In February’s newsletter, I wrote about protecting your wealth through forms of business entities and insurance coverage. After all, growing wealth is not particularly helpful unless you also ensure that you can preserve that wealth, especially when life throws unexpected and unwanted curveballs at you. 

To continue the theme of wealth protection, Part 2 will discuss investment and estate planning considerations. 

Investment Protection 

As our wealth grows over time more and more of that wealth will find its way into various investments. Protecting your investment wealth is a complicated topic and what is right for one person is not at all what will be right for others. I’m not an investment advisor so I will stick with a few fundamentals. 

Let’s start with a few basics. There are essentially two kinds of retirement accounts. The first allow you to make tax-deductible contributions and pay taxes when you take the money out (Traditional IRA, pre-tax 401k, SEP). The second allow you put after-tax money into the account, but then allow you to draw the money out (including the growth) tax-free (Roth IRA and Roth 401(k) account). 

In terms of wealth preservation all retirement accounts have an important quality: they generally are fully protected from creditors, including in bankruptcy. This is especially true of 401(k) plans protected by the federal ERISA law. That is not true of “regular” investment or brokerage accounts, bank accounts, CDs, etc. 

Most of us remember the banking collapses in 2008 and are familiar with the investment losses caused by Bernie Madoff and, more recently, FTX in the crypto world. The first lesson of protecting your wealth is, if it’s too good to be true it probably isn’t true. 

That doesn’t mean all “risk” investments must be avoided. We are talking now about risk management. The key to protecting your investment wealth lies in how you manage your risk by allocating your investment wealth among various asset classes and diversifying within those asset classes so that no one or even two “disasters” undo what you’ve spent years accumulating. 

Similarly, when your investments are not insured it is essential that you not allocate too much of your wealth to the investment. Nobody gets it right all the time. Too many eggs in too few baskets creates great risk, and as you get older and your “accumulating” years start running out that’s a risk few can afford. So, whether you are handling your own investments or are relying on an investment advisor or financial planner, be sure you are adequately spreading your wealth among various assets and asset classes, rebalancing regularly, and that most of your wealth is in federally protected accounts. 

With that in mind, a word about investment advisors. If you are relying on an investment advisor, the most important protection for you is ensuring that the advisor owes you a fiduciary duty. A fiduciary duty means the advisor is required by law to put your interests ahead of their own. (This also goes for insurance advisors. Some insurance agents are “captive,” meaning they work for the insurance company. Don’t expect them to direct you to a better or less costly policy offered by a competitor.) 

Read the materials any proposed advisor gives you and if you don’t find that advisor prominently describes their fiduciary duty to you, look elsewhere. Also keep in mind the compounding cost of an advisor. In your early years of accumulating wealth paying an advisor may end up costing you far more than you realize due to the effect of “reverse compounding.” Every dollar paid to an advisor is a dollar not invested and therefore not able to grow over time. Many will find that they do not need an advisor (or can lean on their CPA for advice) until after they have accumulated significant wealth and are closer to retirement. This greatly reduces the impact of reverse compounding.

Finally, it is helpful to understand that, in retirement, wealth preservation requires a different set of skills than wealth accumulation required during our working years. Whereas accumulating wealth focuses on maximizing earnings, savings, and returns, preservation of acquired wealth in retirement is generally more a conservative strategy and requires expertise in matters such as retirement, withdrawals, taxes, and generating income from your wealth. Just because you successfully manage your own wealth accumulation does not mean you have the skills to preserve that wealth in retirement. A good financial planner should spend a good deal of time helping you preserve the wealth your acquired.  

Estate Planning Considerations

Most of us don’t think about it this way, but all your wealth, everything you own, is part of your “estate.” Therefore, estate planning is an essential aspect of wealth preservation, for you, your spouse, and your heirs. This brings into consideration the topic of using trusts to hold our estate. 

Trusts use three terms it is helpful be familiar with. There is the “grantor” of the trust. That is the person (or persons) that create the trust. There is the “trustee” or “trustees” of the trust. This is the person or persons that manage the trust. And there are the trust “beneficiaries.” These are the people that obtain benefits from the trust. 

For some period, you may be all three! The trust may be designed where the trustee is authorized and directed to take care of you (and your spouse) and then, when you are gone, to take care of your children or grandchildren, or to distribute the trust’s assets to them and end the trust. 

There are essentially two kinds of trusts: living or revocable trusts and irrevocable trusts. The idea behind a trust is that you have your assets held or owned by your trust, not you, so if you die or become disabled the only thing that changes is the name of the trustee of the trust – the person that manages the trust’s assets. 

Thus, you don’t own your home or your investment accounts as an individual, you own them in your capacity as the trustee of the trust. By holding assets in trust you avoid the (wasted) cost and hassle of probate. In a revocable or living trust you can move assets in and out of the trust at any time and can revoke the trust if you choose. However, the assets in your trust generally receive no protection from a creditor by virtue of being “in trust.” 

In contrast, in an irrevocable trust has strict restrictions, but the assets in the trust are typically protected from creditors. And this protection can extend to the beneficiaries of your trust, protecting those beneficiaries (such as your children or grandchildren) from being scammed (or simply being irresponsible). 

Once you begin accumulating wealth (this means equity in your home, value in your practice, and your investments and savings) a consult with an attorney that specializes in estate planning is an essential part of wealth protection. It is generally a bad idea to rely on an attorney that does not do estate planning for a living as it is a highly specialized area of law that changes all the time, especially as tax law changes. An estate planning attorney will help you prepare a living trust, transferred your assets into that trust, and will prepare the all-important powers of attorney that addresses what happens if you (or your spouse) become unable to make decisions for themselves – both financial and health care.