Trust Issues

Adam M. Grossman

LIKE MOST PEOPLE, I’ve made my fair share of financial blunders. I’ve also had some successes. But I definitely spend more time beating myself up over my errors than celebrating my successes.

Undoubtedly, my biggest mistake fits into the relatively obscure category of asset location. If you aren’t familiar with the term, I can explain it by way of an example. Suppose you have two investment accounts: a retirement account and a standard, taxable account. In these accounts, you want to buy some stocks and some bonds, and you also want to hold some cash for a rainy day. The question: How much of which assets should you buy in each of your accounts? The answer hinges largely on taxes, but also reflects other factors. This is the heart of asset location.

My asset location error was straightforward: About five years ago, I had some money to invest and was thinking through various alternatives. At the time, my children were all under 10 years old, so I thought it would make sense to establish 529 college savings accounts for them. When I asked an estate planning lawyer, however, he steered me in a different direction. Don’t focus on college costs, he said. Instead, if you want to help your family, establish a trust that’ll protect your money from estate taxes. And that’s what I did.

There were at least four things wrong with this decision:

  1. I gave up one of the greatest tax gifts the government offers. With 529 accounts, all gains are completely tax-free if used for qualified education costs. Suppose I had put $100 into an S&P 500 fund at the time. With the market’s gains, it would be worth about $160 today. If it were in a 529, I could withdraw those funds entirely tax-free. Without the benefit of the 529, though, those $60 of gains would be subject to taxes, leaving me with perhaps $145.
  1. I prioritized a lower-probability occurrence over a higher one. Sure, estate taxes are real, but there are many unknowns. Among them: What will the tax rate be in the year that I die and, by that time, will I even have enough money left for the government to tax? By contrast, my children’s likelihood of going to college is (hopefully) very high, and it’s right around the corner. That should have been my priority.
  1. I took one person’s advice without considering the context. To a hammer, everything looks like a nail. And to an estate planning lawyer, everything looks like an opportunity to save on estate taxes. He wasn’t wrong, but it was my job to consider the alternatives.
  1. Trusts can be expensive. As their name suggests, trusts require trustees, and oftentimes they want to be paid. Meanwhile, 529 accounts are relatively cheap.

Asset location isn’t the most exciting topic in the personal finance world. But a little bit of attention to this seemingly dull topic could yield big benefits.

Adam M. Grossman’s previous articles were Contain Yourself and Take It Slow. Adam is the founder of Mayport Wealth Management, a fixed-fee financial planning and investment firm in Boston.  He’s an advocate for evidence-based investing and is on a mission to lower the cost of investment advice for consumers.

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