Given the probability of a market correction, is it a good strategy to convert the securities in a revocable trust valued at $518,000 to cash, considering the tax liability?
I'm the trustee of my parent's revocable trust and I have three siblings. My father passed away in September 2017. My mother's health declined in January 2018 and passed away in February 2018. The trust was valued at $518,000 in January 2018. The stock market appears to be on the verge of a correction, so I determined that it was worth the risk to convert all the securities to cash. The $84,000 in capital gains represents a tax liability of around $16,000. My thinking was the market could easily move lower than that amount. Is this a good strategy?
I'm sorry, I had originally read that your Mother very ill & I didn't catch that she had passed as well. My condolences, but the step-up in basis below still applies, just the dates for the step-up will be modified. The point still is that you will have little or no capital gains as your cost basis (step-up) will be reset to FMV as of the date of death. All the other comments below regarding the markets still apply.
My first question is whether you marked up the cost basis to your Dad's date of death because you get a step-up in basis to the FMV of assets. So is the $84k capital gains from the stepped-up cost basis from Sept 2017, or when you parents originally purchased the securities. You may have a lot less tax than you think and might need some help with tax & estate planning issues. This would also make the selling decision a lot easier and less painful.
Regarding the markets themselves, I learned a long time ago that what "I think" doesn't mean anything to the markets and unfortunately the markets don't care about me at all. More importantly, I do not want to project my opinions onto said markets because I will be wrong more than I am right. What matters is what the markets are actually doing. Case in point, last year was way out of the norm and a huge outlier for lack of volatility. The markets almost never act that "calm," so when normal volatility does arise or even return to just normal, it "feels" scary emotionally and like we are on the verge of collapse. But statistics show us that most positive stock market years have one double digit correction per year and many have two. But we just went through a 14+ month period of extreme calm so any increase in volatility feels impending.
All that being said, I am not a perma bull and we are in a mature bull market. But the markets can go up a lot longer that you think, but will also sell off and go down quicker and faster than you think. So I always want to have an exit strategy. With this recent volatility, we actually raised cash and currently have approximately 20% cash & a short ETF hedge, and therefore have 75% "net equity" exposure.
Normally you don't want to make "all in" or "all out" moves but rather make moves in waves, thus taking some risks off the table or adding risks on the table. If you move to 100% cash & then the markets go up for another 4 to 5 months, what will you do? How long will you wait before throwing in the towel & then buying to high because you are impatient? The only reason I bring this up is because you need to have measurable metrics & facts to be able to determine probabilities, and then have multiple scenario plans for "what if the markets move higher" and "what if the markets move lower." There are only a couple of indicators or signals that would make us move almost 100% defensive at once.
Now, if you have strong, quantifiable reasons to believe that the market will correct more than the net after paying the taxes, then by all means sell. But there are also other ways to hedge or protect a position with big gains. If most of those capital gains are due to one or two single positions, you may want to buy a put option on that position to protect against loss.
I know this was a lot to think about, but I wanted to give you a different perspective than the "conventional" answers I am sure you are getting. First thing is to check on the cost basis.
Hope this helps and best of luck, Dan Stewart CFA®
That's a great question and one that I encounter with regularity. It is true that there is always a risk of a correction. Prior to recent history, the market encountered a correction of 10% about once a year. To your gut feeling, technical analysis does indicate we could retest February 2018 lows again before running higher. I am a believer in pulling small levers rather than making wholesaler changes. For example, last year one of my clients wanted to go completely to cash because he felt the market had been running too hot for too long. I presented him with alternatives to hedge the portfolio to help us with our downside risk, but still allow us to capture the upside in the event his feeling was wrong. He refused, went mostly to cash, and missed out on a great opportunity to capture returns.
In general, I feel that market corrections are events we drive right over. Generally, the market rebounds within 2 - 3 months (quicker this past February) and then continues higher. If you get out early you miss the run-up before the correction. Once you're out and the market is down 10% do you think you'd be comfortable putting the money back in the market then or would you be worried about more downside? Often these decisions are made with great intentions, but unfortunate execution. Because of this I feel it is wise to drive over market corrections, and worry more about the bear markets that loom further on the horizon. Even then, small adjustments can greatly reduce your downside risk.
Someone else mentioned that you should now have a step-up in cost basis since both of your parents have now passed. If they were the trustees then this is likely true, but double check with a CPA. Some trusts are designed not just to avoid probate, but to avoid estate taxes, and these trusts outside of estates do not receive a step-up. Whoever your current advisor is should be able to tell you or a CPA would be able to answer that as well.
Good luck to you!
Matt Ahrens, CIMA®
My condolences for your loss - it's never easy to shoulder responsibility after the loss of a loved one. This question requires a bit more information before a quality answer can be given. The most important thing to understand is the structure of the trust as well as the composition of the assets inside of the trust. Once that information is determined, you can align the assets to achieve the goals of you and your siblings. The first step would be to determine the level of risk you're comfortable taking with the trust assets. Then, a quick analysis of the assets will tell us if there is more risk being taken than you can accept. Only then can you make an informed decision as to an action plan. Other factors will apply, such as: is this a simple or complex trust? What do the trust documents dictate in terms of asset transfer, etc?
If you'd like to determine your personal risk tolerance, feel free to do so here. If you'd like to discuss that process with a financial professional, reach out to us for a no-obligation initial consultation.
First of all, if the portfolio was in your parents' name you should not owe any capital gains on the stocks that you sold after their deaths. The cost basis on each holding would have been stepped up to the price of each stock as of the day your mother passed away. Please consult a CPA to confirm this. It could save you a ton of money.
Now, on to your question. Let me say for about the twelfth time on Investopedia alone: YOU CANNOT TIME THE MARKET. No one has more than a 50% chance of being right if they try to call the direction of the market. In order to profit from a successful market call you have to get back in at lower levels. Are you up to it? Most people aren't. Stocks are the only thing I know for which demand decreases as the price goes down. You and your siblings will presumably each inherit a nice little nest egg and you all should invest your own portions according to your own objectives. But that objective is almost certainly long-term growth and you should all get fully invested and STAY FULLY INVESTED. Always. Market declines happen when you least expect it and they never last long. They are buying opportunities and should not be feared. Your parents made some nice money by investing in stocks so please learn from their experience and do the same.
OK, end of lecture. Good luck.
I am sorry for the loss of your father last year. Trying to time the market is not the best approach. The market already moved in and out of correction territory this year. The biggest problem with trying to guess when to get out, is when to get back in the market. That being said, there was concern about when the market would pull back. However, the overall economic outlook is strong. If you get distracted by the short term, you are liable to miss the long-term gains. A well invested portfolio should weather the hiccups we encounter over the next few months.