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Issue 42 – July, 2023

What Does the Silicon Valley Bank Collapse Have to Do with Estate Planning?

By Brady R. Marlow, CFP®, CAP®, CPWA®, CExP™, AEP®

Wealth strategists are yielding a variety of important questions from their clients as a result of the Silicon Valley Bank collapse. Among the questions, two stand out as appearing most frequently:

  1. How does this affect me?
  2. What can we learn?

Collapse Recap

To oversimplify, SVB bank purchased long term treasuries when the 10-year yield was at 1.5%, causing a domino effect when the rates aggressively started increasing thus lowering prices. This lowered the value of the banks long term assets, thus creating a $1.8 billion loss in asset sales. The bank was unable to secure additional investment capital, and the run on the bank began.

How Does This Affect Me?

For individual investors, this brings to light the concept of FDIC insured accounts. As most people know by now, up to $250k per account ownership, per institution, is FDIC insured. This doesn’t mean that the entirety of one family’s accounts in an institution are only insured up to the $250k limit – for example, if the family has an account individually owned by one spouse, an account held jointly by both spouses and a revocable trust account, all three accounts are eligible for the $250k protection each.

This isn’t the case if the couple jointly holds two accounts together, in both their names. In this instance, the $250k limit is applied for both accounts together instead of each.

Brokerage accounts are structured differently. Their primary business is buying and selling securities and holding them in a segregated account on the client’s behalf. The brokerage accounts carry SPIC insurance up to $500k per account for cash and securities. The major difference between banks and brokerage firms is that brokerage firms don’t have the ability to use the investor’s assets to pay of their creditors.

By that same token, insured credit unions have an FDIC equivalent in NCUA, which also provides $250k protection per share owner.

So while most account holders can be fairly sure their funds are safe in an insured account, the collapse of Silicon Valley Bank had much more widespread implications than whether or not the funds were insured.

What Can We Learn?

Silicon Valley Bank was a poignant example of what happens when a long-term investment strategy doesn’t meet short-term liquidity needs. Banks and individual investors alike can fall into trouble when their investments aren’t approached from the mindset of liquidity needs across generations.

Consider a simple bucketing strategy.

  • Bucket One holds cash for needs for 1-3 years so that volatility is not experienced and selling low is taken off the table.
  • Bucket Two holds 3-7 years which can be for specific goals or simply taking advantage of the time value of money since Bucket One is full.
  • Bucket Three holds long term investments that are unneeded for 7 years and beyond, which allows for opportunity to take on more growth-oriented assets.

Now layer on additional vehicles that provide incentives but come with reduced availability or penalty if accessed early, such as IRAs, 529 plans, 401ks and annuities.

Next, consider the assets that fund those buckets and vehicles. These could be stocks, bonds, illiquid alternative investments, real estate, etc. Take a one-owner business and fund a self-directed IRA with those shares. Illiquidity and access limitations both exist. You would need to sell the business and be 59.5 before accessing funds without penalty.

Let’s keep going, adding a little behavioral finance into the mix. What about the buckets beyond first few rungs of Maslow’s Hierarchy of Needs, such as family legacy and giving? As we think specifically about the family legacy bucket, similar to Silicon Valley Bank, the irreversibility of decisions comes into play. When designing an intentionally defective grantor trust or spousal lifetime access trust or QTIP, one may be matching the liquidity needs of multiple parties’ timelines.

The grantors may need funds for taxes or lifestyle needs, the beneficiaries may have HEMS needs, and there is the intention of creating legacy for the third generation and beyond.

Avoiding a Mismatch of Liquidity

Without deep exploration into the client’s current, future, and from-the-grave wishes, a mismatch of liquidity can occur. This can cause a domino effect of costly changes to the estate plan or penalties.

Saving on federal estate taxes is one variable, but the ability to maintain the strategy due to other timeline factors is another variable entirely. Often clients do not think in terms of multi-generational liquidity needs. It becomes important for the advisor to propose a strategy that helps the client plot out potential needs.

Visualize a Gannt chart for a construction project. Scheduling the drywall without first installing the electricity is going to lead to a teardown of some beautiful drywall. Similarly, if too restrictive of an estate plan is built, the client may regret their structure because flexibility to either fund goals at certain times have changed, or economic conditions have changed.

Consider a farm – it may seem like a great asset to pass on from generation to generation. But what if the next generation no longer wants the farm and has liquidity needs? Is there the ability to swap assets or borrow from the asset

Layering in the needs of the next generation with the structure and asset paints the picture of what is possible for the client, thus helping them to move forward with the recommendation. Anecdotally, feedback from clients is that though taxes are saved for the estate down the road, there is no connection to how the wealth truly perpetuates family legacy and values.  This can cause lack of implementation, even though the estate planning strategy is sound.

Individual investors can garner a valuable lesson from the collapse of Silicon Valley Bank. When a long-term investment strategy doesn’t meet liquidity needs, things can quickly fall apart in a dramatic fashion. Investment strategies should consider both short-term and long-term goals and necessities.