• VPF contracts involve significant risks, including counterparty risk, liquidity risk, and the potential for total loss of the underlying collateral. These strategies are generally intended for sophisticated, high-net-worth investors.

• The Monte Carlo simulations presented are hypothetical in nature, do not reflect actual investment results, and are not guarantees of future results. Actual results will vary, perhaps significantly.

• This post is for educational purposes only. Always consult with a qualified tax professional before entering into a VPF or Direct Indexing strategy.

I continue to study how advanced tax planning strategies affect financial planning and portfolio risk management. In this blog post we’ll deep dive into risk management when using Variable Prepaid Forward (VPF) contracts.

If you would like to make yourself familiar with VPFs first, I recommend reading our previous posts. They should give you a good overview and prepare for this blog post:

• Variable Prepaid Forward (VPF) Contracts

• Analyzing VPFs as a Leveraged Diversification Tool

VPF is a complex strategy which affects both portfolio expected returns and volatility. It’s often paired with other strategies such as Long/Short Direct Indexing which intentionally increases idiosyncratic risk within the portfolio to maximize tax-loss harvesting opportunities. This complexity makes answering the question “How much do I need to allocate for my retirement?” more difficult.

Most financial planning software assumes that an investment portfolio is some combination of stocks and bonds with constant standard deviation (volatility). It’s not the case when VPF contracts are used.

How do we estimate Portfolio Success and decide the initial fund allocation for a retirement fund if we’re enrolled in a VPF contract?

Risk & Returns Tradeoffs

Both portfolio expected returns and volatility affect the size of our retirement portfolio needed to cover our future living expenses:

• Higher investment returns allow us to reduce initial fund allocation.

• Higher volatility in the portfolio requires us to increase initial fund allocation.

In the accumulation phase, volatility is our friend (dollar-cost averaging, direct indexing), but in retirement, it’s one of the biggest threats. If the market drops while we are working, we simply wait for it to recover. But if the market drops while we are withdrawing funds for our lifestyle, we are effectively “locking in” those losses.

Expected returns and volatility have positive correlation, but the relationship is not linear and complex strategies such as VPF make both expected returns and volatility change over time.

VPF Volatility

In my previous post Analyzing VPFs as a Leveraged Diversification Tool I argued that portfolio volatility is higher during the VPF contract. While it’s true, it’s overall portfolio volatility. It can be ignored because the stock used in the VPF contract is essentially locked and can’t be used to cover living expenses.

It’s only diversified portfolio volatility (money that we invested using prepaid amount) which matters. The exception is only the year when we deliver the concentrated stock to the bank: we may deliver fewer shares and by that get additional profit. We also may or may not need to liquidate part of the diversified portfolio to pay capital gain taxes after delivering the concentrated stock.

These events create a temporary spike in portfolio volatility that year. Liquid Portfolio volatility is the only volatility that the investor who uses the portfolio to cover their living expenses should care about.

VPF Monte Carlo Calculator

To understand the nuances of portfolio risk management when using VPF contracts, I implemented a VPF Contract Calculator. We use it to compare two hypothetical scenarios:

1. The investor sells their concentrated stock right away, pays taxes and invests in a diversified portfolio

2. The investor uses VPF. The cash payment received from the bank is invested in the same diversified portfolio

In the second scenario, the investor delivers a variable number of shares (depending on the stock performance in a simulation run), pays taxes and if there are any shares of concentrated stock left, they sell them and invest in the same diversified portfolio. If concentrated stock doesn’t perform well, the capital gain taxes are paid by selling some portion of the diversified portfolio.

We run Monte Carlo simulations for both cases and estimate the probability of the investor making more money when using VPF.

The calculator has three sections for input parameters. Each of them impacts the probability of the investor increasing their overall returns when using VPF contracts:

• Main Parameters include the concentrated stock current value, cost basis and marginal LTCG tax rate. These parameters define the benefit of delaying paying capital gains. In the current version of the calculator we assume the current and future LTCG tax rates are the same, but in reality they may differ. Lower future tax rate significantly increases the benefit of VPF.

• VPF Contract Parameters: You get them from the bank when you negotiate the terms. You can use SOFR Swap rates as an implied interest rate and then convert that into cash payment for a given VPF contract duration. Floor and Cap are parameters of the Collar.

• Market Assumptions: Both concentrated stock and diversified portfolio expected returns & volatility impact the probability of the investor making money when using VPF contracts. The S&P 500 historical data is used for diversified portfolio default values. As I show it below, correlation between concentrated stock and diversified portfolio also affects the results.

The right panel shows a few charts:

• Total Portfolio Value Over Time includes both concentrated stock and diversified portfolio value for VPF contract. Technically, the concentrated stock remains the part of your portfolio until it’s delivered to the bank.

• Liquid Portfolio Value Over Time chart excludes the concentrated stock, but you can notice spikes in VPF portfolio value at “VPF Expiry” year. It’s caused by additional concentrated stock profit and taxes.

• Liquid Portfolio Annual Return and Liquid Portfolio Annual Volatility: using monte carlo results we calculate average (mean) portfolio return and volatility. Monte Carlo is configured to run 10K simulations.

Annual Volatility Chart demonstrates the spike at “VPF Expiry” year I was discussing above:

The most important value we’ll be looking at when analyzing different VPF parameters is P(VPF beats Sell): probability that the investor makes more money when using a VPF contract. It represents the % of monte carlo runs when the VPF portfolio ended up having more money than a simple sale.

Important insights

Experimenting with model parameters gives us a few important insights which help us understand how VPF contracts work and avoid mistakes when negotiating contract terms with banks:

Concentrated Stock Expected Growth Rate: Using VPF contract makes sense only if the investor believes that the concentrated stock will continue to grow over the next N years. If we set both return and volatility to 0% for concentrated stock, P(VPF beats Sell) = 30.5% for the given set of parameters.

Why: delaying capital gains is beneficial if saved money continues to grow.

Duration of the VPF contract. Longer VPF contract duration increases the chances of the investor making money.

• 2 Year contract: P(VPF beats Sell) = 65.5%

• 4 Year contract: P(VPF beats Sell) = 83.0%

• 6 Year contract: P(VPF beats Sell) = 92.0%

• 8 Year contract: P(VPF beats Sell) = 95.7%

Why: Longer durations maximize the benefit of tax deferral. The longer you delay the capital gains tax, the more time your ‘prepaid’ cash has to compound in a diversified portfolio.

Important: VPF Cash Payment will reduce as the duration of VPF contract increases. The real P will probably be lower.

Cost Basis of Concentrated Stock. VPF is more beneficial for concentrated stock with a low cost basis and investors with high marginal LTCG tax brackets. For the default parameters:

• $250K Cost Basis: P(VPF beats Sell) = 87.9%

• $1M Cost Basis: P(VPF beats Sell) = 80.8%

• $2M Cost Basis: P(VPF beats Sell) = 63.1%

• $3M Cost Basis: P(VPF beats Sell) = 50.4% (~ coin flip)

Why: the lower cost basis, the higher taxes we pay when we sell the stock.

Floor, Cap and Cash Payment. Lowering the Floor (the strike price of the put protection) appears to increase the probability of success in the model:

• 100% VPF Floor: P(VPF beats Sell) = 88.3%

• 80% VPF Floor: P(VPF beats Sell) = 95.0%

In practice, it doesn’t happen. In the real world, the Floor, Cap, and Cash Payment act as three corners of a triangle. If you move one, the others must move to compensate.

The bank’s upfront cash payment is essentially the Present Value (PV) of the Floor.

• A 100% Floor means the bank is collateralizing the full current value of the stock, allowing them to give you a higher cash payment (85-90%).

• An 80% Floor means you are only collateralizing 80% of the value. In this scenario, the bank will give you significantly less cash upfront (65-70%).

It is very easy for a bank to offer terms that look ‘safer’ on the surface but actually undermine the strategy, making it less likely that the VPF will outperform a simple sale. When evaluating a contract, never look at the Cap or Floor in isolation, always treat the Prepaid Cash Percentage and the Floor as a linked pair.

VPF & Financial Planning

Now when we understand how expected returns and volatility change over time when using VPF contracts, we can start integrating this strategy into our financial plan. I believe that the right approach to integrate complex tax planning strategies in a financial plan is importing calculated expected return and volatility for each year and then testing that portfolio in a Monte Carlo simulation against expected contributions & withdrawals and initial fund allocation.

Conclusion

Navigating the intersection of tax optimization and retirement readiness requires moving beyond the static assumptions of traditional financial modeling. As we have explored, VPF contracts introduce a unique volatility profile, characterized by a period of relative stability in the liquid portfolio followed by a sharp “settlement spike” at expiry.

The Monte Carlo analysis highlights that the effectiveness of a VPF is not a binary “good or bad” decision; it is a highly sensitive calculation that depends on your specific cost basis, the duration of the contract, and the negotiated collar terms.

Ultimately, VPFs are sophisticated tools for deferred tax liability management and leveraged diversification, but they cannot exist in a vacuum. Integrating year-by-year volatility and return expectations into a holistic financial plan is the only way to ensure that while you are optimizing for taxes today, you are also protecting your lifestyle against the sequence of returns risk.

About the Author: Alex Sukhanov, founder of Nauma, a financial planning platform built for people in tech and high-net-worth families. Alex previously worked at Google and started Nauma to help more people in tech make better financial decisions and achieve more in their lives. You can reach out to Alex on linkedin.

Nauma is supported entirely by its users with no commissions and no affiliate incentives. It is designed to give people clarity on taxes, equity compensation and retirement planning.

A VPF reduces downside risk relative to simply holding the appreciated stock and using a Securities-Based Line of Credit (SBLOC) and allows delaying the payment of capital gain taxes. You can learn why delaying realizing capital gains is important here.

At the same time, VPF should be considered as a riskier strategy than simply selling the stock today to cover the large expense. If the stock doesn’t grow in the next N years (the duration of the VPF contract), the investor loses money equal to the VPF discount (normally 15-20%).

VPF Contracts as a Diversification Tool

But what happens if the investor enters into a VPF contract, but instead of using the money received from the bank to cover their upcoming expenses, they invest the proceeds? How much investment risk do they actually take?

It turns out that in this case the VPF contract acts as leverage: the investor continues to own the concentrated stock for the next N years, and at the same time they are also invested in the market. It could be a simple total stock market fund or more aggressive Long/Short direct indexing strategy, but the important thing is that they are invested twice:

• Concentrated Stock: investment risk is limited by Floor, upside is limited by Cap

• Diversified Portfolio: No Floor and Cap but portfolio is diversified

The investor should know that during the VPF contract they are taking more investment risk in their portfolio. Depending on their financial goals (their future expenses) and their current savings, exposing themselves to additional investment risk may be either a good or bad idea.

When estimating potential benefits of using the VPF contract as a diversification tool, the investor needs to take into account not only the expected return of concentrated stock but also expected return of the diversified portfolio. These two may or may not move in the same direction and it significantly impacts the benefit of the strategy:

The investor makes money using a VPF contract only when the concentrated stock is expected to grow. If the stock remains flat or drops significantly in the next N years, the investor loses money equal to VPF discount minus diversified portfolio return. Consider this example:

• Stock Provided to Bank = $1.3M

• Cost Basis = $250K

• VPF Cash Payment = 85%

if the concentrated stock does not grow (0%), but diversified portfolio generated 10% annually, the total loss is $1.3M x 15% - $54.2K = $140.7K, where

• $1.3M x 15% = VPF fees

• $54.2K = 10% annual return generated by diversified portfolio over 5 years

What is the best use case for VPF?

Using this strategy makes sense when the investor thinks that the concentrated stock will continue to go up in the next N years (duration of the VPF contract), but they can’t accept the amount of risk that comes with holding this individual stock. There are two components when it comes to risk management

• Risk tolerance - how much risk the investor is comfortable taking emotionally (psychology).

• Risk capacity - how much risk the investor can afford to take financially (financial goals).

For instance, if the investor has a net worth of $8.8M and for all of their financial goals they need $6M today, they can’t have a concentrated position of $4M. If this concentrated stock drops 90% and never recovers, it’ll affect the investor’s financial goals.

In the next example, if the concentrated stock appreciates 10% annually, but the diversified portfolio stays flat (0% annual return), the investor receives extra $344.7K profit after fees when using VPF compared to simply selling the stock today. Why? In the model the stock continues to appreciate 10% annually and money not paid as taxes continues to appreciate over the next 5 years.

Yes, the investor will pay more in taxes eventually ($563.6K 5 years from now instead of $323.4K today) but even with that they make more money.

Benefits, Investment Risk and Fees

When we make a decision about using a financial strategy or product, we need to understand all three aspects:

• Expected Benefit

• Investment Risk

• Fees

VPF benefit depends on the current value and cost basis of the concentrated stock, marginal long term capital gain tax rate, expected return of the concentrated stock in the next N years and parameters of the VPF contract (floor, cap, duration and cash payment). A simple deterministic model to estimate the benefit can be built in Google Spreadsheets by comparing two scenarios:

• Simply sell the concentrated stock today and pay taxes

• Use VPF contract and pay taxes N years from now when delivering the stock

In contrast to most other financial products, VPF contract fees are the easiest to calculate: it’s the difference between the current stock value and cash payment you receive in return today from the bank. The 15-20% discount represents the fees. The fees are determined by the duration of the contract and interest rates.

Calculating the investment risk is the hardest part when making a decision to use VPF contracts in the portfolio. During the contract (N years) the investment risk is elevated, because the VPF contract acts as leverage and the portfolio contains approximately 54% concentrated stock and 46% diversified portfolio (only 85% of current concentrated stock is delivered by the bank as a payment and then invested in a diversified portfolio).

There is a formula to calculate the overall portfolio volatility (measure of investment risk) for N stocks:

where,

• w[i]​ = weight of stock i

• sigma[i] = standard deviation of stock i

• ρ[i,j] = correlation between stock i and stock j

The challenge is that by setting Floor and Cap for the concentrated stock we affect both standard deviation of the stock and its correlation with other stocks in the portfolio. The right (and simplest) approach would be to run Monte Carlo simulation with Cap and Floor, and it’s a topic for a separate blog post.

To get started, the investor should know that their investment risk (standard deviation) in the portfolio is higher during the VPF contact:

Conclusion

The Variable Prepaid Forward (VPF) contract is a sophisticated financial instrument which could be used by investors managing concentrated, highly appreciated stock positions. It enables the transition toward a diversified portfolio while deferring the significant capital gains taxes.

• The Tax Arbitrage: The primary “win” is keeping money that would have gone to the IRS working for you for an additional N years. If your diversified portfolio or the concentrated stock performs well, the compounding effect on those deferred taxes can be substantial.

• Leverage: VPF isn’t just a hedge, it’s a form of leverage. By reinvesting the proceeds while still holding the capped/floored stock, you are effectively “double-exposed.” This is why understanding your Risk Capacity (how much you can afford to lose without ruining your goals) is important as well as your emotional risk tolerance.

• The Growth Prerequisite: A VPF is rarely a winning strategy for a stock you expect to stagnate. Because of the 15-20% fee, you generally need the concentrated stock to appreciate or the diversified portfolio to significantly outperform the cost of the contract to break even.

About the Author: Alex Sukhanov, founder of Nauma, a financial planning platform built for people in tech and high-net-worth families. Alex previously worked at Google and started Nauma to help more people in tech make better financial decisions and achieve more in their lives. You can reach out to Alex on linkedin.

Nauma is supported entirely by its users with no commissions and no affiliate incentives. It is designed to give people clarity on taxes, equity compensation and retirement planning.

• It is remarkable that the tool can generate legit PDF forms.

• There are accuracy issues and mistakes in the generated forms.

• This UX may work only for those who try to avoid paying filing fees (aside from the Claude subscription and postage) and have a significant amount of time to review, correct, sign and send these forms.

Running Claude

I used the simplest possible test case: Single, no children, and only one W-2. I excluded 1099s, K-1s, or any other complexities.

To begin, you simply run Claude and instruct it to use the skill. It then guides you through a series of predefined questions, including where to find your W-2, 1099, and other forms on your local machine.

use this skill: https://github.com/robbalian/claude-tax-filing/blob/main/skills/tax-filing/SKILL.md

Note, that you can’t use this skill in the browser because of security limitations:

I currently use a $20/month Claude subscription, which is usually sufficient for my tactical needs like brainstorming technical designs or refactoring code. However, generating this “simple” return (consisting only of Form 1040 and Form 540) consumed 95% of my daily quota. This suggests that for a tax return with any real-world data, a $200/month subscription would likely be necessary.

It took Claude about 30 minutes to follow the instructions in the skill file, which included:

• Researching IRS.gov and FTB.ca.gov to retrieve federal and state tax brackets and standard deductions.

• Computing Federal and State returns using Python.

• Downloading blank PDF forms from the IRS website.

• Filling the forms using the computed data.

I ran Claude without the --dangerously-skip-permissions flag, meaning I had to manually review and confirm every script and bash command execution.

Reviewing The Results

While the Federal return looked accurate for my simple case, the California State Return (Form 540) contained a notable error. Claude mistakenly entered the total tax which belongs on Line 64 into Line 40 (Nonrefundable Child and Dependent Care Expenses).

Looking at the generated Python script, the bug was easy to spot:

As long as a human is responsible for verifying the data and fixing bugs, this is a manageable issue. However, the bigger hurdle is the final step. Claude suggests printing the forms, signing them by hand, and mailing them to the IRS. Anyone who has dealt with the IRS knows that preparing a physical package, driving to the post office, and paying for certified mail is a time-consuming chore.

The Value Proposition

It is hard to justify this workflow when TurboTax can handle everything, including e-filing and instant notifications of acceptance, in one click for roughly $200.

For anyone earning more than $50/hour, the math doesn’t add up. Between a $200/month Claude subscription, $20 in postage, and 2–3 hours of manual verification and mailing, the “free” route becomes very expensive. For reference, the median Google Software Engineer salary in the Bay Area is approximately $330k/year, or roughly $158/hour.

Data correctness, e-filing, and time savings are TurboTax’s core value propositions, and Claude doesn’t disrupt them yet. Until the IRS allows everyone to e-file directly and Claude guarantees filing accuracy, TurboTax’s business model is safe.

The second time, I asked it to “find logical mistakes in this post”. Gemini found multiple logical mistakes and flawed calculations in the same post. It completely rejected the idea that some families might want to prioritize Mega Backdoor Roth over ESPP and insisted that people should always prioritize ESPP.

I guess Gemini may have a problem forming and sticking to opinions. Like ChatGPT, it tends to give the user what they want to hear, but does it in a more subtle way than ChatGPT which is known for its flattery.

That creates a real concern about using such models in financial planning, where guidance is a critical part of the process. Models can sound very convincing, but they may lead us in the wrong direction, which becomes dangerous in high-stakes environments like financial planning.

With that said, I’ll appreciate it if you share your opinion. I want to hear what you think.

Does Greedy Algorithm Always Work?

Families with high incomes and disciplined spending should ideally leverage every available wealth-building tool from 401(k) matching and ESPPs to tax-advantaged accounts like the Roth 401(k) and Roth IRA. However, cash flow constraints often force a choice. Because strategies like the ESPP and Mega Backdoor Roth require direct payroll deductions, a limited paycheck or competing financial priorities may make it impossible to maximize both. In these cases, families need to choose a strategy they want to prioritize.

Online guides including FAANGFire often suggest prioritizing ESPP arguing that it’s basically free money. But does the greedy algorithm always work when we plan our contributions?

The Hidden Cost of ESPP

The problem with the Employee Stock Purchase Plan (ESPP) is that while it may look like “free money,” it can distract from a more impactful tax strategy: the Mega Backdoor Roth.

People who prioritize ESPP over the mega backdoor may be missing two key points:

• If they sell the stock without waiting two years from the grant date, the gain is taxed as ordinary income.

• The proceeds often end up in taxable brokerage accounts, where future gains are also taxed.

In reality, the decision between ESPP and the mega backdoor depends on a family’s needs. If they don’t need access to the money anytime soon, focusing on the mega backdoor and ignoring ESPP might be a better strategy if they can’t afford to do both.

Consider this example:

• Family lives in California

• Household income is $600K

• Marginal ordinary income tax = 44.3% (federal 35%, CA 9.3%)

• Marginal capital gain tax = 33.10% (federal 20%, CA 9.3%, NIIT 3.8%)

• Employer offers 15% ESPP discount

• Employer offers a 401(k) plan with mega backdoor support

To make two scenarios comparable, we assume that the family can allocate only $21,250/year from their paycheck and must choose between ESPP and the mega backdoor. Here’s how the numbers work out over 15 years:

Scenario 1: Do Mega Backdoor for 15 years using total stock market index

• Total contributions over 15 years = $318,750

• Total gains after 15 years = $432,517

• Taxable gains = $0

• Total portfolio value = $751,267

Scenario 2: Do ESPP for 15 years, sell ESPP as it vests and buy Total stock market

• Total Contributions into ESPP = $318,750

• ESPP Distribution = $375,000

• Contributions into taxable account (after tax) = $350,081

• Total gains after 15 years = $450,112

• Capital Gain tax paid when withdrawing money = $148,987

• Total value after tax = $676,125

Mega backdoor comes out ahead for this family if they don’t need short-term liquidity:

• Higher portfolio value: $751K vs $676K

• Money ends up in a tax-free vs taxable account

• Less hustle: No need to sell ESPP and buy VTI every vest

Now let’s imagine, the family doesn’t need to sell the assets and use the money immediately after 15 years. They quit their jobs but keep the money invested without touching for another 15 years.

Scenario 1: Mega Backdoor portfolio

• Total portfolio value at year 15 = $751,267

• Cost Basis = N/A

• Growth Rate = 10.13%

• Total portfolio value at year 30 = $3,194,323

Scenario 2: ESPP Portfolio in Taxable Account

• Total portfolio value at year 15 = $825,112

• Cost Basis = $375,000

• Growth Rate = 10.13%

• Total portfolio value at year 30 = $3,508,306

• Capital Gain tax paid when withdrawing money = $1,037,124

• Total value after tax = $2,096,181

The difference between the two scenarios would be $3.1M - $2M = $1.1M after tax

Look Back Provision Changes The Math

The previous comparison assumes a flat 15% discount on the current stock price. However, most top-tier ESPP plans include a “Look-back” provision. This allows you to purchase the stock at a discount of either the price at the beginning of the offering period or the end, whichever is lower. In a rising market, this isn’t just a 15% gain, it can be a 50% or even 100% gain in a single six-month window.

Among top companies, only Microsoft doesn’t have a “Look-back” provision.

How can it be Mitigated

The “paycheck squeeze” is the primary barrier preventing families from maximizing both strategies simultaneously. Once you understand the potential challenges and long-term effects of different strategies on your wealth, you can build a more effective plan.

If your base salary cannot support the combined deductions for both a maximum ESPP and a Mega Backdoor Roth contribution, you have a few options:

1. Pick one strategy that benefits your family the most. For some families it would be ESPP, for others it might be a mega backdoor. Understanding long-term trade-offs can help you make a better decision and avoid local optimums when building your wealth. This is the simplest approach.

2. Use the “ESPP Carousel”. ESPP is a liquid asset that can be used 6 months later to cover living expenses. Once the first ESPP period vests, sell the shares immediately. Use those proceeds to supplement your next six months of suppressed paychecks. The biggest hurdle is the initial 6-month accumulation period where your take-home pay is significantly reduced.

3. 401k Bonus Front-Loading. Many FAANG-style companies allow you to set a separate, higher contribution percentage for your annual or sign-on bonuses. You can direct your performance bonus toward your 401(k) and Mega Backdoor Roth. By hitting your limits early in the year, you free up your remaining paychecks to focus entirely on ESPP.

4. Use RSU to cover living expenses. If you receive Restricted Stock Units, instead of thinking of them as your savings, you can treat them as a “paycheck supplement.” This allows you to “teleport” your RSU value into a tax-free Roth environment.

Conclusion

An ESPP is a great benefit, but if you find yourself in a situation where you need to choose between an ESPP and a Mega Backdoor Roth, you should be aware of the long-term benefits of the Mega Backdoor Roth. The ‘Greedy Algorithm’ sometimes fails when it optimizes for an immediate 15% gain while ignoring the decades of tax-free compounding offered by a Mega Backdoor Roth.

P.S. If you want to explore these trade-offs using your own inputs, tools like Nauma are designed to help you build and stress-test different scenarios.

For those who want help going deeper, we also work with a small number of clients to build custom models tailored to their career, family, and risk profile. We currently have limited availability in May and June. Details are here.

The investor followed the Boglehead approach and chose low-cost broad-market index funds:

• BND - Vanguard Total Bond Market Index Fund

• VTI - Vanguard Total Stock Market Index Fund

Between July 2021 and April 2024, BND lost 18.48% and VTI gained 11.07%. The conservative portfolio, despite the investor’s attempts to preserve capital, lost 12.57%.

It’s a tough pill to swallow when an investor follows a “conservative” playbook and still ends up in the red. They did everything by the book: low-cost index funds, a Boglehead philosophy, and a high bond allocation to “protect” their capital for a short-term goal. Why did this happen?

Interest Rates and Bonds

Between 2021 and 2023, the Federal Reserve aggressively raised interest rates to fight inflation. This change broke the inverse correlation between stocks and bonds and created a textbook effect: when interest rates go up, existing bond prices go down.

In July 2021, interest rates were near zero. When the Federal Reserve began aggressively raising rates in 2022, existing bonds (like those in BND) became less valuable because new bonds were being issued with much higher payouts.

This investor fell into a trap that catches many: confusing “conservative” with “risk-free.” While bonds are generally less volatile than stocks, they carry a specific type of risk called interest rate risk, which is measured by a metric called duration.

The duration of a bond fund measures its sensitivity to interest rate changes. A rule of thumb is that for every 1% rise in interest rates, a bond fund will lose value equal to its duration. Because rates rose so quickly and significantly in 2022, BND took a massive hit that its small dividend yield couldn’t offset. In 2021, BND had an average duration of approximately 6.7 years.

6.7 years x 5% rate hike = 33.5% theoretical price drop.

While the interest payments (yields) collected along the way helped offset some of that loss, the sheer speed of the rate hikes led to the worst year for bonds in modern history.

Short-Term vs. Long-Term Bonds

The difference between bond types usually comes down to the trade-off between yield (the paycheck) and volatility (the price swings).

How to Avoid This

The investor’s mistake wasn’t buying bonds; it was buying the wrong duration for their timeline. This is a concept called Liability Matching. If you need the money in three years, you have a “3-year liability.” If you buy a fund like BND with a 7-year duration, you are mismatched. You are taking seven years’ worth of interest rate risk for a three-year goal.

Some options how it can be avoided:

• Match Duration to Timeline: If your goal is two years away, your bond duration should be roughly two years. Look for “Short-Term Bond Funds” (like BSV) instead of “Total Market” funds.

• Use Defined-Maturity Instruments: For a 2024 goal, the investor could have bought a Certificate of Deposit (CD) or a Treasury Bill that matured in early 2024. This locks in a guaranteed return and eliminates price volatility.

• Cash is a Position: For goals less than two years away, High-Yield Savings Accounts (HYSA) or Money Market Funds are often “safer” than bond funds because their duration is effectively zero.

Conclusion

The Vanguard quiz logic relies on a traditional premise: Bonds = Stability and Stocks = Growth. While this is usually true, it assumes a “normal” interest rate environment. What occurred between 2021 and 2024 was an outlier—one of the worst bond markets in decades.

This didn’t happen because the investor did something “wrong.” They followed a standard framework. It happened because interest rates rose faster than expected, and the investor held “total market” bonds with a high duration, making them highly sensitive to those rate hikes.

To avoid this in the future, investors should focus on Liability Matching. By choosing assets that mature exactly when the bills come due—such as T-Bills, CDs, or ultra-short-term bond funds—you remove the guesswork. This ensures that a “conservative” portfolio actually functions as a “protected” one.

I’m Alex Sukhanov, founder of Nauma, a financial planning platform built for people in tech and high-net-worth families. I previously worked at Google. I started Nauma to help people think clearly about complex financial decisions while avoiding hidden incentives, commissions, or generic advice to just invest more.

Nauma is supported entirely by its users with no commissions and no affiliate incentives. It is designed to give people clarity on taxes, equity compensation, retirement, and planning for the future.

Families who have a financial plan in place experience less stress if they are affected by layoffs. Understanding their financial situation helps them think clearly and more broadly about their career and consider less traditional paths such as taking time to recharge, learning new skills and trying an idea they’ve always been thinking about.

Uncertainty and lack of understanding of the financial situation, on the other hand, push people without a plan to find another job as quickly as possible. In the challenging market like today (February 2026) it’s hard. The number of available well-paying and interesting positions is far less than the number of people looking to get them. High competition turns into a frustrating experience: days spent filling meaningless online applications and no interviews.

Layoffs are stressful and emotional. No matter how prepared someone is, it can still feel like rejection. Going through a prolonged job search in an extremely tough market can further erode confidence. This vulnerability makes it easy to fall into a trap: accepting any available job, even if it’s not well aligned with career goals and professional interests.

Taking a step back and reassessing the situation is a better approach.

What is a Financial Plan?

A good financial plan includes a list of family goals and the actions the family should take to achieve them with a desired probability. That’s it.

If a family can clearly articulate:

• Their major upcoming life events (having kids, moving parents, buying a house, starting a company)

• How much each life event will approximately cost (accounting for inflation)

• How much they need to save today to cover those future costs

• How much they should reserve for taxes, given how they use tax-advantaged accounts

• The probability of success based on their portfolio and contribution/withdrawal schedule

…then they have a plan.

Otherwise, the family is operating blindly, and major unexpected events such as layoffs, a market crash, or an unexpected loss can create significant stress which potentially lead to reactive mistakes.

Consider an example: The family lives in California. Their net worth (excluding primary residence) is $4.8M. They estimate that their total expenses to cover their retirement needs are $10.5M. To cover these future expenses, they already allocated $2.6M from current savings and plan to maximize their retirement contributions until 2036. They are looking to get an 8.2% target return.

The family separated their other goals. They have two children who will go to college. They estimated that the total school & college expenses are around $440K per child and in order to cover these expenses the family needs to allocate $228K-$275K from their savings and then contribute 10K+15K = $25K/year.

They also have other goals which they can see on the dashboard. This family has a plan.

Are We Trying to Predict the Future?

Financial Planning is not an attempt to predict future life events, investment returns, inflation and taxes. Instead, it’s an attempt to articulate family preferences, making sure that these preferences are reasonable and then identifying steps that should be taken to achieve the things they want. Financial planning is about setting direction and being intentional about money.

Most assumptions about the future are wrong and mistakes tend to accumulate over time. That said, regular updates of the financial plan help mitigate that and adjust the trajectory based on the information received from the real world. This approach makes financial plans useful and helps see issues early before they become big problems for the family.

If the plan doesn’t hold anymore, the family adjusts their financial goals by either:

• changing their income (staying employed longer or changing a job)

• adjusting expenses

• changing investment risk and expected return in the investment portfolio

Updating Income & Expenses

Finding a new job takes time, and it’s a good idea to be conservative when doing financial planning and assume that finding a new job may take not 3-6 months but 12-18 months. For that, the family go to their financial projection and make the following changes:

• Set the current job to stop now

• Estimate and add severance package

• Start a similar job 12-18 months from now

Companies normally share severance package details in advance. The family takes that information, estimates the severance payment and adds it as an ordinary W-2 income so the model could properly estimate their income taxes:

Before adding a new job, it’s a good idea to look if the projection still holds. Many people who spent decades in tech and worked at successful companies whose stock significantly appreciated are already financially independent, especially if they are willing to cut some of their discretionary expenses:

When the second job is added, the family can see their updated annual budget and reserve funds to cover the budget deficit. This specific family now has a small deficit in the next 2 years and they won’t be able to save:

• 2026 = $13K annual deficit (previously, $159K profit)

• 2027 = $35K annual deficit (previously, $178K profit)

Updating Financial Goals

Now, when the expected income is updated and future expenses are decided by the family, they want to recalculate their financial goals. From the projection, they already know that they won’t be able to save. That said, they still may contribute into their 401K and IRA accounts as the second partner still works and contributions to 401K reduce taxable income. That said, it’s going to be more of a transfer from taxable to tax-deferred and tax-free accounts rather than saving because the family is expected to spend more than they make in 2026/2027.

The family reduces their 401K contributions and plans to continue them starting September 2027. That makes the fund p5 percentile to run out of money in 2061. The family is targeting 95% success chance for their fund and fund duration is until partners turn 95 years old:

The family has three options now:

1. They either can increase their initial fund allocation

2. They can delay their retirement and withdrawals from the fund by 1-2 years

3. They can do nothing and accept lower chances (92%) of success instead of initially planned 95%.

The family has $1M not allocated towards any financial goal at the moment, so they simply can increase their allocation from $750K in taxable accounts to $800K to make their plan balanced again:

Then they review their Success Chances in Monte Carlo Simulation and adjust allocations and contributions if they think their success chances are too high or too low. It’s natural to want to have a 100% success rate when setting financial goals. But the truth is that when it comes to investing, 100% chances is a signal that the investor is either over-saving for their financial goal or under-investing which most of the time leads to regrets in the future.

As investors, we would like to take a reasonable amount of risk. For each financial goal and person it’s going to be different.

Preparing Funds

Now the family should prepare their funds and make sure their portfolio reflects that. For that they can go back to Financial Projection and review their “Withdrawals”. The family is expected to have a deficit of $13K in 2026 and $35K in 2027. But because they would like to continue contributing into their 401 and IRA accounts, they’ll need to withdraw $63K and $106K in 2026 and 2027 accordingly from their taxable accounts.

They know that they should keep these amounts in low-risk and liquid funds available for withdrawals:

Conclusion

A layoff is a significant life event, but it does not have to be a financial catastrophe. The difference between a stressful job hunt and a strategic career pivot lies in the clarity of the plan. As we have explored, a robust financial plan serves three critical functions:

1. Emotional Stability: It replaces the “scarcity mindset” with data, allowing you to reject unsuitable roles and wait for the right opportunity.

2. Agility: By modeling “what-if” scenarios (such as extended unemployment or reduced contributions), you can identify which levers to pull, whether that is cutting discretionary spending or reallocating taxable assets.

3. Intentionality: It forces a conversation about what truly matters. If a family discovers they are already near financial independence, a layoff might not be a setback at all—it might be the nudge needed to start a business or focus on long-delayed personal goals.

Ultimately, the best time to build a financial plan is when things are going well, but the best time to use it is when they aren’t.

P.S. If you want to explore these trade-offs using your own inputs, tools like Nauma are designed to help you build and stress-test different scenarios.

For those who want help going deeper, we also work with a small number of clients to build custom models tailored to their career, family, and risk profile. We currently have availability in April and May 2026. Details are here.

Here is how it works:

1. An appreciated asset is moved into an irrevocable trust

2. You receive a charitable income tax deduction in the year of the gift

3. The trust sells the stock and reinvests it without paying immediate taxes

4. Each year, you receive a fixed percentage of the trust value (usually 5-8%)

5. When you pass away, whatever remains in the trust goes to one or more charities you’ve designated.

Here are some nuances:

• Once you fund a CRUT, the assets are no longer part of your estate and cannot be taken back. This can reduce estate taxes, but creditor protection varies by state.

• CRUT distributions to beneficiaries are taxable. A CRUT generally defers capital gains taxes but does not eliminate them.

• The charitable income tax deduction is based on the present value of the remainder interest going to charity. There is a specific IRS formula used to calculate it.

• The maximum charitable deduction is limited to 30% of AGI when donating appreciated stock, and you can carry forward any unused portion for up to five years.

• Your chosen charities receive the remaining funds only after the CRUT term ends, which may be 20+ years from the date the trust is established.

Why CRUTs Exist

Before 1969, charitable giving through trusts was something of a “Wild West,” leading to potential abuses in which donors took large tax deductions while charities ultimately received very little. To address this, Congress passed the Tax Reform Act of 1969. This landmark legislation created the formal structures we use today, including the CRUT.

The government had two main goals in mind:

• Encourage Philanthropy: Lawmakers wanted to provide an incentive (significant tax deductions) to encourage wealthy individuals to fund nonprofits and private foundations.

• Ensure Integrity: By creating the 10% remainder rule, the IRS ensured that charities would receive a meaningful benefit. The law mandates that, based on actuarial calculations, the charity must be projected to receive at least 10% of the initial value of the trust.

Types of Charitable Remainder Unitrusts

Depending on your liquidity needs and the type of assets you are donating (e.g., public stock vs. real estate), you might choose one of these common structures:

• Standard CRUT (S-CRUT): The most straightforward version. You receive a fixed percentage of the trust’s value annually, regardless of whether the trust earned enough income that year. If the trust doesn’t have the cash, it may have to sell assets to pay you.

• Net Income CRUT (NICRUT): The trust pays the lesser of the fixed percentage or the actual net income earned by the trust. This is safer for the trust if it holds illiquid assets that don’t produce immediate cash flow.

• Net Income with Makeup CRUT (NIMCRUT): Similar to a NICRUT, but if the trust pays out less than the fixed percentage in lean years, it “remembers” the deficit. It can make up those underpayments in future years when the trust has excess income.

• Flip CRUT: This starts as a NIMCRUT (perfect for unmarketable assets like real estate) and “flips” into a Standard CRUT after a specific triggering event, such as the sale of the asset.

The CRUT Math

Suppose you have a $3M concentrated stock position with a $300K cost basis. You are a high earner in California with $750K of annual ordinary income.

Option A: Sell the Stock Personally

If you sell the stock today, you face a “triple threat” of taxes on the $2.7M gain:

• Federal capital gains tax (20%) = $540K

• Net Investment Income Tax (3.8%) = $102.6K

• California state tax (12.3%) = $332K

Total tax: 36.1%, or approximately $974.7K

Net proceeds to reinvest: about $2.03M

Option B: The CRUT Strategy

If instead you contribute the appreciated stock to a CRUT, the trust can sell the shares without paying immediate capital gains taxes. The full $3M remains invested.

The capital gains are not eliminated, they are deferred and recognized over time as distributions are made to beneficiaries. It is important to emphasize that a CRUT is a tax-deferral strategy, not a tax-elimination strategy. Here is a simple explanation how deferring capital gains helps.

In addition to tax deferral, you receive a charitable income tax deduction. Under the IRC rules, the deduction is subject to limits. Because the family is donating appreciated stock, the annual deduction is capped at 30% of their Adjusted Gross Income (AGI).

With $750K of AGI, you may deduct up to $225K per year. If the calculated value of the charitable remainder interest is, for example, $800K, you can deduct $225K in Year 1 and carry forward the remaining amount for up to five additional years.

At a $750K income level, your effective tax rate is about 37.13% and total income tax is $278K. By reducing your AGI by $225K, you reduce your total income tax from $278K to $162K which results in a $116K saving in year one. You’ll continue reducing your taxable income until you fully use your charitable income tax deduction which depends on CRUT parameters.

Family Income and Taxes without Charitable Income Tax Deduction

Family Income and Taxes with Charitable Income Tax Deduction Applied

At the same time, you begin receiving annual distributions from the trust. This is where the “unitrust” feature of a CRUT comes into play. Unlike an annuity that pays a fixed dollar amount, a CRUT payout is a fixed percentage of the trust’s value, which is revalued each year (typically on January 1).

If the trust grows, your payout increases. If the market declines, your payout decreases. Here is how the math works in our $3 million example, assuming a 7% payout rate and a 10% annual return:

Year 1:

The trust starts at $3,000,000.

Payout: 7% of $3,000,000 = $210,000.

Year 2:

Assuming the trust earns 10% ($300,000) and pays out $210,000, the new value is $3,090,000.

Payout: 7% of $3,090,000 = $216,300.

Because the assets grow tax-deferred inside the trust, compounding applies to the full $3M rather than the $2.03M you would have had left after a personal sale. Over 20 years, this difference in working capital can result in potentially higher cumulative income, depending on market returns, payout rate, fees, and tax circumstances.

Although the trust itself does not pay income taxes, beneficiaries owe income tax when distributions are received. CRUT taxation follows a tier system, meaning some distributions may be taxed as ordinary income and others as capital gains, depending on the trust’s accumulated tax balances.

Financial Goals Before Tax Optimizations

Before diving into the legal paperwork, you should step back and look at the “big picture.” A CRUT is a tax planning strategy designed to help families with charitable aspirations achieve their financial goals. However, the family must clearly understand those goals before deciding whether to use a CRUT and which assets to contribute.

There are three high-level buckets:

• Lifestyle Bucket: Money you need to maintain your standard of living and enjoy your life.

• Legacy Bucket: Money you want to leave to children, grandchildren, or other heirs.

• Philanthropy Bucket: Money you want to use to make an impact on the world.

Each family balances these buckets differently. Because a CRUT is irrevocable, funding one is effectively a permanent decision to move assets from the unallocated or undecided bucket into the “Lifestyle” and “Philanthropy” buckets. You receive income for yourself now, and the charity receives the remainder later, but your heirs generally will not receive those specific assets.

Before deciding whether to use a CRUT, you would like to project your net worth, income, and expenses using financial planning software, determine how much investment risk you are willing to take, and only then evaluate tax-planning strategies.

Starting with complicated strategies without clear goals and alignment with your partner often leads to unnecessary stress and uncertainty later.

CRUT is not a DIY strategy

A CRUT may be a good strategy if the family decides that they want to donate a portion of its net worth to charity and is comfortable with the fact that the charity will receive the remaining funds after the donors pass away.

While the benefits are high, the strategy is complex. This is not a DIY project. Setting up and maintaining a CRUT requires a coordinated team:

• Estate Attorney: To draft the trust document and ensure it complies with state and federal laws.

• CPA: To handle the specialized annual tax filings (Form 5227) and track the “four-tier” accounting rules for distributions.

• Financial Advisor (CFP): To manage the internal investments and ensure the payout rate aligns with your long-term cash flow needs.

Between legal setup fees and ongoing administrative costs, a CRUT typically makes the most sense for assets valued at $500,000 or more. If the numbers support it, a CRUT remains one of the most powerful ways to do well while doing good.

It’s a major financial decision and it deserves careful planning. Setting up a college fund remains a non-trivial task for many families as they need to understand the needs of their children, the family’s ability to absorb expenses, inflation, investment returns and taxation. As a result, families often end up either over- or under-saving for college. Many of them experience financial stress or find themselves decades later with hundreds of thousands of dollars in unused 529 funds, facing a dilemma about whether to pay penalties or keep the money locked up.

In this blog post we’ll discuss how you can estimate child related expenses, set up a college fund, decide how to use tax-advantaged accounts and minimize the risk of undersaving and oversaving.

Estimating Living Expenses

In the Bay Area, adding children to a household often triggers “lifestyle jumps,” such as needing a larger home or a specific school district, which can cause costs to spike exponentially.

Most couples move from a 1-bedroom to a 2-bedroom when they have their first child, and it typically adds $1K–$1.5K/month in rent. If the family decides to buy a house, their annual housing expenses go up from $39.6K/year to $104K/year which includes mortgage, property taxes, maintenance cost and insurance. Food & Groceries grow 30% and medical expenses (insurance premiums and out of pocket expenses) often double.

The second child increases most family expenses. Housing increases by $15K-20K/year if they rent, and if the family decides to become owners and buy their own place, the increase in housing costs might be around $60K–85K/year. Food & groceries increase 10-20% and their medical expenses increase around 30%.

Having 3 kids is often the “tipping point” where a standard 3-bedroom home or a mid-sized SUV is no longer sufficient. Upgrading to a 4-bedroom home in a “good” district often adds another $20K-50K/year to the budget depending on whether the family is renting or owning the place.

Interestingly, the incremental cost of food and clothing per child tends to decrease slightly with more kids due to significant savings on clothes and gear for the 2nd and 3rd child. Bulk buying of groceries lowers the per-meal cost.

Development Expenses

Development expenses are often the largest discretionary category in a Bay Area family budget. They include school tuition (public vs. private), extracurricular activities, supplies, and transportation, and they tend to accelerate sharply as kids get older.

Unlike housing or food, these expenses are not strictly linear — they are driven by family values, choices, and competitive pressure in a high-income environment. Two families with identical incomes can easily differ by $30K–$80K per child per year depending on these decisions.

Public education in the Bay Area can be good, especially in strong districts. However, “free” is a bit misleading. Parents still pay for after-school care, enrichment, tutoring, fundraising, and transportation. Many families move (or overpay for housing) to access better districts, indirectly converting tuition into housing costs. Private school tuition ranges widely. Modest religious or community schools may cost $12K–$20K/year. Top independent schools often range from $35K–$60K+/year.

Many families start with public schools and switch to private in middle or high school, which introduces a sudden step-change in expenses that should be modeled explicitly.

Extracurriculars are where costs quietly compound: sports teams, music lessons, robotics, tutoring. Competitive programs often require travel, equipment, and private coaching. Costs increase meaningfully in middle and high school as activities specialize. It’s common for Bay Area families to spend $3K–$25K per year per child here without realizing it.

Why College Planning is Hard

What makes planning hard for families is that inflation, investing, and taxes all interact in non-obvious ways. Education costs often grow faster than general inflation, contributions happen over many years, and investment returns are uncertain. As a result, translating future expenses into a monthly savings rate today is far from straightforward.

Tax-advantaged accounts like 529 plans can reduce taxes on growth, but they come with usage restrictions: not all education-related expenses are eligible, and not all families want to fully commit to locked-in accounts years in advance.

At the same time, families still need to account for tax provisioning: how much of future expenses will need to be funded with taxable dollars, what the marginal tax rate might be at the time, and how withdrawals interact with the rest of their financial plan. Ignoring taxes can easily lead to overconfidence in savings progress or unpleasant surprises later.

This is why education planning works best when expenses, accounts, investment assumptions, and taxes are modeled together, rather than treated as separate decisions.

Creating Financial Projection

We’ll consider a family, Steven and Sophia, in their early 30s. Both work in tech and welcomed their first child, Kevin, last year. They’re expecting their second child next year. They are creating their financial plan and setting up savings accounts for their kids.

Steven and Sophia start by creating a financial projection and adding future income and expenses. They adjust their living expenses to reflect the increased costs that come with a second child and begin to see how this affects their net annual cash flow, savings rate, and net worth.

To make their financial projection adjustable and perform what-if analysis later they use Milestones. They create milestones for the most important events and then use them to set start and end dates for income & expenses in the projection. Adjusting the milestone date then automatically updates all associated income and expenses.

With the first version of their financial projection in place, the family can start discussing educational expenses for their kids and decide what fits their family best. To do this, they use a simple Google spreadsheet to estimate costs and assign probabilities to whether those expenses will occur. This helps them decide how to allocate savings between flexible taxable accounts and more restrictive 529 plans.

If the family is confident that a specific 529-eligible expense will occur, they can use a 529 plan for that purpose. Otherwise, they may prefer regular brokerage accounts, which allow assets to be reallocated toward other financial goals in the future.

This is also a great time for partners to have open conversations and align on values and priorities. Using their draft financial projection, Steven and Sophia evaluate whether they can realistically afford these expenses and decide whether private elementary, middle, or high school makes sense for their family. They also discuss the extracurricular activities they envision for their kids. By the end of this process, they can see how expenses are expected to change over time based on their current choices for one child.

Finally, they add the agreed-upon expenses to their financial projection and observe the impact on their net worth. You can see how net annual cash flow (the blue line on the left chart) varies over time. Typically, the higher a family’s income and net worth, the more year-to-year variability they experience.

Setting School & College Fund

The financial projection is the first step—it shows how future expenses appear on the timeline and how they impact net worth. However, Steven and Sophia still need to determine how much to contribute to their 529 plans and taxable accounts to actually fund those expenses when the time comes. To do this, they move to Financial Goals and create a new goal.

Their objective is to choose an initial fund size, ongoing contributions, and an investment portfolio that will cover all expected education expenses, adjusted for inflation and taxes, with a desired probability of success. That probability is determined using Monte Carlo simulations.

In the first scenario, they allocate $50K from existing savings and superfund their 529 plans. Together, they contribute $180K upfront ($19K × 5 years × 2 partners), then add $21K per year between 2026 and 2043. They target an 80% success probability, meaning they evaluate the 20th percentile Monte Carlo outcome when the college fund reaches zero. Other families may prefer a more conservative approach, aiming for a 90% or 95% success rate, which would require higher contributions.

In this scenario, taxes (shown as grey bars in the cash flow projection) are minimal because the family uses a tax-advantaged 529 plan and begins using contributions relatively soon after they are made. Total planned contributions add up to:

$50K + $180K + ($21K × 17 years) = $587K

If the family already has investable assets but chooses not to use a tax-advantaged account, they would need to allocate approximately $635K to cover the same expected expenses. The higher total reflects the drag from taxes, which increases the amount that must be saved to achieve the same outcome.

Once this process is complete, Steven and Sophia can repeat it for their second child and incorporate both education goals into their overall financial plan:

Conclusion

Raising kids in the San Francisco Bay Area is as much a financial journey as it is an emotional one. Housing, childcare, education, and enrichment expenses don’t just grow over time, they arrive in waves, often coinciding with major life decisions that compete with other goals like retirement, career flexibility, or financial independence.

The key takeaway is that education planning is not a single decision. It’s an ongoing process that requires:

• Estimating expenses realistically across different life stages

• Acknowledging uncertainty in inflation, markets, and future choices

• Balancing tax efficiency with flexibility

• Aligning financial decisions with family values, not just averages or social pressure

Families that run into trouble are rarely careless, they’re usually planning in silos. They estimate college costs without modeling taxes, commit too aggressively to 529 plans without flexibility, or delay planning until the window to adjust contributions meaningfully has already passed.

A better approach is to treat education funding as part of the overall financial system: expenses, accounts, investments, and probabilities modeled together. This allows families to make informed trade-offs, course-correct early, and avoid both the stress of undersaving and the regret of overcommitting capital.

Because of that, the central question for many people in tech is not whether they can earn “enough” money, but how to maximize life opportunities and experiences. At a certain point, an extra dollar of net worth doesn’t meaningfully change day-to-day life: the jump from $100K to $1M is life-changing, but from $10M to $11M often isn’t. Economists call this diminishing marginal utility.

One of the biggest invisible long-term risks for high earners is not financial failure. It’s waking up in the 70s or 80s with unused millions of dollars and the realization that they could have had more experiences in their life when their parents were alive, their kids were young, their energy was higher, and their appetite for trying new things was stronger.

At the same time, work in tech is often more demanding, making it difficult to sustain high compensation levels through a traditional retirement age. Opportunities to create generational wealth are rare, so major career and financial decisions require careful consideration to avoid costly mistakes or unnecessary risks. Balancing these trade-offs is more challenging for people in tech compared to workers with more traditional, linear careers.

The Desire to Start a Company

Tech naturally attracts curious, ambitious, and hardworking people with a strong desire for autonomy. For many of them, high compensation, free food, and even amazing offices with ping-pong tables are not always strong enough incentives to stay.

Starting a company is often considered an alternative to MBA programs and used to gain unique experience. Even when startups fail, founders typically develop a deeper understanding of business and acquire highly sought-after skills that help them land leadership roles at more established companies.

At the same time, starting a company is a major undertaking and long-term commitment that can significantly affect a family’s financial situation. It can become a trampoline for future wealth or a mistake that creates long-term financial stress.

That’s where financial modeling and financial planning tools can help and start to matter.

Startup Success: Setting Realistic Expectations

We’ll be considering tech VC-backed startups rather than traditional businesses. Tech startups are riskier than traditional businesses, require extensive upfront R&D investment, and almost always aim to disrupt existing industries. Because of that, startups often require more time to achieve success and have a higher failure rate.

Traditional businesses have a very different risk/reward profile and a different impact on family finances. Modeling starting a family restaurant or small service business would look very differently from capital requirements and expected cash flow.

Peter Walker and Carta have been publishing aggregated data for startups hosting their CapTables on the platform. Using their data, I compiled a simple calculator that estimates the value of founder shares given traditional VC dilution and the probability of a VC-backed company reaching each stage.

A few takeaways from that data:

• For a median company, it takes 1.2 years to raise a seed round

• The probability of reaching Series C (a company is considered to have found PMF and is actively scaling) is 4%.

• At Series C, founders normally own 30-40% of the company

If someone is a first-time founder, it’s unlikely that they would be able to raise immediately after quitting their job. They’ll need to reserve funds for 1-3 years to support themselves and potentially their startup if the founder can’t bring angel investors.

According to Peter Walker (link), while VC-backed companies raised more money in 2025, the number of startups raising remained the same, which supports the thesis that fundraising remains hard while large mega rounds often create a distorted impression among founders.

Financial Modeling

Financial modeling doesn’t answer the question “Should I start a company,” but it helps clarify the impact on family finances if someone tries and fails versus continuing to work in big tech. It also helps show how starting a company at different ages and net worth levels affects long-term family finances.

Researchers have known for some time that the peak age for entrepreneurship tends to occur in mid-career, roughly from the mid-30s to the mid-40s, which contrasts sharply with the popular narrative that successful founders are typically twenty-something billionaires.

We’ll consider a hypothetical scenario:

• A 25-year-old software engineer living in California who has just joined a top FAANG company as an L3

• They have $50K in brokerage accounts and $25K in student loans

• They are currently single, but will get married in five years and start filing MFJ

• They will have two children at ages 32 and 34

• They will be a single-income household and save on daycare costs

• They will follow a standard promotion progression:

  • L3 → L4: 2 years

  • L4 → L5: 3 years

  • L5 → L6: 10 years

• They will stop working at age 55

Once we build the base scenario, we’ll inject a Startup Life event at different stages of life (ages 25, 35, and 45):

• No income for 1 year after starting a company

• Moderate income for the next five years, followed by a weak exit

Planning for a weak exit is a good practice in financial planning, as it helps evaluate worst-case scenarios. If the exit is strong, the founder is likely to be financially well off regardless.

We’ll use Nauma to build financial projections for the family and run what-if analyses.

Scenario #1: Successful Career in BigTech

We used Google Salaries from levels.fyi and added 401K company match = $12,250/year to the total compensation, assuming maximized 401k contributions and 50% company match:

It’s generally a good idea to be conservative in financial projections. In this and the other scenarios, we assumed no RSU appreciation between grant and vesting, a 6% annual investment return before retirement and 4% after retirement, and 3% annual inflation.

For simplicity, and to make the scenarios comparable, we assumed the family rents for their entire lifetime. This avoids having to adjust scenarios in which the family could not purchase a home due to lower income and allows for more consistent comparisons across scenarios.

In the first scenario, the family successfully raises two children, funds their college education, travels, and reaches a net worth of $14.7M in 2057, which is equivalent to $5.9M in 2026 dollars.

Scenario #2: Tech Startup At 45

We added startup-related milestones to make the financial projections adjustable, using the assumptions described above. In this scenario:

• The founder invests $125K of their own capital (equivalent to what Y Combinator provides to its companies).

• They work for one year with no income.

• In year two, they raise a seed round and begin paying themselves a salary.

• They continue working for another five years and experience a weak exit.

To make this scenario viable and avoid running out of money in retirement, we had to increase the retirement age in the model from 55 to 62. Under these assumptions, the family reaches a net worth of $14.5M in 2062, which is equivalent to approximately $5M in 2026 dollars, and is able to cover its expenses.

In this scenario, the founder would need to either work an additional seven years or adjust their lifestyle, such as by relocating from California to a lower-cost area. During the startup phase, the founder family net worth remains flat in nominal (actual) dollars:

Scenario #3: Tech Startup At 35

In this scenario, we moved all startup-related events 10 years earlier and delayed all W-2 promotions to follow the original schedule: promotion to L4 after 2 years, to L5 after 3 years, and to L6 after 10 years. The founder is still able to invest $125K of their own capital into the company, avoiding the need for fundraising and pre-seed investing, which is often unproductive. However, this decision reduces their net worth to nearly zero by 2041.

After returning to work, the founder gradually rebuilds their net worth. However, as in the previous scenario, they need to work longer than in the original plan and are projected to retire at age 63.

Scenario #4: Tech Startup At 25

This is the most concerning—and arguably the most depressing—scenario, especially given that many startup accelerators encourage young, entrepreneurial students to pursue entrepreneurship early in their careers.

In this scenario, we removed the $125K founder investment because the founder does not have the capital available at the time and instead assumed it is provided by an accelerator. The model shows a negative family net worth until 2040, when the founder turns 40.

Under these assumptions, the founder would need to work until age 62 to retire successfully.

Comparing the Scenarios: Same Decision, Very Different Lives

Looking at the four scenarios side by side, the most important insight is not the final net worth number. In fact, all scenarios eventually “work” on paper if the founder is willing to extend their career, adjust lifestyle expectations, or relocate. The real difference lies in when financial stress occurs and what life stage it collides with.

The same startup outcome, a few years of low or no income followed by a weak exit, feels radically different depending on whether it happens at 25, 35, or 45.

At 45, the startup period overlaps with years when kids are older, college costs are approaching, and parents may begin needing financial or emotional support. At the same time, founders at this age often have a strong professional network, established reputation, and deep domain knowledge, all of which can make building a business meaningfully easier than earlier in their career.

At 35, the picture is mixed. The founder has more skills, credibility, and savings than at 25, but the startup phase coincides with young children, peak childcare expenses, and a household that is often dependent on a single income. The recovery is possible, but the opportunity cost compounds quietly: missed promotions, delayed compounding, and a longer path back to financial stability.

At 25, the startup appears deceptively “cheap” from a lifestyle perspective—no kids, fewer fixed expenses, and more tolerance for uncertainty. But this is also when financial fragility is highest. A prolonged period of negative net worth early in life has long-lasting effects: delayed investing, delayed home ownership, delayed optionality. What feels like freedom in the moment often converts into lost compounding that cannot be fully recovered later.

Experiences Are Age-Dependent, Not Just Wealth-Dependent

Another subtle but critical insight is that experiences are not fungible across time.

A sabbatical at 45 is not the same as a sabbatical at 25. Traveling extensively with young kids is not the same as traveling before kids or after they leave home. Starting a company when your identity is still forming is a fundamentally different psychological experience than doing it after 15–20 years in a structured environment.

Some experiences become more meaningful with age. Others become harder, more expensive, or simply impossible.

This is why optimizing purely for “maximum net worth” is often the wrong objective. A plan that leaves someone extremely wealthy but exhausted, risk-averse, or constrained during their healthiest decades may look successful financially while failing experientially.

P.S. If you want to explore these trade-offs using your own inputs, tools like Nauma are designed to help you build and stress-test different scenarios.

For those who want help going deeper, we also work with a small number of clients to build custom models tailored to their career, family, and risk profile. We currently have limited availability in February and March. Details are here.

However, the U.S. tax code can complicate this goal by forcing families to trade off asset protection against higher taxes.

Context

To illustrate this tradeoff, consider the following example. The family lives in California and works in tech. They have accumulated around $2.3M in tax-deferred retirement accounts: $1.9M in 401K Pre-Tax and $360K in Traditional IRA.

The family is working on setting up a Dynasty Trust to protect their wealth. Their plan is to move some of their assets into this trust and make their children beneficiaries. The family can’t move their IRA and 401K accounts into the trust: retirement accounts must remain owned by an individual. However, the family can name the trust as a beneficiary.

Compressed Tax Brackets for Trusts

A trust can be designed either to distribute income to beneficiaries or retain it. If the trust is designed to retain income, the income is taxed using highly compressed federal tax brackets: the 37% tax rate starts at only $16,000 of income.

California doesn’t have separate tax brackets for trusts, but the state uses the same income tax rate schedules for trusts as it does for single individual filers, meaning trusts reach the highest tax brackets at much lower income levels than married couples filing jointly.

The family has their financial projection built, and they see that their tax-deferred retirement accounts are projected to grow from the current $2.3M to $3.3M in 2044 in today’s dollars. The value will start reducing over time and reach $392K at the end of the financial plan when partners turn 95.

Create Your Financial Projection

Non-spouse beneficiaries (including most trusts) must withdraw the entire account within 10 years. That means that the trust will need to withdraw between $56K and $470K annually (assuming a 7% annual growth rate)

The family has 2 children. When withdrawing $470K/year, the individual effective tax rate for a married couple filing jointly is 23.97% assuming that retirement accounts will be split 50/50 between kids. By contrast, for a trust that retains earnings and is subject to compressed trust tax brackets, the effective tax rate rises to 45.36% which results in $1M additional tax paid over 10 years:

Available Options

Given these tax dynamics, the family faces three primary options for their tax-deferred retirement accounts:

Option 1: Name children as beneficiaries
Each child inherits up to $1.65M (in today’s dollars), taxed at individual rates.

Option 2: Name the irrevocable trust as beneficiary and distribute income
Trust income flows through to beneficiaries, generating up to $235K per child per year of ordinary income.

Option 3: Name the irrevocable trust as beneficiary and retain income
Assets remain fully protected, but IRA withdrawals are taxed at compressed trust rates, resulting in approximately $1M of additional taxes over 10 years.

Naming a trust that retains earnings as the beneficiary of tax-deferred accounts provides the highest level of asset protection, but requires the family to pay the additional tax depending on the size of the inherited account. If asset protection is a priority and the family prefers the trust to retain income, the family can mitigate the tax cost by proactively reducing the size of tax-deferred accounts during their life:

• Do Roth conversions earlier in life to reduce future withdrawals

• Prioritize withdrawals from tax-deferred accounts in retirement over taxable and tax-free assets

Why the IRS Uses Compressed Tax Brackets for Trusts

The IRS uses compressed tax brackets for trusts because trusts are not meant to function as long-term tax shelters, and the tax code is designed to push income out of trusts and into individual beneficiaries’ tax returns.

Trusts exist primarily for asset protection, control, and administration, not as independent economic actors. If trusts were taxed using the same brackets as individuals, high-income families could accumulate income inside trusts indefinitely and avoid progressive taxation. Compressed brackets reduce the incentive to “park” income inside a trust.

Compressed tax brackets also help prevent income splitting across multiple trusts. Without compressed brackets, families could create many small non-grantor trusts and spread income across them to exploit lower brackets. The IRS also targets this behavior also via the multiple trust rule (IRC §643(f)), which allows the IRS to aggregate trusts created to avoid taxes.

Conclusion

The key takeaway is that the most important planning happens before assets are inherited. Families with substantial pre-tax retirement balances may benefit from evaluating how much of that wealth ultimately flows into a trust structure versus being taxed at individual rates. Decisions around beneficiary designations, Roth conversions, and withdrawal sequencing can materially change outcomes, but they require careful modeling and coordination with tax and estate planning professionals.

In short, dynasty trusts can be powerful tools for multigenerational wealth protection, but when retirement accounts are part of the picture, understanding and planning around compressed trust tax brackets is essential to avoiding unintended and costly tax outcomes.

The Problem

Imagine you are already retired or approaching retirement. A fund manager approaches you and offers to reduce volatility (standard deviation) in your portfolio from 12.16% to 10.71%. Returns unchanged or potentially slightly lower. They ask you to pay them $8,000/year. Would you agree?

Most people will probably say no, because the value proposition is vague. It’s not clear how it helps and whether it’s worth the asked price. We can understand the value of $8,000 dollars, but the value of lower volatility, especially when returns may reduce, is much harder to assess.

Yet for retirees, volatility is not an academic concept. It directly affects sequence-of-returns risk, the probability of running out of money, and ultimately the size of the portfolio required to retire with confidence.

In this post, we’ll look at how to approach that cost–benefit tradeoff as a DIY investor and examine an asset class designed explicitly for this purpose: Managed Futures.

What are Managed Futures?

Managed futures strategies were developed to address a practical portfolio problem: how to perform differently when traditional assets struggle, while improving diversification and risk control. They were never intended to replace equities or beat the S&P 500 every year. Their role is defensive: reducing portfolio volatility and improving long-term survivability, particularly during extended market stress.

Historically, managed futures strategies were mostly accessible to institutions and ultra-high-net-worth investors. Mutual funds expanded access in the 1990s, and ETFs made them broadly available starting in the 2010s. Early ETF launches include WTMF and FMF (2011–2013), followed by newer funds such as DBMF and RSST in the 2020s.

Managed futures have low correlation with the stock market, which can help reduce portfolio volatility. The DBMF ETF, launched in 2019, has shown a lower correlation with the total stock market than bonds (-0.17 vs. 0.57) over the period from January 2020 to November 2025.

Five years is not a long enough period in investing, but the ETF was launched at a very unusual time when the Federal Reserve cut rates and expanded the money supply dramatically, which significantly affected correlations across most major asset classes. During this same period, DBMF showed a -0.17 correlation with VTI.

It was also less volatile than long-term bonds:

Fees: The Explicit Cost

Like any financial product, managed futures should be evaluated across three dimensions: benefits, risks, and fees.

Fees are high. Managed futures ETFs typically charge between 0.78% and 1% AUM.

For a $1M investment, that translates to $7,800–$10,000 per year. Because fees are charged as a percentage of assets, the dollar cost grows as the portfolio grows. At a 7–8% annual return, fees compound over time alongside the investment.

High fees do not automatically make a product unattractive, but they demand a clear, measurable benefit.

How Beneficial Are Managed Futures?

Say, an investor needs a $4.2M portfolio invested in a traditional 60/40 stock–bond allocation to fund retirement with 90% confidence through age 95. They already estimated withdrawals including tax provisioning.

Then the investor replaces the bond allocation with a Managed Futures fund, and that increased portfolio success from 90% to 99% in Monte Carlo simulation for their initial portfolio value and expected cash flow.

If the investor doesn’t need 99% success chance and targets the original 90%, they can reduce the initial fund size. The Monte Carlo simulation analysis suggests that reducing initial portfolio value from $4.2M to approximately $2.3M reduces the portfolio success back to 90%.

That means that by paying the fund a 0.85% annual AUM fee (in this case, applied to 40% of a $2.3M portfolio, or about $7,820 in the first year), the investor can reduce the required initial portfolio from $4.2M to $2.3M.

The math says that investor can free up to $1.9M for other goals (earlier retirement, bigger house, higher spending). In exchange, they pay roughly $8,000+ per year, with fees compounding over time. Over a 45-year retirement with 7% annual growth, total fees paid would be approximately $2.2M.

Viewed this way, the tradeoff becomes much more concrete.

Are Managed Futures Better Than Bonds?

Like bonds, these funds are not designed to generate higher returns but to reduce overall portfolio volatility. The Bogleheads forum seems to be skeptical as the data is still limited. That said, these funds have already been tested during an unusually turbulent period (2020–2025), when the bonds so often recommended failed to provide the diversification and protection against sequence-of-returns risk that many investors expected. During this period, the Total Bond Market Fund declined by 21.19% between December 2020 and October 2022:

The central open question remains whether managed futures can sustain low correlation with equities over multiple decades. There is no definitive answer yet.

Managed futures trade futures contracts across markets, using rules to decide what to buy or sell, how much risk to take, and when to exit. They are about responding to price trends, not forecasting the economy. The underlying strategies trade futures across global markets using systematic, rules-based approaches rather than discretionary decision making by fund managers.

That rules-based structure reduces reliance on human judgment and helps limit behavioral biases, a benefit similar in spirit to index investing.

Estimating Initial Fund Size and Cashflow

Evaluating strategies like this requires a financial plan, not just return assumptions. The cash flows used in the Monte Carlo simulations above come from a family financial plan built using Nauma.

The process begins by modeling future income, expenses. The platform automatically estimates income taxes and withdrawal provision for taxable, tax-deferred and tax-free accounts:

To estimate contributions and withdrawals for the retirement fund, a financial goal based on projected future income and expenses is created. By adjusting the initial fund size and contributions, you can identify an optimal allocation.

Once cash flows are defined, they can be exported and analyzed using tools such as PortfolioVisualizer to test different asset allocations.

Final Thoughts

Managed Futures value lies in whether they meaningfully reduce portfolio risk in ways that matter for retirees: lower volatility, improved sequence-of-returns protection, and smaller required starting capital.

The right question is not whether managed futures are “good” or “bad,” but whether the risk reduction they offer is worth their cost given your specific goals, timeline, and constraints.

1. Sell appreciated RSUs

2. Use a Variable Prepaid Forward (VPF) Contract

The cost basis of their stock is $250K, and the marginal long-term capital gains (LTCG) tax rate is 30.8% (20% Federal + 7% WA State + 3.8% NIIT). If they sell, they’ll need to set aside $468K for taxes, meaning they’ll have to sell a total of $1.77M worth of stock to net $1.3M after taxes.

VPF Math

Another option is to use a VPF contract, a tax-deferral strategy often used by investors holding appreciated stock.

In this arrangement, the investor enters into a contract with a financial institution and agrees to deliver a variable number of shares in the future. In return, the investor receives an upfront cash payment, typically between 75–90% of the current stock value. The discounted stock price is the fees the investor pays to the financial institution. The number of shares ultimately delivered depends on the stock’s performance.

Let’s consider a hypothetical example:

• VPF Cash Payment: 85%

• Stock provided to the institution: $1.53M (to receive $1.3M)

• Expected stock growth rate: 10%

• Time period: 5 years

• Expected stock value after 5 years: $2.46M

VPF contracts typically use a collar strategy that sets a floor of 80% and a cap of 160%. This means the stock will be effectively sold at the 160% cap, or $2.44M. Assuming the marginal tax rate remains the same at 30.8%, the tax paid after 5 years would be $676K.

The additional profit the investor earns would be calculated as:

$2.44M - ($676K - $394K) - $1.52M - $229K = $406K, where:

• $2.44M = stock sale value

• $676K = LTCG tax paid after 5 years

• $394K = LTCG tax that would have been paid today if not using VPF

• $1.52M = stock value pledged to the financial institution

• $229K = VPF fees (cash discount)

This math assumes the stock grows 10% annually. If the stock falls or remains flat, the investor loses $229K (the VPF fee).

Risk/Return Tradeoff

Now, with this calculator we can see the risk/reward tradeoff of the VPF Contract:

• The investor gains $406K on a $1.52M asset over 5 years if the stock grows 10% or more.

• The investor gains $62K on a $1.52M asset over 5 years if the stock grows 5%.

• The investor loses $229K on a $1.52M asset over 5 years if the stock doesn’t grow.

The math shows that a VPF increases portfolio risk compared to selling today, but reduces downside risk relative to simply holding the appreciated stock, since the contract sets the floor at 80%. We can visualize it by putting these options on the risk/return chart:

Using Collar Strategy in VPF Contracts

A collar is an options-based structure that combines selling a call option and buying a put option on the same stock. In a VPF, this collar is embedded directly into the contract rather than executed separately by the investor.

• The put sets a floor (e.g., 80%), limiting how much downside the investor is exposed to.

• The call sets a cap (e.g., 160%), limiting how much upside the investor can keep.

Together, the collar defines a bounded range of outcomes for the stock’s future value.

The collar is not primarily designed to benefit the investor, it exists to control the bank’s risk. When a financial institution advances 75–90% of the stock’s value upfront, it is exposed to downside risk: If the stock collapses, the institution will lose the money.

By buying a put option the bank protects the position against downside risk. The put option is not free and costs money. To offset this cost the financial institution sells a call option.

Insider Trader Policy

Many public-company employees are subject to insider trading policies that prohibit trading derivatives on company stock even if those derivatives are embedded inside a structured product like a VPF. In such cases, the investor needs to check with their employer and get approval before they enter into a VPF contract.

If the institution structures VPFs using European-style options (not American), with expiration dates that fall during an open trading window, the investor can avoid selling shares when the trading window is closed. However, this does not guarantee compliance. Ultimately, the employer’s insider-trading policy governs and the employer makes a decision.

Wait, How Can Floor Be Lower Than Cash Payment?

It’s a great question. If you asked it—congratulations. You already have a solid understanding of how VPFs work. If the stock falls below the cash payment, the bank loses money. But does the bank take that risk?

When banks enter into a VPF contract, they may hedge their exposure. In this case to offset the risk of the stock falling, the bank shorts a specific amount of that stock in the open market.

Why not simply match the floor and the cash value?

The institution wants to avoid creating a constructive sale under Internal Revenue Code §1259, which would force the investor to recognize gains immediately. A forward contract that requires delivery of a substantially fixed number of shares for a substantially fixed price can trigger constructive sale treatment. The IRS does not provide a clear formula (at least I wasn’t able to find one). Instead, it asks two practical questions:

• Do you still meaningfully participate in the upside?

• Do you still bear meaningful downside risk?

If the answer to those questions is “no,” you likely have a constructive sale.

721 Exchange Funds

The investor knows that by delaying paying capital gains, they can potentially increase their post-tax returns.

Instead of selling, the investor joins an Exchange Fund to diversify in a tax-efficient way. The investor contributes their appreciated stock to a partnership and, in return, receives an interest in that partnership. No gain is recognized at contribution because Section 721 of the Internal Revenue Code says:

721(a): No gain or loss shall be recognized to a partnership or to any of its partners in the case of a contribution of property to the partnership in exchange for an interest in the partnership.

That’s why these vehicles are often referred to as “721 Exchange Funds”—they are partnerships relying on IRC §721.

The IRS imposes several important constraints:

• No single contributor (or related group) may control the partnership (50% or more ownership) after contribution.

• At least 20% of the fund’s assets must be invested in “qualifying” illiquid assets, typically real estate.

• Investors generally must remain in the partnership for about 7 years to receive a diversified basket of securities without recognizing capital gains.

Because an exchange fund is a pass-through entity, all gains and losses realized by the partnership flow through to investors. If contributed stocks pay dividends or if the fund manager sells any securities, those gains are passed directly to partners.

The Exchange Fund manager now has a choice. They either can:

• Sell ~20% of contributed stock to purchase real estate, or

• Borrow money, using contributed stock as collateral, to acquire real estate investments.

The first approach reduces tax efficiency by realizing gains investors hoped to defer. The second increases investment risk by introducing leverage.

During the dot-com crash, the NASDAQ fell nearly 80% between March 2000 and September 2002. An important question, therefore, is: What happens if the collateral used to finance the real estate portion of the fund drops by 80%?

If the fund faces a margin call and cannot post additional collateral, it may be forced to liquidate positions, realizing capital gains at precisely the worst possible time: during a market downturn.

Bottom line: If you’re considering an exchange fund, you should ask how the manager satisfies the IRS 20% requirement, as this directly affects your risk exposure.

351 ETF Exchange Within Exchange Funds

Rebalancing an exchange fund portfolio is highly constrained. Most contributed stocks have low cost basis, and selling them would trigger capital gains that pass through to investors. To maintain index-like exposure and limit tracking error, many exchange funds use a secondary strategy known as a 351 ETF Exchange.

Under Section 351 of the Internal Revenue Code, investors can contribute appreciated stock to help “seed” a new ETF. In exchange, they receive shares of the ETF. Because this is an “in-kind” contribution to a newly formed entity, it does not trigger an immediate capital gains tax. Your original cost basis simply transfers to the new ETF shares.

351(a): (a) General rule

No gain or loss shall be recognized if property is transferred to a corporation by one or more persons solely in exchange for stock in such corporation and immediately after the exchange such person or persons are in control (as defined in section 368(c)) of the corporation.

Once the ETF is launched, the appreciated stocks can be sold inside the ETF without triggering a taxable event for the exchange fund partnership. For this reason, these structures are sometimes referred to as “351 Exchange Funds.”

At the end of the typical 7-year period, investors in a 721 exchange fund may receive ETF shares rather than a basket of individual securities.

ETF management fees often range from 0.2%–0.4%. It’s important to ask whether these fees are included in the exchange fund’s stated fee or layered on top.

Exchange funds themselves are expensive, with annual fees typically between 0.4% and 1%. For a $3M position over 7 years (assuming 10% annual growth), this can translate into $160K–$262K in fees. Adding an additional 0.4% ETF layer could cost another ~$125K over the same period.

Standalone 351 ETF Exchange

A 351 ETF Exchange can also be done outside of a 721 exchange fund. This approach can significantly reduce fees and avoids the additional risk of implicit real estate exposure and leverage.

However, standalone 351 conversions must meet strict IRS diversification tests:

• 25% rule: No single holding may exceed 25% of the contributed assets.

• 50% rule: The top five holdings may not exceed 50% of total assets.

Because of these rules, an investor cannot simply swap 100% of a single concentrated stock into a new ETF. A mix of assets must be contributed to satisfy diversification requirements.

This isn’t an instant trade. Managers like Alpha Architect or Cambria schedule these launches in advance. During the onboarding period, your stock remains exposed to market volatility.

If you attempt to meet the diversification test by contributing an ETF (such as VTI) alongside your concentrated stock, the IRS applies a “look-through” rule. If VTI contains 5% of your concentrated stock, that exposure counts toward your 25% limit.

You should also ensure that all conversions are reported correctly when you file your tax returns. Reporting errors and mistakes do happen. It might be a very good idea to work with your CPA to verify correctness of reported transactions.

Learn More

We recently hosted a personal finance learning session where Marcel Miu, CFP, joined us to discuss the nuances of 351 exchanges and exchange funds.

You can watch the recording here:

Taxable Accounts

If we look at what financial advisors do for their high-net-worth clients, we’ll notice that many tax-aware strategies attempt to delay paying capital gains taxes in taxable accounts. Very few people understand why this is important or how it works.

Here’s a simple example. Suppose an investor has a $3M concentrated stock position that they are not comfortable holding. The cost basis is $1M. For simplicity, assume the investor’s long-term capital gains tax rate does not change over time and remains 36.1% (20% federal, 3.8% NIIT, 12.3% California state), whether the stock is sold today or 10 years from now.

• Current Portfolio = $3M

• Cost Basis = $1M

• LTCG Tax Rate = 36.10%

• Expected Rate of return = 10%

• Years = 10

In the first scenario, the investor sells the concentrated position now, pays taxes, reinvests in a diversified fund, and exits the market after 10 years:

• Tax Paid Today = $722K

• Portfolio After Tax Today = $2.28M

• Cost Basis Today = $2.28M

• Portfolio Value Pre Tax 10 years later = $5.90M

• Portfolio Value After Tax 10 years later = $4.5M

In the second scenario, the investor uses tools that allow them to diversify while deferring capital gains taxes, then exits the market after 10 years:

• Cost Basis Today = $1M

• Portfolio Value Pre Tax 10 years later = $7.78M

• Tax Paid in 10 years = $2.44M

• Portfolio Value After Tax 10 years later = $5.33M

By delaying taxes in a taxable account, the investor increases their expected after-tax portfolio value. In this example, over a 10-year period with a 10% annual return and a 36.1% LTCG tax rate, the investor generates an additional $735K in after-tax value, equivalent to increasing their post-tax growth rate by ~1.5% per year.

Don’t Let Taxes Mismanage Your Investment Risk

While delaying the realization of capital gains in taxable accounts can be powerful, it should never come at the expense of proper diversification.

Consider the case of Block, Inc., a fintech company best known for Square, Cash App, and its crypto-related products. The company went public in 2015 under the name Square and later rebranded to Block. During the 2021 tech bull market, the stock reached an all-time high, fueled by growth expectations and enthusiasm around fintech and Bitcoin. In the years that followed, the stock experienced a significant drawdown, lost around 75% of its value and never recovered since then.

Tax-Deferred Accounts Work Differently

Taxable and tax-deferred accounts work differently. Sometimes people hear about strategies that apply to one type of account and automatically try to apply them to another, which is incorrect.

In taxable accounts, capital gains taxes are applied to the difference between the current portfolio value and the cost basis. In contrast, in tax-deferred accounts, ordinary income taxes are applied to the entire account balance when money is withdrawn or converted to a Roth account. Once money is converted to a Roth account, it is never taxed again.

This means that there is no difference between doing a Roth conversion (and paying taxes) today or in the future, as long as the current and future tax rates remain the same.

The decision of whether to convert to Roth today or later is usually based on the investor’s expectations about their future ordinary income tax rate. If an investor anticipates being in a lower marginal tax bracket later, it makes sense to delay the conversion until that time. If the investor believes that their current marginal tax rate is lower than it will be in the future, they might want to consider doing a Roth conversion now.

We recently worked with a family, and one of the questions they wanted to answer was where they should spend their retirement. Their kids will be heading to college in a couple of years, giving them more flexibility around where they live. One of the options they’re considering is moving to Florida. How would moving to a different state affect their financial situation?

To answer this, we built several financial models that gave the family insights and helped them make a decision.

In this post, we’ll walk through a hypothetical example to show how you can build similar models yourself and understand how a move like this could affect your long-term net worth.

Hypothetical Family Profile:

• The family lives in the San Francisco Bay Area

• Steven (47) works in a top tech company and earns $530K/year

• Sophia (49) works in tech too and earns $270K/year

• They have two kids: Kevin (17) and Steph (15)

The family net worth is $6.4M:

• $2.6M in taxable accounts (cost basis $1.35M)

• $1.88M in tax-deferred accounts

• $542K in tax-free accounts (Roth and 529)

• They own a house worth $2.2M which they bought for $1.6M in 2016

• Mortgage balance is $887K: 2.65% for 30 years taken in 2021

Scenario 1 – The Family stays in The Bay Area

We mapped all their future income and expenses on a timeline, assuming they stay in the Bay Area.

• Their house will require ongoing payments for property taxes, insurance, mortgage, and maintenance.

• Living expenses will decrease once the family stops working (Sophia plans to retire in 4 years, and Steven in 7 years).

• After they stop working, they will need to purchase their own medical insurance until they transition to Medicare at age 65.

• We also included the expected long-term care expenses for both partners.

• Kevin will go to college in 2026, and his AAA travel team expenses will end.

• Steph will go to college in 2028, and her lessons will end at that time.

• The family plans to fund their DAF with appreciated stock in 2027 and benefit from the charitable deduction.

• They own a couple of cars and plan to replace them every 10 years.

Things in this plan will certainly change over time, but mapping them out on a timeline helped the family better understand their major future expenses and have a meaningful conversation about what they truly want in life and the lifestyle they envision.

When we build financial projections, we’re not trying to predict the future, but rather to set the direction and work toward it.

One of the things that made the family reluctant to give up their current high income was the variability of school and college expenses. They mentioned this as a concern during our discussion. The lack of clarity and the unpredictability of these costs led them to believe they needed to continue working until their children graduated from college.

We helped the family better understand these expenses and added them to the timeline. This allowed them to visualize and start estimating how much they would need to set aside for school and college costs, taking into account inflation, expected investment returns, and taxes (with some savings in regular taxable accounts and others in tax-advantaged 529 plans).

The model has shown $9M net worth (right chart) at the end of the financial plan. Green bars represent liquid assets, yellow bars mean non-liquid assets. We can see that with all the assumptions about income, expenses, taxes and investment returns the family is expected to use almost all their liquid assets if they stay in the San Francisco Bay Area:

Scenario 2 – The Family moves to Florida

The family is considering moving to Sarasota (FL) and we used zip code 34238 when fetching data for living expenses, health insurance and other expenses.

When estimating living expenses, we used MIT Living Wage Calculator and Payscale data. These sources gave us a reduction between 29% and 42% depending on family size and their employment. For our family we used a more conservative 20% reduction in living expenses because we separate medical expenses, taxes and primary residence expenses in our models.

We use healthcare.gov data to estimate ACA health insurance costs in both California and Florida. The family is considering moving in 2028, so we increased the age of each partner by 2 when entering the data on the website and set their income to be $50K assuming that they won’t work in the future.

BlueOptions Bronze,Silver, Gold plans gave us $476/month, $1703/month, $2,063/month. We estimated the total annual expense as a monthly premium x 12 + MOOP (Max Out Of Pocket). We picked the Silver Plan in our model and that gave us $36.6K/year which is very conservative because it assumes that the family will be maximizing their MOOP every year.

Long Term Care (LTC) In Florida is less expensive than in California: $155K/year vs $182K/year private room and $63K/year vs $88K/year assisted living community. For this family we used in-home care option and reduced the LTC cost accordingly:

We planned the move for September 2028, when Steph goes to college. At that point, the family will sell their home in California. We updated the model to stop the mortgage in 2028 and added $2.2M in sale proceeds. Their cost basis is $1.6M, and with the $500K Section 121 exclusion for married couples filing jointly, we increased the adjusted cost basis accordingly. We also included closing costs equal to 6% of the sale price.

The family plans to rent in Florida for a year to give themselves time to explore neighborhoods and find the right home. After that, they expect to buy a place for around $540K. They don’t plan to take out a mortgage, since the proceeds from selling their current home should be enough to cover the purchase.

One important item to consider is the high cost of insurance in Florida, especially in coastal areas. We increased their estimated insurance from $2,500/year to $12,000/year. Coastal homes, particularly those in hurricane- and flood-prone zones, often face significantly higher premiums due to wind and water-damage risk and stricter building-code requirements.

To update the tax estimates accordingly, we added a new milestone to the family’s Financial Projection called “Relocate to Florida” and attached a Tax Config to it. This tells our tax model to begin calculating state taxes as if the family resides in Florida starting in 2028.

If the family moves to Florida, they expect to stop working in tech that same year. Changing states and ending their income both affect their estimated taxes. The model automatically calculates the family’s income taxes in both scenarios. We didn’t need to calculate anything manually:

Let’s compare scenarios

The model makes many assumptions about future income, expenses, and investment returns. But given that everything else remains the same and only the changes described above are applied, the family is projected to have a net worth of $9M at the end of the financial plan if they stay in the Bay Area.

If the family moves to Florida, they stop working in 2028 instead of 2033 (gaining five years back), and their net worth is projected to be $11M at the end of the plan.

Also, the family assets are going to look much differently. If they stay in the Bay Area, they are expected to spend all their savings in taxable, tax-deferred and tax-free accounts. It’ll be primarily their real estate which is left at the end of the financial plan.

If the family moves to Florida, they are expected to have a healthy mix of taxable, tax-deferred and tax-free savings and will be able to pass assets down to their heirs.

Conclusion

Deciding whether to stay in the Bay Area or relocate to Florida is ultimately a personal choice. Financial modeling can highlight the trade-offs: lower taxes, reduced living costs, and an earlier retirement timeline in Florida versus the familiarity, community, and opportunities that come with staying in San Francisco, but numbers alone can’t make the decision.

What the model can do is give families clarity. By mapping out income, expenses, taxes, healthcare, housing, and long-term care needs across both scenarios, this family was able to understand how each path might shape their financial future.

Every family’s values, preferences, and life priorities are different. Some will choose financial optimization; others will choose proximity to friends, career opportunities, or simply the lifestyle they enjoy most. The right answer is the one that aligns with what matters to you.

If you’d like to build your own projections and explore scenarios like this, you can give Nauma a try.

At Nauma, we recently worked with a family in their 30s who faced this exact question.

To answer that, we built two full financial projections. One assuming they continue renting, and one assuming they buy a home. Below is what we discovered and what you should consider if you’re facing the same question.

The Family’s Background

• A married couple in their 30s

• Both partners work in tech

• Have young kids, plan to have more

• Net worth: ~$2M

• Live in San Francisco and currently rent

The family goal is to build a reliable long-term financial plan that supports raising a family, affording school/college costs, preparing for healthcare expenses, and eventually retiring comfortably.

Scenario 1 — Continue Renting in San Francisco

For the “rent” scenario, we built a full financial projection that included:

Current Financial Picture

We reviewed their complete financial picture—including assets, liabilities, income, and spending—and incorporated future salary expectations, taxes, childcare costs, and lifestyle expenses.

Kids’ Future Costs

We added the future expenses for the kids, including school and college expenses, as well as changes in extracurricular activities and childcare needs over time.

Long-Term Living Expenses

We modeled dozens of spending categories using aggregated data, including groceries, household expenses, and childcare, as well as lifestyle costs that evolve as the children grow. We also accounted for periodic vehicle purchases every 10–15 years, along with travel, entertainment, and other recurring expenses.

Retirement Healthcare

A major factor many families underestimate is how healthcare costs change over time. We separated healthcare expenses and incorporated the following categories into the model:

• ACA coverage pre-Medicare

• Vision & dental

• Medicare Parts A, B, C & D

• Long-term care assumptions

Scenario 1 — Projection

Long-term net worth outcomes depend on expected real estate and stock market returns. Historically, the benchmark S&P 500 (with dividends reinvested) has averaged approximately 8.5–10% annual nominal returns. In comparison, from 1999 to 2024, single-family homes in the San Francisco metropolitan area experienced a compound annual growth rate of about 6%.

After discussing the family’s views on stock market and Bay Area real estate returns and plugging the assumptions into the model, the projections showed an $11M net worth (Today dollars) by the end of the financial plan, assuming housing prices do not materially outperform investment returns.

Scenario 2 — Buy a Home in San Francisco

Then, we modified the projection to model a home purchase.

The Assumptions

• Home price: ~$3M

• Down payment (20%): $600K

• Closing costs: ~$50K

• Moving + furnishing: ~$150K

• Mortgage: $2.4M at 6.25%

  • Payment: ~$14.8K/month

• Homeowners insurance: ~$3K/year

• Maintenance: $30K/year

• Property tax: 1.1% increasing at Prop-13’s 2% cap

The Hidden Giant: Maintenance

Many homeowners underestimate this category. We estimated ~1% of home value per year, or $30K/year, based on realistic Bay Area costs:

The Surprising Result

Buying the home was financially feasible, but it significantly reduced the family’s long-term net worth. When we compared the two full lifetime projections, the difference was substantial: the expected net worth at retirement (in today’s dollars) was approximately $11M if they continued renting, versus about $5M if they purchased the home.

The $6 million difference is due to:

• Higher cash outflow due to mortgage + maintenance

• Opportunity cost of the $600K down payment

• Property tax

• Lower expected return of real estate vs. diversified investments

• Long-term drag from high carrying costs

Buying a home did offer lifestyle stability, predictable housing as they aged, and potential emotional benefits but the financial trade-off was clear.

So… Should You Buy or Rent in San Francisco?

Buying a home isn’t always the financially optimal choice. In high-cost markets like San Francisco, ownership can materially reduce long-term net worth even when a family can comfortably afford the purchase. Renting is not ‘throwing money away’; for many tech families, it preserves flexibility, increases liquidity, and can lead to stronger long-term wealth outcomes.

At the same time, finances aren’t the whole story. Families often prioritize school stability, more space for children, control over their living environment, and the emotional security that comes with homeownership. Ultimately, the right decision depends on your financial capacity, life priorities, and risk profile.

How to Make This Decision for Your Own Family

If you’re trying to navigate the Bay Area buy-versus-rent decision, the first step is building a real financial projection—not just a simple spreadsheet, but a comprehensive model that incorporates your income and career plans, long-term expenses, housing scenarios, taxes, healthcare, children’s education, retirement strategy, investment returns, and overall risk capacity. This is exactly where Nauma can help.

We had a learning session last week focused on one of the most important but often misunderstood parts of financial planning: building realistic projections.

A solid financial plan typically follows this order:

1. Understand your current situation

2. Build realistic financial projections (income, expenses, taxes)

3. Define your financial goals

4. Construct portfolios aligned with those goals

5. Do tax planning on top of everything else

In our November 7th session, we focused on step 2, financial projections, and discussed the most common modeling mistakes we see people make. The conversation covered how small errors in assumptions about Social Security, healthcare, living expenses, and taxes can compound over time and distort a plan’s accuracy.

Here’s a condensed summary of that discussion, along with practical ideas for fixing each mistake.

1. Social Security: Ignored, Mis-Modeled, or Taxed Wrong

Mistake A: Ignoring Social Security entirely

High-income families often leave Social Security Benefits out of their projections. We understand the concern: “I don’t want to rely on it,” or “What if the system changes?” But for most people who’ve worked long enough, Social Security is real money: often $20K–$40K per year (in today’s dollars) for decades. Completely ignoring it usually makes the plan more confusing, not safer.

Instead, include Social Security in your projections—and if you’re concerned about potential cuts or means-testing, apply a discount (for example, model 50–70% of the estimated benefit) rather than dropping it to zero.

Mistake B: Using the SSA PDF at face value when retiring early

Many people pull their estimate from the Social Security website, see numbers for age 62, 67, 70, and plug those straight into their model. Those numbers usually assume you keep earning your current income until the claiming age. If you plan to stop working at 50, that estimate can be significantly inflated.

Instead, go to the SSA website and use the tool that lets you edit future earnings—set your income to what you actually expect: keep it similar if you plan to continue full-time, reduce it if you plan to work part-time, or set it to zero if you plan to stop working early—and then use those updated estimates in your projection.

Mistake C: Treating Social Security as W-2 income in the model

Social Security is taxed differently from salary—only 0–85% of your benefit is taxable depending on your other income, so it’s not just another W-2 paycheck. If you label it as W-2 income in your planning tool, your tax calculations will likely be inaccurate, often too high.

Instead, use the specific “Social Security” income type (if available) and let the software apply the correct rules based on your total income each year.

2. Medical Expenses: Underestimated, Oversimplified, or Ignored

We rarely see people enter medical expenses manually. For early retirees especially, this is dangerous. Think of medical costs in three phases:

1. Pre-65: ACA / private coverage / COBRA

2. 65+: Medicare + supplemental

3. Late life: Long-term care & support

Mistake A: Hand-waving medical costs

If you retire before 65, health insurance doesn’t disappear—it often becomes an important expense. Under the ACA, both premiums and subsidies depend heavily on your income, especially your taxable income. Common mistakes include underestimating the income used in ACA calculations (for example, Social Security is treated differently than it is for federal taxes, and tax-exempt muni bond interest still counts), forgetting that Roth conversions can increase ACA premiums, and not planning for potential changes to today’s subsidy rules.

Instead, model your pre-65 coverage explicitly: whether that’s ACA coverage with estimated premiums and maximum out-of-pocket costs, COBRA for up to 18 months (or 29 months if disabled in some cases), or private insurance.

For ACA plans, you can use your projected income to estimate premiums. A conservative approach works best: for each pre-65 year, plan to cover both the premium and the maximum out-of-pocket amount so you’re prepared for expensive years.

Mistake B: Ignoring the “gap” at very low income

If your income is too low, you could fall into a coverage gap in states that haven’t expanded Medicaid—people who aim for near-zero taxable income for tax purposes sometimes lose ACA subsidies by accident. Instead, make sure your projected income stays above your state’s ACA minimum thresholds, and if you’re intentionally keeping income low to qualify for subsidies, confirm you’re not slipping into the coverage gap.

Mistake C: Forgetting long-term care and “non-covered” health costs

Long-term care is costly—and most people need it only near the end of life, typically for 2–4 years. Yet we often see two extremes: no long-term care modeled at all, or overly conservative projections assuming 20 years of nursing home expenses. Both approaches can be misleading. People also tend to overlook expenses like dental, vision, acupuncture, chiropractic care, and other services that aren’t fully covered by Medicare or insurance.

Instead, model 2–4 years of long-term care near the end of life using realistic local cost estimates. Then decide whether to self-insure—by setting aside a dedicated bucket in your plan—or to purchase long-term care insurance. Self-insuring offers more flexibility and can be more cost-efficient for higher-net-worth families, while insurance may be better for those who struggle to save consistently. Finally, include a modest recurring budget for dental, vision, and other out-of-pocket health services.

3. Living Expenses: One Giant Number for 40 Years

A common mistake is treating all living expenses as one flat number forever—like saying, “I spend $10,000 a month, so I’ll just project that with inflation for 40 years.” That approach ignores that different expenses follow different timelines: childcare and tuition eventually end, mortgages get paid off, early-retirement travel often spikes in the first 5–10 years then slows, and overall spending tends to decline later in life even as medical costs rise.

Instead, break your spending into a few broad categories with their own timelines—for example: baseline living expenses (food, utilities, transportation), child-related costs (daycare, private school) with end dates, big temporary “fun” goals (early-retirement travel, sabbaticals), support for aging parents, and gifts or charitable giving. You don’t need extreme detail—just separate expenses that clearly start or stop.

It’s also essential to view your projections in both today’s dollars and future (inflated) dollars: today’s dollars show the lifestyle your plan supports, while nominal dollars reveal what your actual future spending and balances will look like with inflation. Both perspectives matter.

4. Homeownership: Underestimating the True Cost

When people talk about housing costs, they almost always focus on the mortgage—but the mortgage is time-limited (15–30 years) and often not the biggest long-term expense. The costs that tend to strain retirement plans are property taxes, HOA dues, insurance, and especially maintenance and major repairs.

Maintenance can seem minor most years—until you need to replace the roof, fix the foundation, repipe the house, or repaint the exterior. Those are five-figure expenses, and if you haven’t planned for them, you may end up pulling from investment accounts at bad times and triggering unnecessary taxes. A good rule of thumb is to plan for 1–1.5% of your home’s value per year in maintenance costs over the long run—some years will be light, others expensive, but it averages out reasonably over decades.

And don’t forget selling or moving. If you expect to downsize after the kids move out or relocate from a high-cost state, model those transitions explicitly—include realtor and transaction costs, potential capital gains taxes on appreciated property, and the new property taxes, insurance, and maintenance for your next home. These choices can cause visible “spikes” in your tax and cash flow projections, and seeing them charted helps you plan when and how to make the move strategically.

5. Unrealistic Growth, Inflation, and Tax Assumptions

The last category of mistakes is conceptual but hugely important.

Mistake A: Over-optimistic growth and inflation assumptions

We often see projections with unrealistic assumptions—income growing 10% a year for 20 years, medical or long-term care costs inflated at 10–12% for 30 years, or portfolios expected to earn 15–20% annually just because recent markets have been strong. But compounding works both ways—aggressive assumptions can make a fragile plan look bulletproof on paper.

Instead, use conservative, historically grounded assumptions for portfolio returns, inflation, and medical cost growth. Be especially careful with high growth rates over long time horizons (20–30 years)—they can make your numbers explode and give a false sense of security.

Mistake B: Treating taxes as a fixed percentage forever

Tax planning isn’t as simple as saying, “I’m in the 32% bracket today, so I’ll always be in the 32% bracket.”

Over a typical lifetime, your tax picture changes:

• During peak earning years, taxes are high.

• After you stop working but before RMDs and Social Security begin, taxes often drop.

• Later, when RMDs and Social Security kick in, taxes can rise again.

• Major events—like selling a business, exercising stock options, or buying and selling property—can create one-time tax spikes.

If your projection assumes a flat tax rate, you’ll miss major planning opportunities (like Roth conversions or timing large sales) and may underestimate future tax drag.

Instead, model different income types separately—salary, RSUs, Social Security, Roth conversions, RMDs, and so on—and let the software apply tax rules year by year. Look specifically for years with unusually low income (ideal for Roth conversions) and for years with large income spikes (from home or business sales, or option exercises) that could benefit from spreading income over multiple years when possible.

Bringing It All Together

A good financial projection isn’t about predicting the future perfectly—it’s about being honest about what you know today, staying conservative where uncertainty is high, and keeping your assumptions internally consistent.

If you thoughtfully include Social Security (perhaps with a discount), model pre-65 healthcare and long-term care realistically, separate temporary from recurring living expenses, account for the full cost of homeownership, and use reasonable assumptions for growth, inflation, and taxes—you’re already well ahead of most “back-of-the-envelope” plans.

From there, it finally makes sense to move on to discussions about asset allocation, withdrawal strategies, Roth conversions, and gifting or legacy planning.

You can watch the recording of this Learning Session here:

Most people see charitable giving as a way to help others and support causes they care about.

That’s true – but it can also be a powerful part of your tax strategy.

When done right, charitable donations can lower your tax bill, avoid capital gains, and make every dollar go further.

The Basics: When Is a Donation Tax-Deductible?

To qualify for a tax deduction, your donation must go to a qualified charity, typically a registered 501(c)(3) nonprofit.

You can only claim this deduction if you itemize on your tax return using Schedule A, rather than taking the standard deduction.

When you itemize, charitable donations count alongside other eligible expenses such as state and local taxes (SALT) and mortgage interest on your primary home. However, if your total itemized deductions don’t exceed the standard deduction, your charitable gifts won’t actually reduce your taxable income that year.

That’s why many people choose to “bunch” donations — making a larger contribution in a single year instead of spreading smaller gifts across several years. This strategy helps push total deductions above the standard threshold and allows your charitable giving to deliver real tax savings.

Two Common Ways to Donate

When it comes to charitable giving, the two most common methods are cash donations and donations of appreciated assets such as stocks, ETFs, or mutual funds.

The table below summarizes the key differences between the two:

An Illustrative Example

Let’s look at a simple example comparing a $50,000 cash donation to a $50,000 stock donation.

If you give cash, your deduction equals the amount donated, i.e. $50,000. Assuming you’re in the 32% tax bracket, that saves you about $16,000 in taxes.

Now, suppose instead you donate appreciated stock worth $50,000 that you originally bought for $10,000.

• If you were to sell the stock first, you’d owe capital gains tax on the $40,000 gain and about $8,000 long capital gain tax at a 20% rate.

• By donating the stock directly, you avoid that tax and still deduct the full $50,000 market value.

In total, your tax benefit jumps to $24,000 ($16,000 deduction savings + $8,000 avoided capital gains).

A Comprehensive Case Study: The Long-Term Impact of Charitable Giving

While the illustrative example makes the math clear, it’s also oversimplified. It looks at just one year, assumes a fixed tax bracket, and doesn’t consider how income, deductions, or portfolio values change over time.

To see the full picture, let’s look at a long-term projection.

Let’s consider a couple in their late 30s with two children and several long-term goals. Their financial snapshot looks like this:

• Annual household income: $350,000

• Net worth: Approximately $2.2 million split between taxable, retirement, and real estate assets.

• Ongoing expenses: living expenses, mortgage payments, property taxes etc.

• Financial goals:

  • Fund college education for their two children

  • Prepare for retirement

  • Plan for potential long-term care needs later in life

Case 1: cash donation of 50K in 2026

Let’s start with a one-time $50,000 cash donation in 2026.

• Without the donation: total tax for 2026 is about $75,000

• With the donation: tax drops to $58,000

• Saving $17,000 on tax with the donation

In the projection, the donation barely affects their overall cash flow — it shows up as a small, one-year expense — but the tax benefit is immediate and significant. The deduction lowers their taxable income and reduces their federal tax bill for that year.

Case 2: Higher-Income Year — Cash Donation with a $200,000 Bonus

Now let’s see what happens if the couple’s income spikes in 2026. For example, one spouse receives a $200,000 bonus or a large investment is sold that year.

This higher income pushes them into a higher marginal tax bracket, meaning every additional dollar they earn is taxed at a steeper rate. In that situation, a charitable deduction becomes even more valuable.

Using the same $50,000 cash donation:

• Without the donation, their projected tax bill for 2026 rises to about $156,000.

• With the donation, it drops to $135,000.

• Saving $21,000 tax, 4K more compared to $17,000 in the base case.

The difference shows how timing matters — giving during a high-income year amplifies the impact of your deduction. When your income (and tax bracket) are elevated, the same charitable gift can deliver a larger after-tax benefit.

Case 3: Liquidity Constraints and Their Hidden Tax Effects

Now, let’s look at a different dynamic — a scenario driven by lower liquidity.

For simplicity, we model this by reducing the couple’s income by $100,000 before retirement. This lowers their annual net cash flow and, in turn, their ongoing contributions to taxable accounts over time.

Over time, however, the donation reduces their liquid savings, leaving less flexibility later in life. In our projection, their taxable account is depleted around 2051, forcing them to draw from tax-deferred accounts earlier than planned. Those withdrawals are taxed as ordinary income, increasing their tax liability in later years.

So while the donation provides an immediate tax benefit, it also creates long-term ripple effects. The same liquidity issue can arise even for high-net-worth households, especially when much of their wealth is tied up in real estate or other illiquid assets. Understanding how a donation affects your liquidity and withdrawal strategy is essential for managing long-term tax outcomes.

Case 4: Cash vs. Asset Donation

Finally, let’s compare donating cash versus appreciated assets, such as stocks or ETFs that have increased in value over time.

When the couple donates $50,000 in cash, the tax benefit appears immediately, as seen in earlier examples. But when they donate $50,000 in appreciated assets with a much lower cost basis, in addition to the immediate effect, something more subtle happens over the long term.

By giving investments with built-in capital gains, the overall cost basis of their remaining taxable portfolio rises. As a result, future withdrawals from these accounts generate smaller capital gains, and therefore less tax over time.

In our projection, this difference becomes visible in 2030, a year with significant withdrawals:

• With asset donation: total tax is about $19,000

• With cash donation: total tax is about $20,000
  
  

That’s roughly a $1,000 difference for that year. In the projection, we use the average cost basis to estimate taxes. In fact, the difference appears in every year the couple withdraws from their taxable account, and the actual impact depends on how much they withdraw each year.

In short, donating appreciated assets creates layered tax savings, first by avoiding capital gains when the gift is made, and later by reducing taxable gains in future years.

Summary: When Charitable Giving Makes the Most Sense

As we see from the cases, the impact of charitable giving depends on timing, income level, liquidity, and what you give.

Higher income = bigger benefit.
When your income (and tax bracket) rises, for example from a bonus, investment gain, or business sale, each dollar of deduction saves you more in taxes. That’s the ideal time to make charitable gifts.

Itemizing amplifies the impact.
If you already itemize deductions, such as mortgage interest or high state and local taxes, charitable donations stack directly on top, making them far more valuable than in years you take the standard deduction.

Liquidity matters.
Even wealthy households can face tax ripple effects when most of their assets are tied up in real estate or other illiquid investments. Donating from liquid, taxable accounts reduces flexibility and may lead to higher taxes later when you’re forced to draw from tax-deferred accounts. Always consider how a gift affects your long-term cash flow and withdrawal strategy.

Donating appreciated assets multiplies the savings.
Contributing investments instead of cash lets you avoid capital gains tax while deducting the full market value. It also improves your future tax position by raising the cost basis of what remains in your portfolio.

By understanding these principles and planning strategically, you can make a bigger impact — for both the causes you care about and your long-term financial future.

Want to see how these projections look in action?
Here is a step-by-step demo of how giving strategically can lower your taxes and shape your financial plan.

It sounds simple — but the answer depends on your unique situation, assumptions, and goals.

In this post, I’ll walk through a real scenario analysis we ran in Nauma, showing how the numbers change under different assumptions.

The Case Study

Let’s start with a real-world example.
A couple in their late 30s, with two kids, is trying to decide whether to keep renting or buy a home.

Here’s their financial snapshot:

• Household income: $350,000 (pre-tax)

• Savings: $600,000 in a taxable account

• Currently renting: $5,000/month

• No existing real estate or debt
  
  

They’re considering buying a $1.5 million home with a 20% down payment ($300,000) in 2026.

For simplicity, we’ll express everything in today’s dollars — meaning we adjust future values for inflation so that all amounts reflect their value in today’s purchasing power.

Scenario 1: Keep Renting

If they continue renting, they pay $5,000/month (increasing with 2% inflation).
All of their assets remain liquid — mostly invested in taxable and retirement accounts.

After 30 years, (end of 2056), they will have

• $6.8 million net worth (today’s dollars)

• All in liquid assets — easy to access and flexible

Scenario 2: Buy a Home (6.5% Mortgage, 2% Appreciation)

Now let’s see what happens if they buy a home.

They put $300K down and pay about $50K in closing and moving costs, then take out an 80% mortgage at 6.5% for 30 years.

After three decades, their projected results look like this:

• Net worth: $5.7 million

• Includes $1.5 million in home equity and $4.2 million in liquid assets

In this scenario, buying ends up roughly $1 million lower than renting — mainly because of higher borrowing costs and slower property appreciation.

We’ve assumed the home value grows at 2% per year, matching the inflation rate. Since we’re expressing everything in today’s dollars, that means the home’s value stays flat at $1.5 million over time in real (inflation-adjusted) terms — shown as the constant blue bar in the chart.

Scenario 3: Lower Mortgage Rate (3%)

Now, let’s see what happens if they secure a 3% mortgage rate instead.

Lower interest means smaller monthly payments — and that frees up more cash flow to invest elsewhere. Over time, that compounding difference really matters.

Here’s the result:

• Net worth: $6.9 million

• Slightly higher than renting
  
  

Even a few percentage points in mortgage rates can completely change the outcome — turning buying from a financial drag into a long-term advantage.

Scenario 4: Faster Home Appreciation (5%)

In some markets — especially places like California — home values have historically grown much faster than inflation.

Let’s keep the mortgage rate at 6.5%, but assume the home value appreciates at 5% per year instead of 2%.

• Net worth: $7.9 million

• About $1 million higher than renting
  
  

Even with the same borrowing cost, stronger property growth turns buying into the clear winner. The faster appreciation not only builds home equity more quickly but also pushes total net worth above the renting scenario — showing how much long-term results depend on local housing trends.

But There’s a Catch: Liquidity

One important factor people often overlook is liquidity — how easily your wealth can be accessed when you need it.

When you buy a home, a large portion of your net worth becomes tied up in home equity. It looks great “on paper,” but it’s not cash you can easily use without selling or borrowing against your house.

In our model, if this couple decides to retire early (say at age 52), they actually face a liquidity gap:

They have plenty of total wealth, but not enough spendable cash to cover expenses before they can withdraw from their retirement accounts without penalty.

If they had kept renting, their assets would have remained liquid and accessible — giving them much more flexibility in how and when to use their money.

Other Factors We Take Into Account

To make this comparison realistic, our model includes several key assumptions:

• Account growth rate: 6%
  If the couple doesn’t use their savings for a home down payment, the money stays invested and continues to grow at 6% per year.

• Inflation: 2%
  All future values are adjusted for inflation so we can compare everything in today’s dollars.

• Location: California
  The couple lives in California and pays state income tax in addition to federal taxes.

• Family: Two children, ages 5 and 7
  They plan to fully fund college expenses of $50,000 per year per child (in today’s dollars) from ages 18–22 — which directly affects their cash flow.

• Living expenses: $84,000 per year (excluding rent or mortgage)
  These expenses are assumed to grow with inflation over time.

• Retirement: Age 60
  They retire at 60 and begin collecting Social Security benefits at age 65.

The Takeaway

There’s no one-size-fits-all answer.

• Renting — offers more liquidity, flexibility, and less maintenance.

• Buying — builds potential equity growth, but comes with higher upfront and ongoing costs.

The outcome depends on key factors like your mortgage rate, home appreciation rate, and how long you plan to stay.

The key isn’t guessing — it’s running the actual numbers.

Try It Yourself

At Nauma, we make this kind of scenario analysis simple. Check out this video on step by step guidance to do it yourself:

You can model your own financial plan — compare buying vs. renting, test different mortgage rates, or explore how early retirement might impact your liquidity and long-term net worth.

One option that investors sometimes use to diversify without immediately selling their shares is an exchange fund.

What Are Exchange Funds?

Exchange funds, also known as swap funds, are investment vehicles that allow investors with concentrated stock positions to diversify their holdings without selling their shares and triggering capital gains taxes.

Instead of selling your stock, you contribute your shares into a pooled fund. The fund combines your stock with shares from other investors to create a diversified portfolio. In return, you receive shares of the fund representing your proportional ownership of the pooled assets.

After typically seven years, you can redeem your shares and receive a basket of diversified securities. Importantly, capital gains are not eliminated — they’re deferred. Your original cost basis carries over to your new diversified basket.

How Exchange Funds Work

Here’s a simplified breakdown:

Multiple investors contribute their individual stock holdings into a single partnership or fund. The fund issues shares to each investor in exchange for their stock. After the required holding period (usually seven years), investors redeem their shares for a diversified basket of securities. Taxes are deferred until those new securities are sold.

This structure allows for immediate diversification while postponing tax liabilities.

IRS Rules and Requirements

Exchange funds aren’t a free-for-all. The IRS sets clear rules to preserve their tax-deferred status:

• Qualified Assets Only
  Contributions must be publicly traded, long-only, fully vested U.S. securities.
  Private shares, restricted stock, and stock options can’t be used.

• Minimum Contribution Size

  Traditionally, exchange funds were only available through institutional channels with high minimums — typically $1–$5 million per position. Recently, however, FinTech platforms have started offering exchange funds to DIY accredited investors, sometimes with entry points as low as $100,000.

• Accredited or Qualified Investor Requirement
  Exchange funds are private placements under Regulation D. You must be either an accredited investor (net worth over $1 million excluding primary residence, or high income), or a qualified purchaser (over $5 million in investable assets).

• 20% Rule
  At least 20% of the fund’s assets must be invested in non-publicly traded property — typically real estate or private equity. That’s why even if a fund claims to “track the S&P 500,” part of it will always include real estate holdings.

• 7-Year Lockup Period
  Investors must stay in the fund for at least seven years to receive the full tax benefits.

Tax Treatment and Reporting

While exchange funds are designed for tax deferral, you may still owe small amounts of income tax along the way as they are usually structured as limited partnerships (LPs), which means pass-through taxation of income.

Exchange Funds distribute K-1 forms, often in March or April, which can delay filing of your tax return.

Fees and Costs

Exchange funds are not cheap. They typically charge high management and administrative fees, which can reach hundreds of thousands of dollars over the investment period. Before investing, it’s crucial to:

• Review the total expense ratio.

• Model out net-of-fee returns.

• Ensure the tax deferral benefit outweighs the cost.

Who Should Consider Exchange Funds?

Exchange funds can make sense for three main types of investors:

1. Tech employees with concentrated stock positions often from IPOs, acquisitions, or long-term equity compensation.

2. Long-term investors with low cost basis. Families who’ve held stocks for 20–30 years and want to diversify without triggering taxes.

3. Investors not planning charitable giving. If philanthropy is part of your plan, strategies like donor-advised funds or charitable remainder trusts may be more efficient.

When Exchange Funds Don’t Make Sense

Despite the tax deferral, exchange funds aren’t always beneficial. They may not make sense if:

• Your cost basis is relatively high, reducing your unrealized gain.

• You expect to be in a lower tax bracket soon (for example, after retirement).

• The fund fees outweigh the diversification and deferral benefits.

• You may need access to the money before the seven-year lockup ends.

You can use our Exchange Fund Calculator to model your own scenario and see if it makes sense for you.

The Bottom Line

Exchange funds can be a powerful tax-deferral and diversification tool for investors with highly appreciated, concentrated stock positions — but they come with complexity, high fees, and long lockups. Before committing, it’s wise to:

• Build a financial plan.

• Model out costs, tax scenarios, and returns.

• Compare with alternatives like charitable trusts or structured sales.

Used thoughtfully, exchange funds can help preserve wealth, reduce risk, and defer taxes — but they’re not for everyone.