there does not seem to be broad support for this action and the CDC is already predicting the impact of these early state openings will cost an additional 100,000+ US lives. Despite coverage focused on government re-opening plans and re-opening procedures, it will ultimately be the consumer who will drive the shape of the economic recovery.

While COVID-19 may or may not forever change consumer behavior, one thing is certain. Despite the most thoughtful and deliberate plans to re-open local and state economies, local, state and the national economies will continue to be affected as long as the consumer feels unsafe.

The above commentary represents the opinions of the author as of 5.5.20 and are subject to change at any time due to market or economic conditions or other factors.The information above is for educational and illustrative purposes only and does not constitute investment, tax or legal advice.