Category: Financial Planning

Each year, millions of Americans make donations to charitable organizations and receive something in return – a tax break. However, the 2017 Tax Cuts and Jobs Act curbed this tax advantage because it reduced the number of people eligible to claim a charitable deduction by raising the standard deduction. For 2020, the standard deduction is $12,400 for individuals and $24,800 for married couples filing jointly. If your list of deductions is not greater than those amounts, there is no tax benefit to itemizing – which means you might not be able to claim your charitable donation.

Without the ability to claim a deduction, some retirees just take their normal required minimum distribution (RMD) and bank the money, pay taxes on it and then make charitable gifts or tithe to their church on a monthly basis. For example, say your RMD is $10,000 and you pay 15 percent in taxes on this distribution. If you want to donate the money as a charitable gift, you’ll have only $8,500 left to do so.

However, there is a way to do this that will give you a tax advantage. A Qualified Charitable Distribution from an IRA enables retirees to claim their standard deduction and receive a tax benefit for their gift. The key is to arrange for the distribution to be made directly from your account custodian to the qualified 501(c)(3) charitable organization so that you do not take possession of the assets.

IRA owners may gift up to $100,000 each year, or $200,000 for a couple that files a joint tax return. Note that this option is available only for IRA owners over age 70½; it is not allowed for 401(k)s, 403(b)s, thrift savings plans, or other qualified plans. The QCD will be reported to the IRS and should be claimed by you on Form 1040 as an IRA distribution, but it will not be taxable. Another perk of this strategy is that the QCD can satisfy your annual Required Minimum Distribution (RMD). Be aware that if your QCD does not meet the full distribution amount required, you will have to withdraw and pay taxes on the remaining balance.

Another benefit of using an RMD for a charitable donation instead of receiving it as income is that this could keep you in a lower tax bracket. Consequently, it can help minimize taxes on Social Security benefits and keep your Medicare premiums low.

Thanks to the Coronavirus Aid, Relief and Economic Security (CARES) Act, RMDs are not mandatory in 2020. That’s because the initial market losses triggered by the COVID-19 outbreak were substantial; by not requiring distributions this year, retirement accounts have more time to potentially recover those losses.

Since it isn’t necessary to take an RMD this year, you might want to just make charitable gifts in cash. The CARES Act also enables this option by increasing the adjusted gross income (AGI) limit for individuals who qualify to itemize on their tax return. In 2020, you may deduct up to 100 percent of donations (up from 60 percent) against your AGI. For example, if you earn $500,000 in income, you may donate $500,000 and the entire amount is tax-deductible. This strategy is available to people younger than age 70½ and offers a benefit similar to the QCD.

Even if you don’t qualify to itemize, you may claim up to a $300 charitable gift deduction on your 2020 tax return. As always, it’s best to seek the advice of a tax professional in order to figure out what is best for your situation.

That year or two when you are closing in on your retirement date, followed by a year or two after you retire, are the worst times for a sustained market decline. Market analysts call this scenario the sequence of returns (SOR) risk – because once your principal has been significantly reduced, there’s not enough time in the market left for you to recover those losses.

Two things will likely happen. First, the amount of retirement income you can withdraw each year is irrevocably reduced. For example, if you were planning to withdraw 4 percent a year from a $350,000 portfolio, you would have received a supplementary income of $14,000 a year. But if your principal drops to $280,000 a year, your 4 percent draw will generate only $11,200 a year. If you need that additional money, you will have to increase your draw to about 5 percent of the principal each year.

This leads us to the second consequence of a market decline: your principal will diminish faster. The longer you live, the greater your chances of running out of money.

How Big Is This Problem?

Because the coronavirus pandemic has sent stock markets reeling over the past few months, SOR risk has become a widespread concern. According to research by Spectrem Group, at the end of 2019 there were 11 million millionaires in the United States. By the end of March this year, at least half a million of those people were no longer millionaires.

While losses among millionaires may be disconcerting, the situation is far more dire for middle-class investors, who might not have several hundred thousand dollars to spare in their retirement portfolio.

Strategies To Offset SOR Risk

If the last recession is any indicator, the economic recovery going forward could take several years. That’s not good news for people who were looking forward to retirement. This group may want to seriously consider the merits of delaying retirement and continuing to work longer, such as:

• Allowing their portfolio time to recover
• Continuing to contribute to tax-advantaged retirement accounts
• Enabling their Social Security benefits to accrue higher

Another strategy to help protect your portfolio against future SOR risk is to position a larger allocation to fixed-income assets and/or an annuity. While this might limit your potential for income growth in the future, these assets are backed by more reliable payors and less subject to the vagaries of the stock market. By diversifying your current assets, you can build multiple streams of reliable income to protect you from the future threat of market losses, a global pandemic or changes in Social Security benefits.

It’s worth considering that once we emerge from this current crisis, legislators will have to find a way to deal with the federal deficit and growing debt. The Social Security program was already projected to cut benefits by 2035 without any new funding solutions. Now, that threat is even further exacerbated by the enormous jump in unemployment numbers. This situation leaves even fewer people paying into the Social Security and Medicare programs.

All of this is why it’s very important to address today’s challenges presented by the sequence of returns risk. Explore ways to develop multiple income streams to protect your current assets and ensure they last throughout your lifetime.

The third decade of the 21^st century started out with a vigorous economy, record low unemployment levels, and benign inflation. But late in the first quarter over the span of two weeks, investors faced the fastest stock market correction in history.

With an unpredictable assailant like a global virus, short-term actions by Congress and the Federal Reserve will need time to see if they are effective. Ultimately, the fate of the U.S. and global economies, which in turn will impact the investment markets, is dependent on how long the COVID-19 outbreak continues and if there is a second wave. Clearly, both supply and demand have been dramatically reduced, with a ripple effect on companies, workers, consumers, and investors. Once the crisis has passed, we will learn which sectors, industries, and individual companies remain financially viable with a business model built to sustain this unprecedented economic fallout.

Amid this backdrop, wealth managers must read the tea leaves to anticipate what the investment markets will look like post-coronavirus. The challenge is how to best position assets to take advantage of future gains without giving up ground now and turning paper losses into permanent shortfalls.

For individual investors, it comes down to what you want to accomplish in the next decade – or what your money can accomplish for you. Are you nearing retirement? Will you remain in the accumulation phase, wherein you can afford to take on market risk? Are you just starting out, and are you risk-averse due to the two major economic declines experienced in your relatively short life, or are you prepared to invest in future prospects – wherever they may lie?

Anyone already in or nearing retirement would do well to invest for a steady stream of income. While the DJIA initially took a beating, many blue-chip stalwarts continue to grow and payout dividends as they have long term, through thick and thin. However, pay attention here, as there are some long-standing dividend-paying companies that are starting to suspend or substantially cut dividend payments.

Growth-oriented investors would do well to look at companies that were well-positioned to survive the pandemic, because they may well represent commerce of the future. This includes the well-established FAANG stocks (Facebook, Apple, Amazon, Netflix, and Google), which have become masters of fast and reliable delivery of online content and physical delivery of essential and discretionary products. Unfortunately, the stock prices of these companies have soared in recent years, so it’s time to consider what the “next big thing” in this arena will look like and who are the frontrunners.

With that in mind, take a look at 2020 demographics. Millennials recently surpassed Baby Boomers as the largest generation in the United States, but they aren’t expected to hold this mantle for long. Generation Z/Centennials are on track to enter the workforce in higher numbers during the next decade. This is a generation that has never known life without cell phones and the internet, so expect the technology sector to ramp up not just with consumer innovations, but with ways to help other industries enhance data management, blockchain supply chains, and artificial intelligence – which might become as omnipresent as retail strip malls.

In a post-pandemic world, employers seeking to strengthen their business models might come to embrace the idea of foregoing healthcare and other expensive benefits offered to employees. A subsequent world of higher pay and more public options could spur the growth of entrepreneurship and new small businesses. By taking advantage of remote employees, low overhead expenses, and emerging technologies, smaller companies or conglomerates might be able to compete with the likes of Amazon in both domestic and global markets.

As a short-term precaution, consider how you might defend your portfolio against the possibility of inflation as we stumble out of the pandemic economy. The federal government’s generous stimulus packages combined with a continued easing of monetary policy by the Federal Reserve could lead the United States to higher inflation. This could be exacerbated by the recent shutdown of production in many industries; the initial low supply of products also might contribute to price escalation. During this interim, investors may want to consider investing in commodities and Treasury Inflation-Protected Securities for inflation protection.

As always, it’s best to seek the advice of a professional in this ever-changing environment.

In the days ahead, the COVID-19 pandemic will likely be described in economic terms as a Black Swan. This phrase is used to describe an event that: 1) was unpredictable; 2) causes severe and widespread consequences; and 3) in hindsight was determined to be wholly predictable.

What will be interesting going forward is how much the virus, and its impact on the economy and financial markets, ultimately affects individual portfolios. It’s worth noting that many economists spent the whole of 2019 cautioning that a recession and market correction was imminent. To what extent investors took heed and repositioned their portfolios is yet to be seen.

As predicted, the Federal Reserve might have already exhausted the tools it had available to prevent a further watershed in the markets. Initially, the central bank dropped the federal funds rate to zero and funneled money into the economy. In more recent weeks, its monetary policies have included aggressive purchasing of Treasury bonds and mortgage-backed securities, extending swap lines to foreign central banks, and propping up short-term corporate borrowing and money market mutual funds to help support lending to state and local governments. At first, these efforts appeared to do little to diminish the stock market slide, but the end of March saw a three-day rally with the Dow Jones Industrial Average seeing its biggest three-day jump since 1931.

On the fiscal policy side, Congress is rushing to pass monetary aid as well as stimulus and recovery funds for both individuals and businesses. However, these actions can do little to stop an airborne virus that continues to shutter jobs and businesses and threaten the viability of the country’s health care system and everyday life as we know it.

Portfolio Considerations

When it comes to your own financial risk, let’s look at first things first. For many investors, an initial reaction might be to panic sell holdings before portfolios drop any further. Unless your timeline for needing funds has accelerated, selling now is not generally advisable. What is important to bear in mind is that markets tend to recover quickly after the most significant market declines, so if you’re not invested during the recovery, any paper losses you’re experiencing now will be permanent.

It is worth taking a good look at your holdings to get an idea of what to expect. For example, companies that rely on global supply chains and offshore manufacturing will likely experience the most detrimental short-term impact from the pandemic. This means disruptions in technology, retail, auto manufacturing, travel and tourism, global delivery and oil prices.

On the other hand, the health care industry will likely see tons more investment and demand while the so-called FAANG stocks (Facebook, Apple, Amazon, Netflix and Google) are poised for rampant growth – given the degree to which people are stuck at home using online and delivery services.

Bear in mind that if you make any changes to your portfolio in reaction to market volatility, take into consideration your long-term goals and financial security. The following are a few strategies to consider that could position your portfolio for subsequent growth – assuming you maintain a long-term perspective.

• Use either spare cash, asset allocation rebalancing opportunities or automatic investment contributions to bargain shop for stocks with a strong track record that are likely to recover but are well-priced right now.
• Now might be a good time to convert (tax-deferred) retirement account assets into a Roth IRA. By doing so now, when prices are at their lows, you’ll owe less tax at the time of the conversion – which you won’t have to pay until next year’s tax season. By that time, the market may have recovered, positioning your Roth for greater potential for tax-free growth and tax-free income during retirement.
• Consider using a portion of your assets to pay a lump sum premium for an annuity contract in order to transfer market risk from your portfolio to an insurance company. An annuity is designed to provide insurer-guaranteed income during your retirement, so you can feel a bit better about maintaining an equity allocation during this volatile time until the rest of your portfolio recovers.

The spread of the COVID-19 coronavirus is likely to continue to drive investor uncertainty over the short term. The long term, however, is another matter. Just like the saying, “What goes up, must come down,” history has shown that when it comes to the stock market, what goes down inevitably goes back up. The question is just how long that will take. For now, this is one of those times when it’s handy to have a three-to six-month emergency cash fund available to cover expenses.

At the end of 2019, Congress passed the Setting Every Community Up for Retirement Enhancement (SECURE) Act as part of a year-end appropriations package. This bill is designed to address specific issues related to retirement savings plans in an effort to help Americans save more for retirement.

Retirement Plan Contributions

People are living longer, and a decrease in employer-sponsored pensions has resulted in retirees relying more on Social Security benefits than in the past. So first, the SECURE Act eliminated the age limit on traditional IRA contributions so that people who work into their 70s and beyond may continue to contribute to the traditional IRA up to the annual limit. In 2020, the limit for all IRAs – traditional and Roth combined – is $6,000; $7,000 for individuals age 50 and older.

Retirement Plan Distributions

The SECURE Act also extends how long retirees may keep money invested in their traditional IRA, 401(k)s and other defined-contribution plans before mandating distributions. Starting this year, people who turn 70½ after Dec. 31, 2019 may delay having to start taking annual required minimum distributions (RMD) until age 72.

Inherited IRAs Reigned In

The Stretch IRA is an advantage bestowed to non-spouse beneficiaries who inherit an IRA. While a benefit still exists, the SECURE Act makes it somewhat less advantageous. Starting in 2020, assets in these inherited accounts must be fully distributed by Dec. 31 of the 10th year following the death year of the IRA owner. This means that annual distributions will be larger and the investment will no longer be able to grow beyond 10 years.

Employer-Sponsored Retirement Plans

The SECURE Act also made changes to employer-sponsored retirement plans. For example, it allows employers to increase the cap on automatic payroll contributions to 15 percent (up from 10 percent) of an employee’s paycheck. Research has found that automatic payroll deductions have been instrumental in improving both participation and savings rates among employer retirement plans. However, employees continue to have the ability to retain their current contribution level (or opt out of the plan entirely).

The legislation also requires employers that sponsor a defined-contribution plan to offer it to any long-term, part-time workers. The criteria for this requirement are that individuals must be age 21 or older and work at least 500 hours each year, for three years in row. However, the measurement time for this requirement doesn’t start until 2021.

The SECURE Act attempts to replace the secure pension plan by making it more attractive for employers to offer a lifetime income option as part of their 401(k) plan. Also known as an annuity, this option allows the worker to use his or her retirement plan contributions to purchase an annuity contract over time.

In the past, employers were reluctant to include an annuity option because they could be held liable if the annuity provider is unable to fund the retirement income guaranteed by the annuity contract. To help alleviate this concern, the SECURE Act protects the employer from liability as long as it chooses an annuity insurer that, for at least seven years, is 1) licensed by that state’s insurance commissioner; 2) has filed audited financial statements in accordance with state laws; and 3) maintains the statutory requirements for reserves among all states where the provider does business.

Employers that offer an annuity option must now issue a customized statement each year that estimates how much plan participants would receive in monthly retirement income based on the current balance of their annuity. When employees retire or take a new job, they can transfer their in-plan annuity to another 401(k) or an IRA without incurring fees or surrender charges.

The SECURE Act also provides new benefits for small businesses that sponsor a retirement plan for employees. They may now receive up to $5,000 to offset retirement plan startup costs, and can get an additional $500 tax credit per year for three years if their plan features auto-enrollment for new hires. The bill makes it possible for small employers in unrelated industries to open a multiple-employer 401(k) plan (MEP) in order to share administrative costs.

Conclusion

Overall, the various provisions of the SECURE Act described above are designed to make retirement savings easier and more accessible. Small businesses will find it less burdensome to offer both full- and part-time employees 401(k) plans by providing tax credits and protections on collective Multiple Employer Plans. Individuals will find they have more flexibility in managing their accounts later in life. Overall, the SECURE Act should ease the coming retirement crisis as demographics change by helping people prepare better.

As we progress through life, we find there are certain things we can control and others we cannot. However, even with the things we can’t control, we can exercise good judgement based on facts, due diligence, historical patterns and a risk/reward calculation.

These strategies play an important role in retirement planning. When it comes to accumulation, spending and protecting your nest egg, financial analysts rely heavily on safety and probability planning strategies.

For example, a probability-based approach generally refers to investing. In other words, prices of stocks and bonds will vary over time, and as investors we do not have control over the factors that cause those price swings – such as poor company management, a dip in sector growth, an economic decline, political instability and even global economic implications. We basically have to do our due diligence to ensure the securities we invest in are stable and well-managed, but in the end it’s a bit of a leap of faith. The markets will inevitably rise and fall and our equity investments will be impacted.

When it comes to retirement, financial advisors often recommend the following probability-based investments because they tend to be more stable and reliable:

• Investment-grade bonds
• High dividend-paying stocks
• Real estate investment trusts (REITS)
• Master limited partnerships (MLPs)

On the other hand, the safety side of the equation involves insurance products. Note that all guaranteed payouts are backed by the issuing insurer, not the Federal Deposit Insurance Corporation (FDIC) or the U.S. Treasury Department. So even though insurance products represent strategies that we consider “safe,” they are only as secure as the financial strength of the issuing insurance company.

Insurance contracts are based on insurance pools. This means they spread the risk of losing money across a wide pool of insured participants, betting that a portion of that pool will die early while others live longer. However, that risk is managed by the insurer instead of the contract owner, who is guaranteed to get paid no matter what happens in the investment markets or how many people in the insurance pool live a long time.

Among safety-based vehicles, you might want to consider a long-term care insurance policy to cover expenses should you need part- or full-time caregiving in the later stages of your life. Like homeowner’s insurance, this type of contract leverages manageable premiums to pay for expenses that you might otherwise not be able to afford.

Another safety contract is an income annuity, which offers the option to pay out a steady stream of income for the rest of your life and the life of your spouse – even if the payouts far exceed the premiums you paid. This is a way of ensuring you continue to receive income even if you run out of money.

 

A retirement plan doesn’t have to rely on safety or probability alone – you can combine these strategies. Many retirees feel more comfortable knowing they have a growth component in their portfolio to help offset the impact of long-term inflation. And within the safety allocation, you can even combine strategies. For example, a hybrid life insurance policy that offers a long-term care benefits rider allows you to draw from the contract if you need to pay for your own long-term care, which simply reduces the death benefit for your heirs. This way you don’t have to pay for coverage you don’t need, but it’s there if you do.

A rising tide might lift all boats, but the same cannot be said for the economy.

When the U.S. experiences robust economic growth, certain sectors of the stock market tend to rise while others hold steady or even decline by comparison. The stocks of companies that experience higher revenues are typically categorized as cyclical. In other words, their good fortune rests mainly on consumers being gainfully employed and having ample discretionary income with which to buy more goods and services.

Take, for example, auto manufacturers. Sales typically increase when more people can afford to buy a new car. But that’s not all the time, because the economy is cyclical – it ebbs and flows over time. Therefore, companies that produce non-essential products – sometimes referred to as consumer discretionary goods and services – tend to flourish during economic cycles of strength and rising GDP. That is why they are called cyclical stocks.

But when the economic future is in decline or at least uncertain, people tend to delay buying non-essential items like a new car. When the economy really takes a nosedive, more consumers are affected, they buy less stuff, manufacturing takes a hit and companies start laying off their workforce.

Despite these unfortunate circumstances, people still have to eat. They buy essential items, such as food and toothpaste and toilet paper. These are considered consumer staples, and the stocks of companies that produce these types of goods are defined as non-cyclical stocks. That’s because those companies are expected to continue earning revenues regardless of economic cycles. Non-cyclical industries include food and beverage, tobacco, household and personal products.

Another non-cyclical sector is utilities. Utilities are a little bit different because people tend to purchase relatively the same amount of utility service – with exceptions for extreme weather or making slight thermostat adjustments to save money – whether the economy is robust or in a downward spiral. Because of this, utility companies are considered a very stable business model.

For investors, that means they are well-established, long-term performers and usually pay out high dividends. Not only are utility stocks a good option for retirees seeking income to supplement their Social Security benefits, but they offer a safe haven for investors to relocate assets during periods of economic decline.

In light of recent cautions by economists predicting a recession in 2020, this could be a good time to review your portfolio from the perspective of cyclical versus non-cyclical holdings. It doesn’t mean you need to sell completely out of your stock allocation; perhaps just temper your holdings to equities that tend to perform reliably regardless of the economy. In addition to consumer staples and utilities, consider companies that specialize in national defense, waste management, data processing and payments.

Also be aware that the past three decades have boasted several of the longest running economic expansions in U.S. history (1991 to 2001; 2001 to early 2007; 2009 through 2019). What this tells us is that U.S. economic growth cycles appear to be lengthening while declines are relatively shorter and followed up with impressive recovery periods.

So, take heart. If you decide to transfer some of your assets to less flashy, non-cyclical securities, you might not have to leave them there for long. However, it’s always a good idea to maintain a diversified portfolio so you don’t have to make adjustments based on economic cycles. And as always, consult an investment professional to help you make these important decisions.