Case Studies

As a financial services company, we can’t provide testimonials. However, we can highlight some real-life client stories that we believe demonstrate our value and expertise.

Avoiding Social Security Mistakes

Charlie and Ann were both 66 years old when Charlie passed away. At the time, neither of them was collecting a Social Security benefit. Shortly after the funeral, Ann came in to meet with Dunlap & Associates Wealth Management. She needed income and, according to her Social Security annual statement, was entitled to about $2,000 a month. Her survivor’s benefit from Charlie was only $1,800 per month.

So, at first glance, it appeared as if she should take her own benefit. But what Ann was not aware of was that, if she chose to take her survivor’s benefit for four years (until she turned 70), then her own benefit of $2,000 would continue to grow. So, when she turned 70, she would be able to switch over to her own benefit-which we projected to be $2,800 per month.

So, a few years of taking a slight reduction in her Social Security income could result in a fairly significant increase in income down the road.

* These are case studies and are for illustrative purposes only. Actual performance and results will vary. These case studies do not constitute a recommendation as to the suitability of any investment for any person or persons having circumstances similar to those portrayed, and a financial advisor should be consulted.

The Reluctant Benefactor

I met Ruth (not her real name) in 1999. At that time she was a widow with two adult sons, and her estate was comprised of a home worth roughly $1 million and $2 million of Coca-Cola common stock that she and her husband had purchased in the 1960’s for less than $20,000. When her husband died in 1994, she cashed in his entire 401(k) plan that she had inherited to pay off her mortgage, but the stock was always intended to be passed on to her boys.

When I asked her about her income she told me that she was living off Social Security ($12,000/year) and the dividends that the Coca-Cola stock was paying – roughly $40,000 a year. She told me that she would really like to do more traveling but her combined income of $52,000 made it tough.

Now I had a number of concerns – not least of which was the fact that, with all of her investment assets concentrated in one stock, she had no diversification and was exposing herself to some significant risk. But, if Ruth sold the stock just for the purpose of diversifying her portfolio, she would incur a capital gains tax of over $400,000!

But Ruth had another problem she wasn’t even aware of. In 1999 the Estate Tax exemption was $600,000 per person. That meant when she died, the first $600,000 of her estate would be exempt from tax, but the remainder ($2.4 million) would be taxable to her sons at a rate of roughly 50% – or $1.2 million in Death Taxes! And those taxes would be due within nine months . . . in cash! So, it was highly likely that, after inheriting the $2 million of stock, the boys would have to sell 60% of that stock in order to satisfy the Estate taxes that would be due.

But I had an idea that I thought would help.

I asked Ruth if she was charitably minded . . . and she said, “Not really.” I asked if she belonged to a church and she told me that she had been a member of the same church for years. I got the name of her pastor and made an appointment to see him. When I met with him I asked if he might be interested in a gift from one of his members of $2 million!! Amazingly, he was!

What I suggested to the pastor was that Ruth would do a “trade” with his church. She would give him the $2 million of Coca-Cola stock if he agreed to put that money into a trust and give her an income of 6% of the value of that trust for the rest of her life, and that, when she died, the church would then keep the remainder of the money left over. This is known as a Charitable Remainder Trust and is a great tool to help people in a situation like Ruth’s.

Once the church received her stock, it was able to sell it immediately and avoid paying any capital gains taxes (churches and charities are not subject to taxation). We were then able to reinvest the proceeds inside this new trust and truly diversify this portfolio. Now, Ruth’s annual income went from $52,000 to $132,000! Plus she effectively reduced her taxable estate from $3 million to $1 million, lowering her expected estate tax from $1.2 million to $200,000. Not only that, but she received a significant charitable deduction on her 1999 tax return as well.

Over the years Ruth enjoyed this much greater income and used it to do all the traveling that she dreamed of. She died a few years ago and left her estate to her boys.

But, wait a minute. Weren’t they supposed to inherit her Coca-Cola stock? Well, once she gave it to the church that option was no longer available. What we did back in 1999, however, was to use roughly $17,000 of her new, higher annual income and we purchased a $2 million life insurance policy on Ruth’s life and placed it outside of her estate inside a Life Insurance Trust (no estate tax!). And the beneficiaries of the policy? You guessed it, her two boys!

So now, not only did the church receive a sizeable gift when she passed (roughly $2.2 million), but her sons also inherited $2 million completely tax-free (insurance proceeds are always tax-free), along with her home.

* These are case studies and are for illustrative purposes only. Actual performance and results will vary. These case studies do not constitute a recommendation as to the suitability of any investment for any person or persons having circumstances similar to those portrayed, and a financial advisor should be consulted.

A Path to Tax-Free Income

Our client David (not his real name) retired back in 2009 when he was 62. His 401(k) retirement plan at that time was worth about $800,000, which he rolled over to us into a self-directed IRA. Plus, he had a non-retirement account, owned jointly between him and his wife, which was worth about $500,000. One thing that he had always told us was that he was very sensitive to taxes and that he wanted to make sure that his long-term financial plan was as tax-efficient as possible.

We sat down with him and his wife and illustrated just how inefficient a 401(k) or an IRA is from a tax perspective – that, even though on paper it looked as if he had an $800,000 account, part of that money always belongs to “Uncle Sam.” Further, any time he earned something inside that account, he had to share those gains with the IRS. And, worse, if Congress ever voted to increase tax rates, he would lose even more of his nest-egg.

But we had a solution for him that we thought made a lot of sense.

We discussed the benefits of systematically converting his IRA into a Roth IRA by, in essence, pre-paying the taxes on his money today in order to build a completely tax-free source of income for the future.

So, our recommendation was to slowly and systematically move the money inside this IRA into his Roth IRA. And that’s exactly what we did.

Because he was over 59½ when we began this strategy, he was able to do these conversions and direct that his State and Federal taxes be paid out of the proceeds. And, in order to avoid having him pay tax at the highest tax rates, rather than convert his entire account all at once, we decided to do these conversions annually – with the goal to have his IRA completely converted by the time he turned 70.

In the seven year period between 2009 and 2016 he successfully did this, converting his entire IRA into a Roth IRA. Meantime, he and his wife used the money in their non-retirement account to pay for their retirement expenses during that time frame.

In 2016, he was about to turn 70 and ready to file for Social Security, and his Roth IRA was now worth approximately $662,000 (remember, he had to pay tax on each annual distribution).

But just look at how tax-efficient his portfolio has become.

His income now comes from three sources – his Social Security, which is about $42,000 a year (it is higher because we encouraged him to delay filing for benefits until he was 70 in order to maximize his income), his wife’s Social Security (about $19,000/year) and a withdrawal from his Roth IRA of about $33,000

That equates to an annual income of about $94,000 . . . and, here’s the beautiful part . . . all of it is completely tax-free!

You see, Social Security is only taxable if you have other sources of taxable income. In this case, David and his wife have NO taxable income . . . therefore their Social Security benefits are completely tax-free!

So, we were able to help this couple manage their retirement income in the way that was most important to them – and that is by creating the most tax-efficient plan that we could. And, no matter how much his Roth IRA may grow over time, he will never pay a dime of income tax on any of those earnings. Plus, Roth IRAs do not have Required Minimum Distributions when you turn 70½, which gives you much more control of your money.

* These are case studies and are for illustrative purposes only. Actual performance and results will vary. These case studies do not constitute a recommendation as to the suitability of any investment for any person or persons having circumstances similar to those portrayed, and a financial advisor should be consulted.

Company Stock Conundrum

One of our clients, Robert (not his real name), was getting ready to retire from a job he held with a private engineering firm in 2003. What made his pending retirement unique was the way his 401(k) plan was invested. Of the $750,000 in his plan, $300,000 of it was in company stock.

And, believe it or not, that fact opened up a real planning opportunity for him.

You see, a few years ago Congress passed legislation allowing for special, more tax-friendly treatment of employer stock inside a 401(k) plan . . . but it doesn’t just happen this way . . . you have to plan for it. And, this strategy is a bit obscure, and not only did our client not know about it, but neither did his tax-preparer!

Essentially, here is how this special rule works: Normally, when you take money out of a qualified retirement plan, such as a 401(k) or an IRA, each distribution is taxed as if it is ordinary income, just the same as your wages would be from your job. But, if you follow the proper steps, company stock inside a 401(k) plan can qualify for capital gains tax treatment, which is typically taxed at a lower rate than ordinary income.

So, in Robert’s example, he had $300,000 in employer stock inside his 401(k) plan that we wanted to help him save taxes on, and here’s how we did it.

Step one is to determine the cost-basis of the stock, and this is something that the administrator of the retirement plan is required to calculate. In his case, we found out that his cost basis was $42,000, which means that his “profit” in that company stock was $258,000. The legal term for this profit is “Net Unrealized Appreciation” or “NUA” for short.

Next we had to establish two accounts – an IRA to accept the portion of the 401(k) that was not in company stock (about $450,000) and a traditional non-IRA brokerage account to hold the company stock.

Along with our client, we contacted his 401(k) administrator and instructed them to roll over the $450,000 into his IRA and to withdraw and deposit the $300,000 of company stock into his brokerage account. By doing so, the cost-basis of his stock ($42,000) was considered ordinary income immediately and recorded as such on his tax return for that year.

That is the “trade-off” . . . you have to pay tax on the cost-basis in order to have the profit (the NUA) taxed at more favorable capital gains rates.

In his case, however, it really worked out well for him.

Now, his company, being privately held, mandates that only employees can own stock, so, when we moved his stock into a brokerage account, it was only for one day. The company immediately bought back all the stock which resulted in our client having to realize this long-term capital gain of $258,000. But, the “happy ending” to this story is that, while the cost-basis of $42,000 was taxed at ordinary income tax rates, in his case 28%, the capital gains tax rate that he ended up paying on his NUA was only 15%!

Had he just done a normal IRA rollover of his entire 401(k) balance, which is what most people do, then the entire value of the company stock would have been lumped together with his other money and eventually everything would have been taxed at ordinary income tax rates. But, because we used the strategy of setting up two accounts and requesting that the stock be sent to its own account, we created an environment for him to save on his taxes.

How much did he save?

Well, had he paid taxes on the entire $300,000 stock value at 28%, his tax bill would have been $84,000. But, by embracing the NUA rule, only a portion of the stock value would be taxed at 28%, with the majority of it taxed at 15%:

This strategy saved our client a whopping $33,540 in taxes! Sometimes just knowing how to take advantage of the “rules” can really impact our clients in a very meaningful way.

* These are case studies and are for illustrative purposes only. Actual performance and results will vary. These case studies do not constitute a recommendation as to the suitability of any investment for any person or persons having circumstances similar to those portrayed, and a financial advisor should be consulted.

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