The political clashing that is occurring over our country’s entitlement programs highlights an ideological divide in our country over how to solve our deepening debt crisis. But it also highlights an important facet of Comprehensive Wealth Management: assumptions about the future are just that – assumptions – and should not be set in stone. True wealth management is a dynamic process and must revisit assumptions and expectations periodically to ensure they continue to be valid.

This has been contrary to the way much of the financial planning industry has operated over the years. Too often, financial planners are obsessed with the creation of “The Plan,” and giving their clients dozens of tactics to implement. Often these plans span more than 100 pages and overwhelm clients with mind-numbing detail and regimented action steps. (I won’t even mention the faux plans generated by the commission-based planners that always seem to lead back to the same conclusion: “You need to buy a variable annuity.”)

Today, the growing realization among serious wealth managers is the need to focus on the planning process, rather than be obsessed with the plan itself. That doesn’t mean, of course, that a wealth management plan isn’t important. What it does mean is that, in a world of rapidly changing facts and circumstances, a wealth management plan should be a living document that is evaluated frequently and revised as needed to reflect the evolving needs of the client, and the evolving world around them.

Assumptions about expected future income must be revisited regularly, particularly as they relate to pensions and entitlement programs such as Social Security and Medicare. Many pensioners have seen their companies head into bankruptcy and have received vastly reduced pensions that were only guaranteed for pennies on the dollar by the federal government. And although the politicians seem to be nearly unanimous in agreement that Social Security and Medicare will be protected for those who are in or near retirement, the same is not necessarily true for those in their mid-50s and younger. Much will be determined about this issue in the elections of 2012 and beyond, and a wealth management plan for someone in their 40s or 50s that assumes a significant benefit from Social Security and Medicare – particularly if those assumptions are inflation-adjusted – may well be unrealistic in its conclusions.

The other issue that is changing rapidly is the lifestyle of people in their 70s, 80s and even 90s. A generation ago, 65 was considered “old.” Many people smoked heavily, drank excessively, and exercised infrequently. As a result, average life expectancy for a U.S. male was 66 years old in 1960. For women, it was 73.

Fifty years later, in 2010, average life expectancy for a U.S. male had advanced by a full decade, to 76, while the average U.S. female had a life expectancy of 81. Today, most 65-year-olds who haven’t had the misfortune of being hit with a chronic condition or disease are active and in good health. Cancer and heart disease are much more treatable today than they were even 30 years ago.

All of this is good news from a quality of life perspective, but it also raises significant wealth management challenges. The old assumptions that a 75-year-old will need little more than food, shelter and a comfortable rocking chair are a cliché. Many people in their 70s and 80s are continuing to travel, dine out, play golf and tennis, etc. At the same time, many people are retiring earlier than ever, in their early 60s or even late 50s. This means many people will live more active retirements with much higher expenses than past generations, and will do so in many cases for 25 or 30 years!

These challenges are not insurmountable; they simply require an effective planning process. That’s why it is vitally important to be sure your wealth management plan is being revisited, evaluated and revised at least annually by your advisor.

I continue to be astonished and frustrated at the media reports of how much collective cash investors hold as a percentage of their investable assets. Incredibly, the percentage of cash that investors hold relative to stocks actually increased during 2010, despite two years of strong equity returns: 

The source of my frustration is that I know investors have little hope of achieving the retirement they expect when they avoid an allocation to stocks in favor of cash. Why, in the face of all of the political and economic uncertainty we are confronted with today, am I confident that a healthy allocation to stocks is necessary for investors to achieve their retirement goals?

Consider what has happened to the noble postage stamp over the past 30 years:

Since 1980, the price of postage has increased almost three-fold – despite a low-inflationary environment that persisted for all but the first few years of that time period! This is a powerful illustration of “inflation risk” – the risk that your assets don’t grow enough to make up for the loss of purchasing power due to inflation. Inflation risk is very subtle but very real. It doesn’t hit you all at once like a sudden drop in the stock market. Instead, inflation risk slowly works away at your purchasing power like termites in the foundation.

Remember when a $20,000 car was expensive? When a $200,000 house was a mansion and not a fixer-upper? When college tuition was four figures? It seems quaint now, but that’s the way it was back in 1980.

Now imagine – even if we maintain the historical 3% - 4% inflation rate going forward – how much things will cost 30 years from now. Will you be able to afford a $100,000 Ford Taurus? Or an annual college tuition bill of $150,000? If history is any guide, stock investors will be just fine in such a world, but cash investors will not.

Despite relatively poor returns over the past decade, stocks historically have been the best way to combat the real danger of losing purchasing power during a long retirement. Yet millions of investors made a decision to bail out stocks in the last few years and continue to do so today despite the fact that the S&P 500 is basically breakeven since Lehman’s collapse in September 2008 (not to mention the fact that small stocks and real estate stocks have very nice gains over this same period).

These investors have let emotions rule their investment decision-making process instead of a solid plan. This is a crucial mistake that has caused those investors to miss out on the nearly 100% gain that stocks have logged since they bottomed out in March 2009!

Don’t make the same mistake. Be sure a solid wealth management plan – not emotion – is at the foundation of your investment decision-making process.

One of the key components of Comprehensive Wealth Management is to run scenarios using different variables to make sure we are addressing different possible outcomes for our clients. For instance, do you want to retire at 58 or 65? Do you want to take Social Security early, or defer to later? Do you spend 2% of your portfolio a year or 12%? (You won’t have a portfolio for long if you take out 12%, by the way.) 

These variables, and many more, are all important to the planning process, which is why we often use complex modeling software to run thousands of different simulations. We need to look at probabilities of success in order to help our clients develop a meaningful wealth management plan.

Yet, for many investors, there is often one variable that supersedes all others, a huge “X” factor that will be far more important to the investor’s financial future than all other factors combined: 

A large concentration in a single stock. 

Think about it: We can run all kinds of simulations addressing all different manner of variables, but if an investor has nearly all of their net worth tied to a single stock – then the other assumptions don’t matter much. The investor’s financial fate is going to be attributable to the fate of that one company. If it swims, the investor swims with it. If it sinks, so sinks the investor. 

Let’s go back to 1999 and imagine I worked with an executive of, say, Delta Air Lines. She has a high net worth, but it is all in Delta stock, which she has amassed through years of stock options and by investing in company stock in her 401(k) plan. Thanks to her loyalty to her company, she has watched her net worth grow from less than $100,000 to over $2 million in just a decade. 

She wants me to do planning for her. But when I tell her the most important part of the plan is for her to diversify her concentration in Delta stock, she balks. After all, Delta stock has been very good to her these past 10 years. The whole reason she is even talking to me, in her mind, is because of the success of good old DAL. Why would she be disloyal to the very stock that has gotten her where she is today and pay a 20% capital gains tax on it to boot? 

With the benefit of hindsight, we know how this story ends. From 1999 through 2007, Delta is on a slow death march to bankruptcy, and this hypothetical executive watches her net worth march downward with it. Her new stock options are all underwater and she no longer buys company stock in her 401(k), but she continues to cling to her existing positions in Delta stock, sure that it will bounce back. But she is wrong: by the time Delta files for bankruptcy, she is out of a job and out of money in her investment portfolio. 

It is blatantly obvious to us that the Delta executive is nothing short of foolish to not diversify her stock position and pay the taxes, but it sure isn’t obvious in real time, because not all stories end badly. Sometimes investors make a tremendous amount of money by holding on to a particular stock. The problem is we don’t know which company is going to be a homerun and which company is going to be a strikeout. Many times companies can hum along for years and then suddenly hit an unexpected turn in the road that tanks their stock. A few recent examples: Blockbuster, Toyota and pretty much any financial stock in 2008. 

Most investors don’t start out with the intent of owning a huge block of concentrated stock – it just happens, either through inheritance, employment, or by selling your company and taking stock in the transaction. It can be hard to pull the trigger not knowing if you have a winner on your hands, but that’s not really the point. 

The point is, you are playing a glorified game of roulette when you let your financial future ride on the fate of a single stock. And that’s no way to plan for a healthy wealth.

The "repeal" and looming reinstatement of the estate tax, with its lower exemption amount and higher rates in 2011, is complex – so much so that I get the sense that many affluent individuals are putting their heads in the sand and hoping more definitive laws will be enacted soon. This, of course, is no strategy at all for what is a vitally important part of Comprehensive Wealth Management.

The question all high-net worth individuals should be asking is, "How does this affect me?" I've asked a member of our expert team, Laura Wartner, an estate-planning attorney with Smith, Gambrell and Russell, LLP, to provide some guidance on how to navigate through the current confusion over the estate tax laws.

I hope that you will take a moment to read her commentary below and review your estate planning documents. If questions arise, please contact me and I will be happy to assist you in getting expert counsel on this complex issue. 

By Laura L. Wartner
Partner
Smith Gambrell & Russell, LLP

Much has been written about the failure of Congress to address the scheduled “repeal” of the estate and generation-skipping transfer (“GST”) taxes before 2010, thereby wreaking havoc on professional estate planners and their clients. We need not repeat the details, but a summary of how this came about is important.

Under 2001 legislation, the exemption for federal estate and GST taxation increased to $3,500,000 in 2009 and will drop to $1,000,000 in 2011. Under that same legislation, the tax rate for estate and GST taxation decreased to 45% in 2009 and will increase to a 55% maximum rate in 2011. During 2010, the 2001 legislation effectively repealed both estate and GST taxation. Because of the obvious inequity and poor national policy, it was widely believed that Congress would address these issues in 2009, but it did not.

The change in gift tax law is only slightly less confusing. The 2001 legislation allowed an effective gift tax rate of 45% in 2009, 35% in 2010 and 55% in 2011, while providing for a lifetime exemption of $1,000,000.

To compensate in part for the repeal of estate and GST taxes in 2010, the 2001 legislation provided for a “carry-over basis,” with some adjustments. Little has been written about the carry-over basis provisions, but statistics show that for decedents dying in 2010, over 70,000 estates will be negatively affected by the carry-over basis rules, while about 6,000 estates would benefit from a repeal of estate or GST taxation.

As though this situation is not complicated enough, there are two additional legislative movements that may provide more confusion. First, Congress may consider legislation to reinstate estate and GST taxation in 2010, which may be retroactive to January 1, 2010. Whether the retroactivity of such legislation would be constitutional remains to be seen. As a result, at the present time, no one can tell whether estates of decedents dying in 2010 will be subject to estate tax or not.

In addition, Georgia and other states are considering legislation which would influence the interpretation of estate planning documents for decedents who die when no estate or GST taxation is in effect, by causing the estate planning documents to be interpreted as though the law in effect in 2009 still existed.

Estate planning has never been so entertaining. The question which seems to be most pertinent to our clients is: “How does this affect me?”

There is no single or simple answer to that question, but you should review your existing wills and trusts (“Estate Planning Documents”), keeping some guidelines in mind:

1. If you are unmarried and your Estate Planning Documents leave specific bequests to children or other persons, either outright or in trust, in all probability your documents do not need to be revised.
    
2. If you are unmarried and you leave bequests to persons utilizing GST planning, you should consult with your estate planning counsel to see whether changes in your documents are warranted. If, in the review of your documents, you see the phrase “GST Exemption” or “Family Dynasty Trust,” your documents would fall into this category.
    
3. If you are married and your Estate Planning Documents leave all of your assets outright to your spouse, in all probability there is no need for any change.
    
4. If you are in your first marriage and your Estate Planning Documents create a Family Trust (to be funded with the amount of your estate tax exemption) and a Marital Share, your documents may or may not need revisions. Most estate plans which are constructed in this manner utilize a formula. In the absence of estate tax law, some formulas would cause all of the assets to pass into the Family Trust; other formulas may cause none of the assets to pass into a Family Trust, or may be unclear. If all of your assets would pass to the Family Trust and your spouse is the primary beneficiary of this trust with your descendents as secondary beneficiaries, passing all of your assets into the Family Trust may work well. But there are many exceptions. If there is any doubt about what would happen, you should have your documents reviewed immediately.
    
5. If you are in your first marriage and your Estate Planning Documents create a “Family Trust,” a “Family Dynasty Trust,” a “Generation-Skipping Trust,” or other language suggesting the use of GST planning, your documents should be reviewed, because the GST tax planning will, in all probability, not be effective.
    
6. If you have children by a prior marriage, and your estate plan utilizes a “Family Trust” and a “Marital Share,” your documents should be reviewed immediately. It is possible that the formula would cause all of your assets to pass into the Family Trust, which may or may not include your spouse as a beneficiary.
    
7. If your Estate Planning Documents include a trust to carry out charitable bequests, such as a Charitable Lead Trust or a Charitable Remainder Trust, you should have your documents reviewed immediately, as the formula amounts that are used to determine the value of property passing into these trusts may not produce the results you anticipate.
    
8. If you are married and you own assets that have unrealized gain in excess of $1,300,000, you should review your situation carefully, as there are special new rules that allow a basis increase for certain assets passing to or in special types of trusts for the benefit of a surviving spouse, up to a maximum $3,000,000 basis adjustment. This special basis adjustment will be lost unless your estate planning documents are properly prepared.

There are several approaches to address these issues. One approach is to write provisions into your Estate Planning Documents which set out alternative provisions for your estate if death occurs when there is no applicable Federal estate or GST tax law in existence. Another approach is to add a provision that interprets your Estate Planning Documents as if the estate and generation-skipping laws that existed on December 31, 2009 are still applicable. It is important for you to contact your estate planning counsel to determine whether you need to do anything and what approach is best for you.