Five Frequently Overlooked Advanced Planning and Wealth Management Mistakes

Watch out for these “gotcha’s” when your guard is down during the dog days of August.

By Elite Advisor Report Staff

Key Takeaways:

  • Many high-net-worth individuals are inadequately insured and don’t even know all the risks they’re exposed to.
  • Don’t let clients take RMDs before they have to or rush to buy cars or capital equipment just to meet an arbitrary calendar deadline.
  • With greater longevity, combined with low interest rates for savers and skyrocketing medical costs, even highly affluent clients could be in danger of outliving their money.

Let’s face it: We all lose our edge a little when the dog days of August set in. But whether you’re tied to your desk or enjoying the pool, beach, lake or mountains, your clients are counting on you to be on top of your game 365 days a year. We reached out to some of our most popular outside contributors for a quick guide of wealth management “gotchas” you want to make sure are not sneaking up on your clients.

1. Inadequate insurance

Even many financially savvy people greatly underestimate the amount of liability coverage they need, according to David Hubbard, vice president, regional marketing manager at AIG Private Client Group. It’s easy to understand why: Responsible, successful people are use to giving careful thought to a situation before they act, and they don’t see themselves as engaging in risky behavior. But no matter how careful you are, there’s no way to predict everything. And the more complex your lifestyle is, the greater the chance of a curveball coming your way—a bitter former household employee who claims harassment or improper firing, a neighbor with an ax to grind, or even an underinsured motorist who hits your vehicle and can’t pay for the damage he or she has done.

Excess liability insurance can protect the assets of your high-net-worth clients from unforeseen accidents and mishaps. To make sure they’re fully protected in a worst-case scenario, use the following points in your discussions and planning sessions.

  • Your excess liability policy limits should match your net worth. If a judgment or settlement exceeds the coverage provided by primary policies, insufficient coverage can put personal assets at risk. If the current insurance provider can’t offer sufficient coverage limits, know that more fitting solutions are available elsewhere. Insurance carriers that specialize in high-net-worth personal lines can typically offer coverage limits of up to $100 million.

  • Some situations are not addressed in standard “umbrella” policies. Depending on your lifestyle, it may be prudent to add coverage for specific risk factors, such as employing domestic staff or sitting on a not-for-profit board.

  • All secondary homes, watercraft, cars and off-road vehicles should be listed on the excess liability policy. Relying on primary insurance to cover liability incidents with these types of properties will usually leave you with significant coverage gaps.

  • Make sure your insurance agent knows whether any special circumstances apply to the homes or vehicles named on the policy. Examples: assets owned by a family trust or LLC, vehicles used for racing, or homes or vehicles that generate business income from tours or exhibits.

  • If your children, domestic staff or others ever use your vehicles, make sure these additional risks are included in your coverage.

  • If you have household staff, your insurance advisor may need to document additional information for the policy, including the kinds of background checks that have been performed on the staff and whether you have workers’ compensation insurance in place.

For more, see Helping HNW Clients Assess Personal Liability Risk Factors.

2. Entrepreneur clients rushing to buy capital equipment they don’t need

Just because a client is having a good year doesn’t mean he or she should go out and buy equipment to get a tax write-off, observed Josh Patrick, CFP, head of Stage2Planning Partners. “Before clients ever buy capital equipment, they should always do an analysis to see if there is a payoff for the expense,” said Patrick. “When you’re advising your clients about what to do with some extra cash that’s burning a hole in their pockets, make sure you help them figure out how to assess the ROI on the intended purchase. If the purchase doesn’t cover its cost of capital, then you should argue against spending the money.”

Most of the time you’re not in the room with your client when they’re about to make a dumb purchase, quipped Patrick. “Make sure you have a conversation with them about their tendency to overspend in December—with the inevitable cash crunch in February. Your client will be glad you did.”

For more, see Six Really Dumb Things That Business Owners Do at Year-End.

3. Taking RMDs when clients don’t need the money

Some affluent retirees find themselves forced to take required minimum distributions (RMDs) of their IRAs at 70 1/2 even if they don’t need the money—thus paying tax on income they don’t want.

Real-world example

Suppose you have a 68-year-old client who is still working and quite healthy. He is divorced, has two grown children and a significant other. His total assets are around $5 million, but $2 million is in his IRA. His main concern is that when he turns 70 1/2, he will have to begin taking required minimum distributions from his IRA, and he doesn’t think he’ll need the money to live on. Essentially, he would be paying tax on income that he doesn’t want. Currently, he gifts regularly to the university he attended, but he has been doing that with appreciated securities.

An advisor (I’m not sure if it was a planned giving officer, an attorney or a financial advisor) suggested the following to the caller: Withdraw the entire IRA and place the proceeds in a Charitable Lead Annuity Trust (CLAT). Despite not having all the information, I was able to determine that the CLAT was a grantor CLAT, which means the income tax deduction would flow through to the man’s personal return. According to the advice, the man would receive a 90 percent income tax deduction. My later calculations suggested that a 15-year, 7 percent payout trust would accomplish something close to that result. Gathering more information, I determined that this transaction would add about $140,000 to the man’s current year income taxes and raise his marginal rate from 28 percent to 39.6 percent.

Pros and cons of grantor CLATs

How does this transaction benefit this client? Certainly, he does get to withdraw $2 million of IRA assets for only $140,000 of income tax. And he is able to make $140,000 of gifts per year for 15 years. He has gotten most of the toxic IRA asset out of his estate and has avoided a lot of income with respect to a decedent tax (IRD) for his heirs. Is there a downside? Several, actually. First, our East Coast friend loses access to his capital for 15 years. And even though he is healthy and working now, it’s impossible to know how long that will be the case. He may also have given away $2 million, and thus disinherited his heirs from those funds. If the CLAT earns 7 percent or less, there will be little, if any, capital left. And while his income tax is “only” $140,000, he still has accelerated the payment of that tax into the current year.

Alternatively, he could wait to see whether the charitable IRA rollover is re-enacted and make an annual gift that way. Second, he could name a charitable remainder trust as the beneficiary of his IRA and allow that income stream to benefit his children and significant other. While this would delay the gift to charity, there is nothing to stop him from making annual gifts to charity from his RMDs. He could also name his alma mater as the beneficiary of the IRA and purchase life insurance to replace the asset for his heirs.

For more, see When the Affluent Ask You: “Should I Do This?”

4. Lease vs. buy

According to Glenn Demby, Esq., the key to making the right decision is to recognize and properly weigh the advantages and disadvantages of each option and how those pros and cons apply to your client’s situation. “Neither method is inherently superior to the other. To make the smart decision, each client has to consider his or her particular circumstances, including cash flow, taxes and psychological needs. Savvy advisors should walk their clients through the pros and cons of each approach to help them make a confident decision without buyer’s (or leaser’s) remorse.”

Demby has ten litmus-test questions that can help you and your clients make the right decision.

For more, see Ten Factors to Help Clients Decide Between Buying and Leasing a Business Vehicle.

5. Is the four percent rule still valid?

Financial advisors are helping clients cope with the reality of retirement. This reality includes living longer, extended low interest yields, inadequate retirement accumulation and market volatility, not to mention the impact of inflation and high medical costs. The question “Where should I invest my money?” is being asked more and more frequently, according to Guy Baker, MBA, MSFS, CFP® of Irvine, California-based BMI Consulting.

The issue for many clients and their advisors is sequence risk, explains Baker. Over the past 90 years, he said the stock market has returned, on average, 10 percent (with dividends reinvested). But again, that’s the average. “It is the down years that drive the potential for retirees to run out of money,” observes Baker. “So it is important to protect against a protracted down market. The market has never been down for five consecutive years, even during the Great Depression. It would be smart to split clients’ money into two funds. One is the income fund and the other is the growth fund. Set aside five years of income in the income fund and then invest the rest in the growth fund.”

For more, see Is Bengen’s Four Percent Rule Still Relevant?


Keeping these financial gotchas in mind in the dog days of August could pay big dividends for you and your clients at year-end and beyond.