The Business Monthly: Gifting Appreciated Securities – A Win-Win Deal

Charitable contributions are an important part of many household budgets. It is quite common for families who budget carefully to base annual contributions to charities on a targeted percentage of gross household income. Charitable donations generally range between 1% to 10%. A typical percentage is perhaps 3%.

Most donees, however, overlook a gifting strategy that can provide significant economic as well as other benefits. This relatively simple strategy involves gifting appreciated shares of stock or mutual funds to your favorite charity in-lieu-of cash.

The most important economic benefit of gifting appreciated securities is that the donor reaps immediate tax savings. Assume a donor originally purchased 100 shares of stock at $10.00 per share net cost (including transaction charges) for a total cost basis of $1,000. With the help of the recent extended bull market, the market value of those shares could have easily doubled over the past 3-5 years to $20.00 per share or $2,000. By donating these shares, your favorite charity will receive the average market value of the shares on the date of receipt. The donor will get credit for the same $2,000 donation on Schedule A, although the original out-of-pocket cost was $1,000. By gifting the shares, the donor avoids having to pay tax on the $1,000 capital appreciation ($2,000 market value of gift less $1,000 original cost). In this example, the donor avoided the 20% long-term capital gains tax ($200) as well as brokerage transaction costs that would have been incurred to eventually liquidate those shares.

A second advantage of gifting appreciated securities is that this technique can be used to periodically rebalance your portfolio. If you are fortunate to own shares of a high-flying stock and are concerned about a potential “crash”, gifting appreciated shares in a timely manner can alleviate this problem. There is no extra cash outlay on your part since you planned to donate the same dollar amount to charity anyway.

Another reason to rebalance your portfolio could be that a particular stock prudently represented 2-3% of your portfolio at the time of original purchase, but has swelled to10% of your total nest egg by outperforming the rest of your portfolio handily during the past few years. Your portfolio risk has increased significantly. Perhaps you have too many eggs in one basket. This is a nice problem to have, but rebalancing may be prudent strategy to reduce risk.

A third example of gifting appreciated shares as part of a portfolio rebalancing strategy is to reduce the exposure of an income generating asset in a taxable portfolio in favor of a more tax-efficient holding.

A final advantage of gifting appreciated securities applies to those who contribute weekly/frequently. Religious organizations are the example that quickly comes to mind. Since gifting securities are drawn from investments instead of income, monthly cash flow can be improved. This technique is particularly beneficial for those who are self-employed and have irregular income streams. It can also benefit those who for whatever reason, fall behind in their annual pledges, or happen to “come-up-short” between pay periods. Since securities contributions are made in one lump sum, eliminating the need to tediously write that weekly check also saves time. Some organizations offer “the convenience” of automated payroll deductions for contributions. Gifting appreciated securities is a superior strategy since it involves pre-tax (capital gains) funds rather than after-tax cash.

When considering gifting securities, here are a four potential pitfalls:
1. Do not donate securities that have depreciated (suffered a loss in value). It makes more sense to gift cash instead.
2. To achieve maximum tax advantages, do not gift securities that are held in tax-deferred retirement accounts.
3. Consider gifting appreciated securities for donations of at least $500. This arbitrary requirement is due to the time and paperwork required to process, and potential benefit.
4. Be sure to identify specifically in a letter to the brokerage custodian which shares of a particular holding that you intend to gift. This is particularly important for mutual fund accounts that have reinvested dividends. Gift the shares with the lowest tax-basis.

In conclusion, by gifting appreciated securities in-lieu-of cash, your favorite charity still wins as you intended, but the donor also wins at the expense of Uncle Sam. To initiate a gift of appreciated securities, contact your favorite charitable organization, your brokerage firm, or your financial adviser for assistance.

This is an updated post of an article that originally appeared in the May 1999 issue of The Business Monthly.

Copyright © by PARR Financial Solutions, 2011

Please feel free to contact us if you have any questions or comments.

The Business Monthly: How to Weather Stock Market Turbulence

Safe to say that with a fair amount of monumental events happening throughout 2011, investors experienced the upsides and downsides of stock market turbulence. Throughout the years I have developed a few ways to weather stock market turbulence and reduce volatility through diversification.

Weathering Stock Market Turbulence

I recommend that investors take these five steps to weather the stock market turbulence:

1. Distinguish financial resources required to meet short-term goals from long-term goals.
2. Understand your portfolio liquidity needs and cash-flow requirements.
3. Be aware of how volatile your investment portfolio has behaved in percentage terms relative to the risk of the overall stock market.
4. Modify your investment plan by reducing your exposure to stocks if your needs have changed, or you are uncomfortable with the current volatility of your portfolio.
5. Stick to your long-term investment plan if you have sufficient financial resources to meet immediate needs and you can accept a higher-degree of risk with funds targeted to fund long-term (> 3-5 years) needs.

Diversify: Reducing Volatility by Understanding Correlations

An investment strategy practicing broad diversification can pay-off with reduced downside volatility. One-way to accomplish this is by carefully selecting different types of investments (technically referred to as “asset classes”) that have low correlations. Correlation is a statistical measure of how different investments behave relative to each other. It can range from +1.00 to -1.00. A correlation of +1.00 indicates perfect correlation. For example, rain and umbrellas have a correlation close to +1.00. Rain and sun have a correlation closer to -1.00 (but not absolutely -1.00 as an analytically-minded engineer would surely be quick to point-out). The correlation between rain and a cow is perhaps 0.00 and implies that these two items are uncorrelated and have nothing to do with each other.

This is an updated post of an article that originally appeared in the May 2001 issue of The Business Monthly.

Copyright © by PARR Financial Solutions, 2011.

Please feel free to contact us if you have any questions or comments.

The Business Monthly: The Mortgage Debt Time-Bomb

As we approach the end of the third quarter of 2002, short-term interest rates set by Federal Reserve Policy are at 40-year lows of 1.75%, and could be headed even lower to stimulate a sagging economy that is potentially on the verge of entering a double-dip recession.  Mortgage rates are also at extremely attractive levels. Fixed mortgage interest rates are driven by the yield on 10-year Treasury bonds currently around 4.08% – the lowest level since 1963!

It is an excellent time to take advantage of low mortgage rates and consider refinancing.  It is possible to obtain a 5.50% fixed rate mortgage with zero points, or perhaps a fixed 30-year mortgage rate with a rate around 6.125% with zero points.  When considering refinancing, keep in mind that even with zero points, there will be closing costs to pay.  Closing costs include appraisal fees, processing costs, and title exam, title insurance, and recording fees.

Until recently, continued robust consumer spending helped to keep the economy out of a serious recession.  To a great extent, consumer spending has been fueled by lower monthly mortgage payments.  Many consumers have also taken advantage of these low rates to get “cash out” of existing mortgages by refinancing and incurring even more debt that in turn has been used to propel spending and consumption.

Many consumers are reaching a point of inflection, however, where they are now tapped out with high debt levels.  Consumer spending is starting to weaken and impact the economy.  The unemployment rate is steadily increasing as companies are increasingly cutting back the work force to deal with declining profits.

There is an emerging trouble spot for many families that has, up to this point, gone relatively unnoticed.  Historically, a prudent mortgage credit policy was to borrow just enough so that an ideal comfortable monthly mortgage payment (principal & interest) was 25% or less of gross monthly income.  Refer to the exhibit “Prudent Credit Management Guidelines”.  Recently, however, aggressive mortgage lenders are approving mortgage payments over 50% of gross monthly income!

Lets look at the consequences from a feasibility perspective by making a few generic assumptions for discussion purposes.  If gross monthly income represents 100% of available funds, 35% of income typically can be expected to be eaten-up by payroll taxes, deductions, and withholding.  In this generic example, net income or disposable income would be 65% of gross income.  Actual individual case-by-case figures, of course, can be higher or lower.

If 50% of monthly income is being used to service mortgage debt, then only 15% of income is available to cover all other monthly lifestyle expenses.  Lifestyle expenses include essential spending items like food, clothing, utilities, property taxes, insurance, and transportation.  There are also discretionary expenses to be covered such as recreation, entertainment, travel, etc.

As you can see, we have not even considered saving for intermediate needs like auto replacement, home maintenance or saving for longer-term goals such as retirement, or perhaps education for children.  Retirement savings alone should be at least 10% of gross income, and perhaps much more for many families who started late, or suffered serious stock market declines over the past two years.  The bottom line is that such a high level of mortgage debt is clearly not feasible for many families.  Many consumers are compensating for the shortfall by taking on increasing levels of consumer debt (credit cards, home equity loans, and personal loans.

A healthier financial model is to start with gross income at 100% and deduct perhaps 35% (or your specific percentage) for payroll taxes and deductions. Next, deduct an appropriate percentage for long-term and intermediate term savings goals.  This follows the rule of “pay yourself first”.  Then structure your ideal mortgage payment to provide a comfortable monthly payment while still having room for adequate lifestyle expenses.  This ultimately will point you toward a policy of living comfortably below your means and while building your nest egg toward the long-term goal of financial independence.

There are a few exceptions that should be considered.  If household income can be expected to grow at a steady pace, higher levels of debt can be manageable and you can “grow into” a comfortable mortgage payment.  Another exception might be if both spouses have stable jobs and can independently support the family on a single income.

These comments are designed to be a wake-up call for many families.  They will also make you think twice about common rules of thumb like these:

–       Borrow as much as you can and invest the difference.

–       Buy as much house as you can afford so that you can have the largest income tax deduction for mortgage interest expense.  (You still are much better off in the long run not paying the interest to begin with!)

–       Consider the lower interest rates available on adjustable mortgages (ARM’s).  While certainly attractive today, your payments will increase when the economy eventually begins to recover and interest rates start to increase.  An adjustable mortgage may be the best option, however, if you plan to stay in your home for a relatively short period of time.

On a final note, no one knows when the housing market bubble could burst.  If you borrowed the maximum, and this situation occurs, you could find your house “underwater” where you owe more than the value of your home.  This in fact happened in the rust belt, in Texas, and in California in the past 20 years as the local economies fell upon hard times and the real estate market collapsed.  Many people defaulted on their loans, lost their homes, and were forced to simply walk away.

This article originally appeared in a 2002 issue of The Business Monthly.

Copyright © by PARR Financial Solutions, Inc. 2002