Goal: To pay off their two mortgages.
Recommendation: Use $2.9 million of the $30 million pool to reduce mortgage debt from $4 million to $1.1 million in order to capture the maximum mortgage interest deduction. Invest the $1.1 million not used for debt reduction, with the assumption that the Basies are in a high marginal tax bracket and, over time, an investment portfolio would probably generate returns greater than their net interest costs on the outstanding mortgage.

Gifting

Goal: Make lump-sum gifts to family members.
Recommendation: Make maximum annual exclusion gifts to family members—as opposed to large gifts—to keep intact the gift-tax lifetime exemption until they adjust to life without earned income. The other option would be to make some combination of annual exclusion gifts and taxable gifts spread out over time to preserve some of their lifetime exclusion while they adjust to their new lifestyle.

Philanthropic Endeavors

Goal: To establish a charitable entity.
Recommendation: Establish a charitable remainder unitrust (CRUT) with $5 million and a payout of 5 percent for the lives of both Mr. and Mrs. Basie. Fund it with low-tax-basis securities and any concentrated positions, because the trust can sell and redeploy without capital gains. This allows them to diversify investments without capital gains taxes on sales of either the low-basis holdings or any concentrated positions now in their personal portfolio. It also affords them the ability to obtain a larger charitable deduction because they can use the fair-market value of the stock contributed to the charitable vehicle rather than their low-cost basis. This will produce $250,000 of cash flow, which will vary in the future according to how the trust’s portfolio performs.

Investment Strategy

The Basies have made some assumptions about capital markets and risk management that could hinder them over the long run. While they are aware of many of the risks a stock portfolio can face—market, sector and company-specific risks—they have overlooked a major risk that will have a significant impact on their investments over time: inflation.

Inflation could be the biggest risk to the spending power of the Basies’ $750,000 annual paycheck for life. To control that risk, we would advise the Basies to rethink their assumptions on stocks versus bonds, as well as the importance of portfolio diversification.

To meet their goals we recommend that they adopt the following investment strategy:

For the IRA portfolio ($3 million) consider:

• A portfolio of diversified U.S. and foreign stocks targeted for capital appreciation rather than income production, using a tactical approach to take advantage of an IRA’s tax-free status ($3 million to start).
• Do not withdraw from an IRA until age 70½, unless there’s an emergency. This gives the $3 million a 15-year period to accumulate tax free. We recommend our tactical growth style, focusing on high-quality mid-cap and large-cap stocks that can grow earnings faster than the market in sectors of the economy that are expanding.

For the taxable portfolio ($19.1 million) consider:

• 30 percent tax-exempt bonds yielding 3.75 percent.
• 40 percent U.S. equities yielding 2.5 percent.
• 20 percent foreign equities yielding 2.5 percent. We recommend our dividend growth–style for both U.S. and foreign equities focusing on high-quality companies that have strong cash flows and rising dividend payments.
• 5 percent REITs yielding 3.8 percent, provided that the Basies understand REITs are equities and are not proxies for the U.S. housing market.
• 5 percent tax exempt cash reserves yielding 3.2 percent.

Note: Yields are approximate current market yields.

This allocation yields cash flow +/– $570,000.

Eileen B. Buckley, portfolio manager; Arlene S. Franklin, JD, LLM (Taxation), CFP; and Timothy F. Lenicheck, JD, CLU, are with Boston Private Bank & Trust Co., an affiliate of Boston Private Wealth Management Group.

The goal of Scenario Planning is to spark discussion on asset management and portfolio realignment with your financial professionals, not to provide advice. Each month, the editors of Worth choose a case study and respondent. Working with a wealth advisor involves an in-depth process that we cannot replicate in this space. No financial advisor can provide comprehensive counsel without a thorough and ongoing dialogue with you about your goals as your life changes, so let this serve as an exercise to open that discourse. This example is for illustrative purposes only, and no reader should attempt to coordinate his or her situation with the given paradigm.