Our latest edition of the 5,5,5 looks at the benefits of a health savings account, the active v. passive debate, investing in bonds when interest rates are rising, buy-sell agreements, and practicing gratitude. Enjoy!
1. Benefits of a Health Savings Account
Health Savings Accounts (HSAs) have become a popular option for people who want comprehensive health insurance while building up tax-free savings for medical expenses that can roll over from year to year. Before you can contribute to an HSA, however, you must first be enrolled in a high-deductible health plan (HDHP).
There are many advantages to investing in an HSA. The first is that it’s triple tax free: 1) Contributions are tax-deductible or can be made pretax, when deducted through payroll, 2) interest earned is tax-free, and 3) withdrawals for qualified medical expenses are tax-free. Qualified medical expenses include most services provided by licensed health providers (including dental and vision expenses), devices for health diagnostics, and prescriptions. Another advantage is the ability to roll over your account balance each year; this is not a use-it-or-lose-it plan, and it follows the employee even if they separate from their employer. This benefit allows consumers to accumulate significant savings over time to pay for your future medical needs.
One of the biggest advantages of and HSA is the option to invest funds to ensure tax free growth (note that some HSA providers require a minimum balance to invest). If you want to know learn more on how you to invest your HSA, please ask your advisor.
A Heath Savings Account is one of the most efficient ways you can save for your qualified retirement medical expenses. We recommend contributing the maximum amount to your HSA annually, as this vehicle allows you to save tax-free for future health care expenses. The 2018 limit (including employer contributions) is $3,450 for individual coverage and $6,900 for family coverage. Individuals 55 and older may contribute an extra $1,000 annually.
2. Active v. Passive
It’s an ongoing debate: Pay for active management or buy the index? Let’s look at it from a different angle.
In response to the Global Financial Crisis, the Federal Reserve Bank reduced its overnight rate from 5.25% in September 2007 to 0% by the end of 2008. Its Quantitative Easing program (QE) also bought more than $2.5 trillion (with a T), of US Treasuries and other debt. The end result was a highly accommodative climate which made stocks more attractive than other asset classes and changed a normal market environment by increasing correlation and decreasing dispersion among stocks.
In short, high correlation = stocks moving up and down together, and low dispersion = lower differences between the best and worst performing stocks. This meant more winners and fewer losers and, more accurately, a much more challenging job for active managers relative to the overall market or benchmark.
Overly simplified, these conditions helped fuel the post-recession run in stocks and the wide adoption of passive strategies along the way. Since that time, the Fed has discontinued QE, begun raising rates, and we’ve seen an increase in volatility this year. Our view is that the next few years will look less like the recent past and more like the first five months of 2018. A likely result of this will be an environment with lower correlations and higher dispersion among stocks that is more suited to active management such as one would find among many of the managers utilized in our clients’ Growth strategies.
3. “If interest rates are rising, why would I want to invest in bonds?”
While rising yields can cause the price of a bond to decline on paper in the short-term, when the bond matures investors will still be paid back at par and would have received the coupon payments along the way. Therefore, short-term fluctuation in bond prices does not impact the fixed maturity price, and the total return for a bond equates to its yield at the time of investment.
Shorter duration bonds can be an effective investment during a period of rising rates. When short duration bonds mature, the proceeds (original principal + income earned) can then be reinvested at the higher prevailing yields which mitigates the impact of rising rates. This phenomenon can be illustrated by looking at bond returns the last time we went through a significant rising interest rate and inflation environment over 30 years ago. From January 1963 through December 1981, the yield on the 5-year treasury bill (a proxy for short-term bonds) rose from 3.53% to 13.97%, a nearly 10.5% increase! Yet despite that incredible rise in rates, the 5-year treasury bill returned 4.83% on an annualized basis with only one year of negative return as shown in the accompanying graphic. Consequently, we welcome rising interest rates as it will allow us to capture higher yields when our existing short-duration bonds mature.
4. Buy-Sell Agreements
An integral part of running your own business is planning for its continuation if one owner were to exit prematurely, e.g. death or disability. There are many ways to plan for the exit of a business owner, with buy/sell agreements among the more popular tools. The two main types of buy-sell agreements are Cross-Purchase and Stock Redemption Agreements.
A Cross-Purchase Agreement allows a company’s partners or other shareholders to purchase the exiting, deceased, or disabled partners shares. The document describes how one partner’s interest may be divided up or purchased by the remaining owners. This type of plan makes the most sense for a business with just a few partners who are roughly the same age. Life Insurance is often used as funding sources for these agreements. The agreement can become cumbersome if there are several owners, as each owner would need to take out an insurance policy on each of the other owners. In the case of a business with two owners, each partner would own and be the beneficiary of the other owner’s policy. The surviving owner would be paid the death benefit of the life insurance policy, which would then be used to buy the deceased owner’s interest from his estate/spouse/other beneficiary.
A Stock Redemption Agreement is just having a plan and agreement in place to address purchasing or transference of ownership shares because of the exit, disability or death of a partner. Typically, a stock redemption agreement is used when there are MORE than two shareholders. Using life insurance to fund it provides that the company can take out a life insurance policy on each owner in the amount of each owner’s interest. The company will be the policy owner and beneficiary for each of the partner’s policies. If one owner/partner were to die, the policy would pay death benefits to the corporation, and the company buys the deceased owner’s interest from his estate/spouse/other beneficiary.
Buy-sell agreements are also effective in planning for an owner’s retirement, disability, or interest in selling. If you are interested in learning more, please ask your Wealth Manager for more details.
5. Practicing Gratitude
Several weeks ago, we started a new ritual in the office: We now kick off our weekly internal meetings by answering the question, “What are you thankful for?” One by one, we offer a story or mention someone or something that blesses us. The only rule is that you must come up with something new to share each week. Initially, everyone migrated to the obvious answers; we are thankful for our families, our health, our clients, our jobs, our country, our pets. This past week, celebrating Memorial Day, being grateful for and humbled by the many men and women who made the ultimate sacrifice for our freedom was at the top of our lists.
Coming up with a unique answer each week has caused us to dig deeper and look for gratitude in less obvious places. Introspection, both organizationally and individually, has been a welcome result of this simple exercise. It’s been rewarding recently to hear more answers like, “I am thankful for the opportunity to sit down with both the husband and wife and try my hardest to make the time valuable for them and impact their lives in a positive way” or “I am thankful that my client shared that he feels better equipped to understand his own relationship with money and how it differs from his spouse’s.” One of my recent favorites was, “I am incredibly thankful for the opportunity to work with a new client who is still reeling from her divorce and really needs our help. Walking through this with her and giving her confidence and peace about her financial future makes my day.”
Consistently and intentionally recognizing the impact of the people in our lives and the appreciation for the deep relationships we have formed with them helps us keep what really matters at the forefront. As we wrap up the June 5,5,5, we ask you to consider adopting this ritual for your own life. Make it a habit to dwell on what you are grateful for then share it with your spouse, your kids, or a friend. Do this as a family and maybe even keep a gratitude journal. Enjoy the journey of introspection and watch how it transforms your thinking and your attitude. And, as always, thank you for reading.