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Charitable Giving: Overcoming the hurdles from the December 2017 tax law changes

Written by Becky Botzet, CFP®, EA on .

There has been a lot of confusion with the new tax laws as to whether you are able to deduct your charitable giving in 2018 and going forward. The Tax Cuts and Jobs Act did not eliminate the tax deduction for charitable gifts, but some of the rules have changed.

The new Federal tax laws have increased the standard deductions ($12,000 for singles and $24,000 for married filing jointly), capped the amount of state taxes you are able to deduct, and eliminated other deductions. This is causing many taxpayers to no longer itemize their deductions. Since charitable contributions are only deductible as itemized deductions, many taxpayers will no longer receive any tax benefit at the federal level, while others may see a reduced tax benefit. Keep in mind that many states still allow for these deductions (including the state of Minnesota), so there may still be some amount of tax savings there.

But all is not lost! While it is more difficult than before to capture tax benefits for charitable giving, SWA is working on several strategies with clients in order to maintain some of the tax benefits.

  • Bunching a few years of contributions into a single year to drive your itemized deductions above the standard deduction amount in that year, then reducing contributions in the following year(s) and using the standard deduction in those years.
  • One tool that works well with this strategy is a Donor Advised Fund.
  • Donating appreciated stock may make sense with a bunching strategy because, as we've seen recently, some days in the market are good for gifting at a high price while others are not.
  • If you are age 70.5 or older, consider donating part or all your required minimum distribution (RMD) from an IRA directly to a charity. This can be very effective because it directly reduces the amount of taxable income you report, instead of having to rely on an itemized charitable deduction.

Regardless of your situation, we continue to recommend you keep good records of your donations throughout the year. See the next page for some tips for deducting charitable gifts.

If you would like help reviewing the best strategy for your specific situation, please reach out to your Summit Wealth Advocates' Advisor.

Tips for tracking your Charitable Gifting

  • Make sure the organization you are giving to is qualified. There is a tool on the IRS website to search for your organization ( https://apps.irs.gov/app/eos/ ).
  • If you receive any financial benefit from your contributions, such as merchandise, tickets to a ball game or other goods and services then you can deduct only the amount that exceeds the fair market value of the benefit received.
  • Donations of stocks or other non-cash property are usually valued at their fair market value of the property (generally, the price at which the property would be sold for).
  • For all cash, check or other monetary gifts, regardless of the amount, you must maintain a bank record, payroll deduction record, or written communication from the organization containing:

 The name of the organization
 The date of the contribution
 The amount of the contribution

  • To claim a deduction for contributions of cash or property equaling $250 or more you must have a bank record, payroll deduction records or a written acknowledgment from the qualified organization showing:

 The amount of the donation and a description of any property contributed
 Whether the organization provided any goods or services in exchange for the gift.

  • If your total deduction for all noncash contributions for the year is over $500, you will need to complete and attach IRS Form 8283, Noncash Charitable Contributions, to your return.
  • Taxpayers donating an item or a group of similar items valued at more than $5,000 must also complete Section B of Form 8283, which generally requires an appraisal by a qualified appraiser.

Note: Always seek the advice of a tax professional to confirm how a charitable gifting strategy will impact your personal taxes.


Don't Know What You've Got Until It's Gone

Written by Matt Wright, CFA® on .

Asset custody is one of those topics that the typical investor doesn't give much attention. Most of us are more interested in the rate of return on our investments than some out of sight/out of mind back office activities. Yet, it's critically important to understand who is actually responsible for the safekeeping of your assets. After all, it doesn't do you much good to have a great return on an asset, only to have the asset itself disappear due to fraud or negligence.

The cryptocurrency world has provided many examples in recent years of why this is a legitimate area of interest. The latest major example is QuadrigaCX, a Canadian cryptocurrency broker who recently reported that its CEO died on a trip to India and supposedly he was the only one with the password to access approximately $145 million of client cryptocurrencies! If they are unable to crack the password, those assets will have literally disappeared. We'll note that some are speculating that there is fraud going on here and not just an unfortunate series of events, but either way it points to a failure by the company's clients to consider the importance of custody and, if it's not fraudulent, a colossal failure by the company to protect its clients.

Some of the most basic requirements of a good custody arrangement are missing here, such as the custodian being an independent third party that is subject to external audits and regulation. Compare this to your a typical employer retirement plan [e.g., 401(k), 403(b)]. A regulated third party is generally responsible to maintain custody and account for those assets. If instead, your employer said they'd stick your money in an account and let you know how much it's worth, how would you know for sure whether the money was really there? Not having an independent third party has been a key issue in some of the largest frauds of all time, including Bernie Madoff's decades-long Ponzi scheme.

The same custody issues apply when working with a financial advisor. SWA, for example, manages accounts for clients at Schwab. If you want to make a deposit to your account, the money is sent directly to Schwab, not to SWA (although we can assist clients with depositing checks and transferring from bank accounts). You always have the ability to go to Schwab directly to verify amounts, transact, or withdraw from your accounts if you chose to do so.

As always, we need to share some disclaimers. Having a third party custodian as we've described does not guarantee that your assets will never be lost or stolen, but we believe the risk is greatly reduced compared to the alternative. It also says nothing about whether your investments themselves gain or lose money and does not protect you from market losses.

The bottom line is if you have assets or are considering investing in something that does not have a third-party custodian (which could include certain partnership investments), think carefully about whether you can verify proof of ownership and accessibility to the assets. Consider whether a potentially higher return is worth the risk of the loss of the asset itself.


Do Your Financial Advisor's Incentives Align With Yours?

Written by By Matt Wright, CFA® on .

A few weeks ago my son was in need of some Cub Scout gear, so I stopped at a local Scout Shop. Our den leader had told me the few specific items that we needed and that everything else was optional. Nonetheless, the Scout Shop employee made a good effort to sell me items that we didn't need. He even pointed out that the amount I was spending was way less than I would spend on sports equipment later on, implying that justifies spending more money when I don't need to. That might work on some people, but I'm guessing not many financial advisors fall for this!

The experience reminded me that every type of business, even a non-profit, has a conflict of interest with its customers. Ideally, a transaction is beneficial for both the business and the customer, but an adversarial tension exists nonetheless.

As with any industry, financial advisors have conflicts, too, but you may not be aware of how different business structures can impact the alignment of interests with an advisor and you, the client. Summit Wealth Advocates, for example, is a fee-only advisor. This means that all of our compensation comes directly from our clients. We are not paid by outside companies to sell their products or services or provide referrals to them. As a result, when we make financial recommendations to clients, we do so as if we are sitting on the same side of the table as them.

This is not the case for all financial advisors, many of whom still operate on more of a traditional sales model where they are paid commissions from the company selling a product, a cost the client doesn't see directly. This business model has typically provided the salesperson a commission. The conflict with this business model is that the salesperson may have an incentive to replace a client's old products with new ones over time in order to generate new commissions.

Some recent moves in the mutual fund industry highlight one way that these conflicts still exist. Responding to regulatory changes, several major firms have announced that some "C class" mutual fund shares held for a specific period (e.g., 10 years) will be converted going forward to "A class" shares. The C class and A class shares of a particular fund represent the same underlying investments – the only difference is how the commissions are paid to the salesperson. Mutual fund A shares generally pay more up front with less on an ongoing basis (e.g. 5.75% up front and 0.25% each year), while C shares may pay nothing up front but more on an annual basis (e.g. 1.0% each year.

Consider a financial advisor with a large portion of his or her income coming from C share mutual funds sold at varying times in the past. As a hypothetical, he/she may be receiving compensation of 1.0% each year from the fund companies. However, as time goes by, portions of this 1.0% income stream will be converted to a 0.25% income stream. That loss of income to the advisor is a cost savings to the client, which seems great at first glance. But look at the incentive problem this just created for the advisor! Will they sit idly by and watch their income decline? Or might some be tempted to convince clients to swap into new products that will get them back to a higher income stream? Will the new products actually be more suitable for the clients both for investment and tax purposes?

Do you really want to be in a position of having to question the motivation of why your advisor is making a recommendation? At SWA, we don't want our clients or ourselves to be in that position, which is why we believe a transparent method of compensation is in everyone's best interest.


Why We Use Asset Location Strategy

Written by Bruce Primeau, CPA, CFP®, PFS on .

Most people want to know how their investments are performing but what really matters is how they are performing on an after-tax basis. This is important because it is what translates into how much you can actually spend from your portfolio.

At SWA, we have developed an Asset Location Strategy (ALS) that encourages each client to build a globally diversified portfolio utilizing a passive, tax-efficient investment approach. We do this by advocating that clients build measurable balances across account types with different tax characteristics, including:

  • Taxable: Individual or Joint investment accounts, Employee Stock Purchase Plan, etc.
  • Tax-Deferred: 401(k), 403(b), Traditional IRA, Deferred Compensation Plan, Employee stock option plans, etc.
  • Tax-Free: Roth IRA, Roth 401(k) and 529 Plans

As each client adds to each of these tax classes, we install an overall asset allocation that is in line with their tolerance for risk. We manage holdings across all three account types in a manner that strives to maximize after-tax wealth. Here is an example of how a client portfolio with asset location is constructed and managed:

  • Taxable Accounts: We prefer clients own equities in taxable accounts as clients can receive tax-preferential rates for doing so. For example, qualified dividends and capital gains capital gains are subject to Federal tax rates of up to 23.8% (including capital gain surtax) compared to the top Federal ordinary income tax rate of 37%.
  • Tax-Deferred Accounts: Withdrawals from these accounts are generally taxed at ordinary income tax rates. Bonds create ordinary income so our preference is to have clients own bonds in this tax class. Because bond income is taxed at ordinary rates and typically client income is greater now than in retirement (when funds are withdrawn), bonds are typically less desirable to own in taxable accounts.
  • Tax-Free Accounts: Unlike the other two tax classes discussed above, gains from tax-free accounts can avoid taxation (assuming all distributions are qualified). Basically, the first two account types force you to share some of your gains with Federal and, for many of us, State tax authorities. But since Tax-Free accounts (primarily Roth IRA and Roth 401(k)) don't have this tax liability attached, we want clients to overweight them with investments that have the highest long-term growth potential, such as International and Emerging Market Stocks.

NOTE: This is meant as an illustration only and holdings will vary based on individual client circumstances.

Managing a client's portfolio in this manner will undoubtedly result in performance variances between each account due to the fact that what is owned in each account is unique and performs in different ways. For example, in 2017:

  • Most Taxable and Tax-Free accounts in an SWA asset location strategy performed well, which primarily hold stocks. Overall global stock index gained 24.0%1 before fees and transaction costs.
  • Most tax-deferred accounts lagged other tax classes due to heavier weightings in high quality bonds, which gained a more modest 3.5%2, also before fees and transaction costs.

While it might seem more appealing to have each account type invested to the same asset allocation and thus show a similar return each year, this can actually produce a less satisfactory result when taxation is considered.

For example, if each account in the portfolio is invested in the same asset mix, here are a few consequences.

  • Taxable accounts might hold positions in bonds, REITs, etc. which produce ordinary income each year that is taxable at a client's highest ordinary income tax rates. This produces an unnecessary tax drag on this portion of a client's portfolio.
  • Tax-free accounts may grow more slowly over the long term since the bond component held in these accounts is likely to produce less long-term annual returns than equity asset classes. This means you are not maximizing the account type that you don't need to share with the government!
  • Transaction fees to the client are significantly increased by having to purchase every holding in every account, as opposed to having a selected number of holdings in some accounts.

The bottom line is that there are ample reasons for SWA to manage client portfolios the way we do. From a long-term perspective, we believe this is the best way to maximize after-tax wealth and produce spendable cash flow from an investment portfolio. Our goal is to help our clients achieve their financial goals, even if a method might seem unconventional at first.

1Based on the returns of the MSCI All Country World Index NR USD. Source: Morningstar
2 Based on the returns of the BloombergBarclays US Aggregate Bond TR USD. Source: Morningstar


Don't Be Kanye--Keep Your Personal Data Safe!

Written by Matt Wright, CFA® on .

Kanye West recently met with President Donald Trump in the Oval Office in a highly publicized event. While the general discussion was outside the scope of our role as wealth advocates, one incident during the meeting prompted us to once again remind everyone about the importance of keeping your personal information safe. Mr. West pulled out his iPhone and, on live TV, punched in a password of 000000 to access it.
While it's arguably better than having no password at all, it was clearly chosen for maximum convenience, not security. We can only hope that he is taking more precautions with other private information and his financial security. But are you doing your best to protect your personal information and your financial accounts? Here are a few tips to consider.

  • Use strong passwords. SplashData, an internet security firm, provides an annual list of the most common online passwords showing that "password" and "123456" have ranked at the top each year since 2011. Don't make this too easy for hackers! A strong password is generally longer than 8 characters, but consider that a minimum. And don't use the same password on multiple sites as the hacker needs to only crack one of your passwords and then reuse it on other sites you may use.
  • Consider using a password manager. A common reason why people use weak passwords is that we all have so many of them for different purposes that we can't keep track of them all. Consider using a password manager to reduce how much you need to remember, and it will allow to use unique passwords at different sites. The password manager allows you to create unique, long and very complicated passwords, without the need to remember.
  • Limit who you share information with. While it's unlikely you'll have an opportunity to give away your password on national TV, control who has access to your personal data. Access to your data should be locked (physically or electronically) at all times.
  • Watch out for Wi-Fi. Don't log into accounts on unsecure Wi-Fi connections (for safety essentially everything outside of your home should be considered unsecure). IF you do use an outside Wi-Fi, confirm with the location what the exact Wi-Fi name is. Unfortunately, there are a lot of hackers that are setting up Wi-Fi connections that sound very much like the legitimate Wi-Fi name. At home, set up a guest Wi-Fi network that visitors can use without being able to access your personal home network.
  • Be skeptical about emails and calls asking you to act urgently. Whether it's a call from the IRS demanding overdue tax payments or an email from a financial institution telling you to log in to your account to review something – STOP! If you are uncertain whether it's a legitimate contact, don't do anything right away. If it's possible that the IRS really does want to talk to you, they will mail you a letter so simply hang up. If you are prompted to log in to a financial account, don't click on a suspicious link (consider all links suspicious), instead open a new browser window and go to the website directly.

While it's hard to avoid all risks no matter what you do, taking some of the precautions above might greatly reduce your vulnerability.

North Metro: 763.355.5873
227 East River Parkway
Champlin, MN 55316-5873

South Metro: 612.987.9112
5871 Crossandra Street SE
Prior Lake, MN 55372-3337

West Metro: 763.639.3425
322 Greenhill Lane
Long Lake, MN 55356

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