The COVID Calculation: The current pandemic is upending many investment and estate-planning strategies
Up until March, many people viewed 2020 as potentially being one of the best years ever in terms of their investments. All of that changed with COVID-19. Today, business owners are scrambling to preserve their businesses and rethinking what they need to do in terms of estate planning and investments. The Milwaukee Business Journal recently sat down with experts in estate planning and financial planning to talk about how the virus is changing the world of wealth management.
There’s nothing like a pandemic to shake up the best-laid plans. How is COVID-19 and the resulting economic uncertainty impacting your clients and their estate planning?
JENNIFER D’AMATO: E-mail traffic and phone calls were really quiet when the shutdown started. I think people were shell-shocked. Business owners were not thinking about succession planning. They were too busy reacting to the shutdown and what they had to do to right away. As time has gone on, we are hearing from clients and seeing some challenges. For example, if you want to amend estate-planning documents, you need to have two witnesses and a notary. That makes sense in a normal world, but now it’s not easy. People are coming up with creative ways to accomplish this, like drive-by signings, where everyone stays in their own cars. Another challenge is working with families where someone has died. It can be emotionally difficult to have the conversations you need to have over the phone, especially when the family wasn’t even allowed a funeral. Finally, the general fear of the virus and its impact on the economy is freezing people in place. There are lots of tax planning opportunities, but it takes a unique client to put the fear and death in the news to the side and make rational decisions to take advantage of those
JOE MAIER: One of the interesting things we’re experiencing is that clients are finding that provisions in their living wills may be inconsistent with the symptoms and science of fighting COVID-19, including the use of ventilators. The health care power of attorney, because it has more flexibility and can be more reactive to the most current science, is turning out to be a better health care decision-making tool. We are also running a lot of in-depth financial plans focused on giving. There has never been a better time to give to children or heirs given how low values are. But to Jennifer’s comment, we are doing a lot of analytical work and worst-case scenarios to make sure our clients are comfortable that they can give and still have enough money to last their lifetime with what is going on.
Are the concerns different than previous downturns?
MAIER: Early on in this downturn, there was a lot of conversation about a V-shaped recovery. The idea was that because we shut the economy down, we could turn it back on and it would bounce back. So at least initially, there was less fear than the 2008 downturn, which was more structural. That is starting to flip now. There are so many unknowns in the science around COVID-19, how we’re going to end the shutdowns, how long it will take consumer confidence to come back and whether some industries will survive. There also are a lot of companies that are too big to qualify for some of the government’s loan programs but may be too small to survive the economic disruption.
D’AMATO: I agree. People are not as shell-shocked as they were in the beginning, but the longer this goes on, there is much less sense that everything will be normal when it ends. Is this going to be something that accelerates trends that were already happening, or is this going to be an inflection point where the ways we do business fundamentally changes? There is a lot more going on than just economics.
Financial viability is of special concern for closely held companies where personal and business wealth are often closely intertwined. What are you hearing from these business owners?
MAIER: The conversations I have had with business owners over the past two weeks have had a similar theme: exhaustion. We have never had two recessions that were as deep and as close together as 2008 and 2020. The 2008 recession hit business owners very hard. But they survived it and they rebuilt everything and now here they are. They feel like they don’t have the energy to do it again and they are thinking about selling. This is exactly the wrong time to sell. What you have is a bunch of intelligent people who are so tired, exhausted and fearful – people who otherwise would make good thoughtful, strategic decisions – who are now thinking emotionally and not logically.
D’AMATO: I agree. It’s a matter of getting them to realize that things will get better. And while they may not want to be doing this again, I do think it helps that they have been through it before. At least they have seen a recovery happen. I have a number of clients who are very successful, however have not gone through an economic downturn and they are totally shaken. They just cannot believe the economy will ever come back.
What are some strategies that owners of closely held businesses and high net worth individuals should be considering at his time?
D’AMATO: There is a lot of opportunity right now because valuations are low and interest rates are low—it’s a perfect time to transfer assets if you are worried about the estate tax. You can gift more shares of stock for a closely held businesses when valuations are low. That means you can move a much greater percentage of the business tax-free to the next generation than you could just a few months ago. The same thing is true for marketable securities. It can also be a good time to sell your business to your children or a trust for your children funding the purchase price with a a promissory note which can use the historically low applicable federal rates. The value of your company is going to be down because of the economy, and the interest rate on the promissory note is also going to be low. I don’t know if interest rates have ever been this low – a 30-year note could use a 1.15% rate. You can really leverage the low interest rates and low values. Another option is to gift to a multi-generational dynasty trust, which is an irrevocable trust which can be structured as an intentionally defective grantor trust, where you transfer assets to the trust, but remain liable for and continue to pay incomes taxes so the assets in the trust, which are outside your taxable estate, grow like a Roth IRA. The math for these strategies looks really good right now, but you have to make sure the client is comfortable. As Joe said, people don’t want to make major moves right now without a lot of analysis behind it.
MAIER: What we know from an evolutionary standpoint is that raw abject fear tends to freeze us. And that is what we have right now. We fear for our lives, for the economy and for our future. And when that happens, people freeze. Even when we can demonstrate the math is perfect and we have run every number and it is logical to do these things, they are still not comfortable. That’s just the nature of the human condition. I want to go back to something Jennifer said – the anxiety of people who have not gone through a downturn before. Another interesting thing we are seeing is that some people who had transitioned ownership and leadership to their kids are getting back in the game. They were retired, or served as chairperson of the board, but now they are taking a more active role in the business because they feel, or their kids feel, that they need to be there to lead the company through these uncertain times.
What strategies would you tell individuals to avoid?
D’AMATO: Unfortunately for non-profits, this is not a great time for charitable giving. Whether giving to your own private foundation or a public charity, you are not going to get the tax benefits you would when the economy is robust, as you are likely to have fewer capital gains to shift. There are other techniques like qualified personal residence trusts that work well with when values are low like they are now, but they rely on high interest rate assumptions to make them effective. Because interest rates are also low, we would not recommend leveraging that kind of transfer.
MAIER: In times of uncertainty, act flexibly. Most people would likely do that anyway, but we are having a lot of conservations around making sure people understand what that means. We always go back to the plan we have already developed. The people we work with don’t view investments as a strictly a math problem. They see them as the means for accomplishing life goals. A market downturn only hurts if you have to sell. So we take every opportunity to make sure our clients are focused on the long-term and are not taking short-term actions unless they have to.
Given the pandemic’s broadside against so many segments of the economy, is there a safe vehicle or industry sector in which to invest?
MAIER: That’s an issue our investment people are looking at. The value of any company is based on its long-term cashflow, and there is a lot that goes into that. There are future revenue projections, taxation issues, macro-economic issues and micro-economic issues. At the end of the day, the question comes down to whether this pandemic will fundamentally change the way businesses and industries operate. Take the hotel industry or the airline industry or the restaurant industry. Will the pandemic forever change them? What happens to the convention industry and business travel as we become more technologically savvy? We do a lot of travel to meet clients face-to-face, but will that be as necessary as everyone becomes more comfortable with Skype and Zoom and all of those things?
D’AMATO: There are industries like brick-and-mortar retail that were virtually on their last legs already, and you have to wonder if this pandemic is going to be the knock-out punch. On the other hand, you have businesses like Amazon that are probably going to continue to eat everybody’s lunch.
There were concerns prior to the pandemic that estate planning could be affected if there was a change in political power in Washington. How has the pandemic affected that line of thinking?
D’AMATO: One of my partners has a client who has never wanted to talk about estate planning. That all changed with the pandemic. He was concerned with polls showing Trump trailing in a couple of key states and what could happen if Democrats win this fall. I think there is some real uneasiness about estate and income tax laws. It’s not just because of the political winds. It’s also because of the stimulus and what that is doing to the already large deficit. If Democrats do take control of Congress and the White House, they will have every reason to say they need to raise taxes. So, people are concerned. People are getting more serious about using the current $11.58 million exemption before it expires in January 2026, or even sooner if the Republicans lose control of the Senate and the White House.
MAIER: If this downturn did not have all of the weird scientific unknowns and medical fear, I think people would be lining up outside Jennifer’s door right now to maximize their gifting. And, if the scientific or medical fear were to alleviate in any way, I think you will see the giving of wealth in the fourth quarter at levels we have never seen. I think it would easily dwarf 2012.
What are the indicators that you think will signal the economy’s return to a more predictable trajectory?
MAIER: Let’s take the obvious ones first. A vaccine is a game changer, as is a treatment that dramatically changes the death rate or hospitalization rate. I asked our Chief Investment Officer about the type of data we are looking at to see indications that people are becoming less fearful and the economy is gaining traction. Here’s some of the things they are looking at: box office receipts, TSA data, retail numbers, open-table reservations and hotel occupancy rates. That’s a lot different than what we were tracking in 2009.
D’AMATO: I don’t have the insights Joe has, so I don’t have much to add. For me, an indication that the economy is returning to normal will be when I can go back to my office, have work as usual and see that our clients’ businesses are coming back. I think it is going to be very uneven. I talked to an owner recently who has parts of his business all over the country. Some are totally shut down, some are going gangbusters.