Turning Your Royalties Into a Lifetime of Income

 

Raymond “Scott” Stone

Stone House Investment Management, LLC

Managing Partner

rstone@stonehousemail.com

570-278-6926

 

 

We work with many natural gas royalty recipients. Many ask for advice on how to minimize their taxation. Due to the income category that royalties fall under, there aren’t a lot of practical strategies for reducing your taxation from year to year. Fortunately, there is one very practical strategy that we recommend our clients consider. 

Royalty income is uncertain. Royalties go up, they go down, they stop, they restart. No royalty recipient should count on royalty income as part of their financial plan. Until the money is in your hand, you should think of it as “extra money” or the “cherry on top of the sundae”. Once the royalties are in your bank account, however, you can make practical plans for what to do with that money. After you reserve out the estimated taxes due (see your accountant for more details), you should consider building a retirement account. I know…. retirement seems like such a long way away. It doesn’t have to be, though.

If you receive significant royalties for a prolonged period of time, you may fund your retirement account quickly and find your can comfortably retire after just a few years. If you have saved for retirement over the years in IRA’s or company sponsored retirement plans, the royalties you receive may be enough to push you over the top. Depending on your age, social security benefit estimate, income needs, etc., you may be able to retire quite early. The key is to build enough money in your retirement account that you don’t need to rely on future royalties to pay your bills because you never know what can happen to your royalty stream over the years. Using some key pieces of information, we can show you how much money you need to accumulate in your retirement account to retire soundly.

Now here is where the tax savings come in. Your retirement account can be invested in several ways. You can max out contributions to retirement accounts and employer sponsored retirement plans if you are still working, but there are annual contribution limits that may not be sufficient to absorb all of your saving needs. You can invest your royalties in a non-retirement brokerage account which gives you the most flexibility but least tax advantages. As an additional alternative, you can invest your money in an annuity. That’s right, I said it; an annuity. I’m not talking about your grandma’s annuity, though.

Over the years, annuities have developed a bad rap for being expensive, inefficient, and inappropriate for many investors. In recent years, however, several annuity companies have created a new breed of annuity products that pass the test of fee based advisers like Stone House. These annuities are LOW-COST and designed to provide a lot of investment options in a tax deferred wrapper. Tax deferral means that your account can grow for decades without you having to pay income taxes. Pretty neat! These new annuities allow you to have your fee based adviser manage your portfolio inside the annuity without needing to pay an upfront commission just to get into the product. Additionally, the annuity fee in these new products is very low. The annuity fee is the fee that the insurance company charges you to provide the structure that gives you tax deferral and keeps the IRS out of your business. In this new breed of annuities, this fee can be as low as $20/month! If that wasn’t enough to peak your interest, because there is no sales commission, there are no charges to get out of the annuity. You can take your money back out at any time you wish.  Just keep in mind that as the annuity provides tax advantages, there may be tax implications to taking your money out of an annuity so you should consult with your adviser prior to taking any distributions.

By choosing a LOW-COST variable annuity for a portion of your retirement assets you can keep the tax man away from your royalties for many years while it grows large enough to pay for your retirement. Then you can just sit back and enjoy life on your own terms. Someone once said that the best thing money can buy is freedom from having to do things you don’t want to do. Low-cost annuities may be a piece of the puzzle that helps give royalty owners like you that freedom.

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Are People Getting “Rich” From Natural Gas?

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Robert J. Brown, CFP®

Partner/Investment Manager

Stone House Investment Management, LLC

210 Maple Street, Montrose, Pa 18801

570-278-6926

rbrown@stonehousemail.com

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Remember when you used to drive on the road and rubberneck at the newest drilling rig with mixed emotions going through your mind?  You feared the unknown risks yet felt optimistic about what this could mean to our area.  What a difference a couple of years make!   On my way back and forth between Montrose, Tunkhannock, Wyalusing, etc… I see the rigs and pads along the way but honestly pay them no mind, much like the hundreds of telephone poles that I pass on that same trip.

Yet there is still a cause for concern about the environmental risks and whether the powers-that-be will do what is necessary to mitigate the dangers as they should.  Each company is unique in how it prepares and moves through the drilling process and each well pad seems to hold its own story as to how this will play out.  Oddly enough, the same can be said for the financial side of the equation.  Each well unit has its own story and each individual landowner has his/her own experiences.  As an owner and financial planner of a premier firm in NEPA, I can honestly say that there is absolutely no consistency with what people are doing with their newfound ‘wealth’.

I am asked all the time, “What’s everyone doing with their money?”

My answer:  “Everything… and nothing at all”.

What?  I’m not trying to be cryptic, just honest.  Let me elaborate by pointing out that many things in life move in cycles.  Look at nat gas since it hopped onto the scene over 6 years ago.  It was priced through the roof; then plummeted to basement low prices for some time and now it’s showing signs of life again.  Look at the volumes of our wells; remember six years ago when those vertical wells were putting out impressive volumes?  Now you cross your fingers that they don’t even drill vertical wells on your land; now you want horizontal or nothing!  Everyone knows how the volume/royalties were higher in the early months of production compared to the current months.  With all of these moving parts, what does that do to the spending habits of royalty owners?  Again, let’s focus on the cycles that take place.

Much like any demographic in history, royalty owners go through their own growth cycle.  For those who have not had ‘extra’ or disposable income before, there is a sense of discomfort, excitement and nervousness.  They do their best to make wise decisions but we’re all human and sometimes we spend with our eyes instead of our minds (we all do it).  It’s usually when the monthly amounts begin to taper to less than half of where they started that there is a shift in mindset.  Wait a minute!  What if this money runs out?  Here comes a whole shift to the spending… until the next cycle.

This is normal.  Most have heard the statistic that many winners of the lottery turn out to be worse off financially than before they won their millions.  But hold on… royalty owners have an advantage here… the checks typically keep coming.  Even if mistakes are made, you might get a “do over”.  In fact, you may get several of them.  Great news!  So what should you do with it this time?  Well, here is what some people are doing:

• Paying down their debts
• Helping children do the same
• Gifting to children and grandchildren
• Buying new homes, additions, remodeling and landscaping
• Picking up a few toys here and there… car/truck/tractor/skid steer
• Building storage for their new toys
• Investing into their own business/farm in ways they could not before
• Turning their hobbies into actual business models
• Buying more real estate to attempt to compound the nat gas effect
• Investing into a variety of portfolios (ie: stocks, bonds, mutual funds, annuities)
• Tucking it under the mattress (CDs, Savings, Checking, Money Markets, etc…)
• Lending it out to others (serving as a personal bank)

Now, each of these above items can be a wonderful strategy, or they can prove to be a recipe for disaster.  The trick is to know which to use and when.  Ultimately the best idea is almost always balance.  Several of these items happening at once can mean better diversification of risk and a better stance for whatever tomorrow throws at you.

As a financial planner, my job is often to help sort through these options and weigh the pros/cons with the clients to find that balance.  I will say that I’ve noticed a difference with the newest generation of royalty owners in that they seem to have heard some good and bad stories from earlier landowners and now seem to be approaching this wealth building opportunity pragmatically and with a purpose.  This is an amazing time to be doing what I’m doing and it’s exciting when clients come into our offices looking for that second opinion and hoping to establish a comfort level with us so they have a place to come back to when they need that advice.

Hey Royalty Owners… Lower Your Taxes!

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Robert J. Brown, CFP®

Partner/Investment Manager

Stone House Investment Management, LLC

210 Maple Street, Montrose, Pa 18801

570-278-6926

rbrown@stonehousemail.com

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We are often asked if there are ways to contribute royalty income to IRA’s or retirement plans. The answer is no, but there is a work around you may want to consider. Think about increasing your contributions to a retirement plan at work.

Who does this work for?  Anyone receiving royalties AND who is employed somewhere that offers a retirement plan or is self-employed.

What you need to do?  Dial up your contribution amounts from your paycheck and into your retirement plan.  It’s that simple.

Why does it work?  It works because you are only allowed to contribute EARNED income to a retirement plan/account. Royalties do not qualify, but you can spend your royalties for your daily expenses and instead contribute your earned income from work to your retirement plan or IRA.

Here’s an example:  Let’s say you’re making $60,000/yr at your current job.  You were putting 3% ($1,800/yr) into your retirement plan at XYZ Company because the company would match it.  However, NOW you’re seeing royalty checks of $2,000/month! You can spend that $2000/month of royalties  on living expenses such as groceries, your mortgage payment, your car payment, etc (after you set aside enough for taxes).  Then you can instruct your employer to hold out much more from your paycheck to put into your retirement account at work.  How much you can contribute depends on your company’s plan.  Some plans allow for more than $20,000 per year!

What if you’re self-employed and don’t currently have a retirement plan in place?  Now might be the perfect time to set one up.  There are many types of plans to choose from depending on the size of your business and what type of contributions you want to make to your own retirement and the retirement of your employees.

For many people, this will give you a great chance to save more for the future and pay less in taxes today.  That’s a win-win in most investors’ minds!

Growing Pains

Raymond “Scott” Stone

Stone House Investment Management, LLC

Managing Partner

rstone@stonehousemail.com

570-278-6926

Virtually every fast growing industry has growing pains and the shale gas industry is no different. From political hurdles to ecological concerns to underutilization of natural gas, the shale gas industry has had its fair share of bumps along the road. In this article, we will look primarily at the issue of demand for natural gas and how it will affect the growth of the industry in the short and long term. It has been hard not to notice the precipitous decline of natural gas prices over the past couple of years. The price of natural gas has declined more the 80% from its peak! This price decline occurred while oil prices have climbed to nearly $100/barrel. Why is natural gas falling in price while oil is climbing? Since they are both sources of energy and can replace one another for certain purposes, it would be reasonable to think that they would rise and fall in price together.

The difference in price is largely due to infrastructure, or lack thereof. Oil has been our national addiction of choice for many decades. There are gas stations in every town, home heating oil delivery companies serving every community and plenty of refineries, pipelines and transportation systems to get the oil and oil by-products from the suppliers to the people who want to use them.

This is not true of natural gas. The facilities and distribution systems needed to get all of this new natural gas supply to the places that want to use it are not in place. Consequently, we have more natural gas available than we currently need. When you have more of something than you need, the price falls and in the case of natural gas, prices dropped like a rock. Prices dropped by so much, in fact, that it may no longer be economical to drill for gas in some areas. Some companies are even scaling back development plans for natural gas in our area.

So what is the outlook for natural gas prices and the natural gas industry in our area? The lower prices go, the less incentive to bring new production online. When you think about it, the reason gas prices are going down is because there is too much natural gas on the market. Making more natural gas is just going to make things worse in the short-run. This will likely lead to slower development of leased properties, less natural gas being shipped to market from developed properties and may be bad news for unleased areas like those in NY State.

The ramifications may be seen in local job growth as companies reduce the amount of drilling rigs in the Marcellus and as mid-stream infrastructure projects get put on hold due to the decreased capacity growth expectations. It may be seen in reduced royalties to land owners as fewer wells will be produced and the wells that are produced may not be produced at full capacity. It may cause more wells to be shut-in and more acreage to be held by production as gas companies try to lock in their leaseholds. It may cause much lower lease bonuses and less favorable lease terms for acreage that is not currently leased or that may be up for a new lease. It makes lease extensions of acreage outside of core development areas less attractive and it may lead some companies to not extend some existing leases into a secondary term. It may also cause the value of mineral appraisals to decline as natural gas price is one of the main determinants of value.

That being said, the volume of production in the Marcellus is so significant that it may be enough to offset the fall in gas prices and mitigate some of the these effects. Additionally, each company has its own set of priorities and needs and each will weigh its long-term success with how it handles this short-term utilization issue. Ultimately, the growth rate of our local economy will be much smaller than if gas prices were still in the double digits.

There is a silver lining in the longer term. The cheaper natural gas is compared to oil, the more incentive there is for end users to switch to natural gas. There is also a tremendous potential to sell our natural gas to foreign countries. All we need in place is the infrastructure necessary to utilize the amazing resource right under our feet. Putting it in place, however, will take a degree of political will and for corporations to get behind projects focused on broadening the market for shale gas locally, domestically, and internationally. Over the coming decade, great advancements will be made in natural gas infrastructure with many projects already being planned. As the utilization of natural gas increases, so likely will the price. Until then, though the industry will continue to grow, create good paying jobs and producing significant wealth for leaseholders, it will be at a slower pace than if there were much greater demand for natural gas.

-Raymond “Scott” Stone