How to Circumvent the Demise of the Stretch: Strategies to Provide for Beneficiaries Beyond the 10-year Rule

How to Circumvent the Demise of the Stretch: Strategies to Provide for Beneficiaries Beyond the 10-year Rule

 

The Setting Every Community Up for Retirement Enhancement (SECURE) Act passed in late 2019, creating significant retirement and tax reforms with the goal of making retirement savings accessible to more Americans. We wrote a blog article detailing some of the high-level changes from this piece of legislation.

We’re going to dive deeper into some of the questions we’ve been receiving from our clients to shed more light on topics raised by the new legislation. We have divided these questions into six major themes; charitable giving, estate planning, Roth conversions, taxes, stretching IRA distributions, and trusts as beneficiaries.  Here is our fourth of six installments on stretching IRA distributions.

One of the major changes from the SECURE Act was the elimination of the ‘stretch’ IRA, which allowed beneficiaries to take retirement account distribution over their lifetime to spread out the income.  While a limited number of beneficiaries still have this option (see blog article referenced above), the act has replaced this option for the vast majority of beneficiaries with a new 10-year payout rule, requiring the retirement account to be emptied by the end of the 10th year following the year of death.  This will significantly shortening the distribution period on those retirement accounts and require the beneficiaries to recognize income more quickly than they would have had to do before.

Now that the stretch has been eliminated for IRAs, are there other options for my beneficiary to receive the income over a period longer than 10 years?

Since the law is only a few months old, new strategies are still being considered to address the compressed distribution schedule for non-spouse beneficiaries. A few strategies have gained traction, but they require intentional actions by the account owner before a death occurs. They include:         

  • Designating a charitable remainder trust as the beneficiary on the IRA. The CRT can pay a lifetime income stream to a person (or persons) of the IRA owner’s choice, but any residual balance will be retained by the charity. This option works best for owners who are already charitably inclined.
  • Consider tactical bequests. For example, leave Traditional IRAs to spouses (since they still have the stretch distribution options) or to charity (since they don’t pay taxes, so the compressed distribution won’t matter to them) but leave Roth IRAs, after-tax accounts, or real estate assets to non-spouse beneficiaries.
  • Take larger IRA distributions during your lifetime to purchase life insurance which can be paid to a trust. Since the life insurance proceeds are post-tax assets, there would be no time requirement on the trust distribution. The trust can even be set up as an Irrevocable Life Insurance Trust to keep the insurance proceeds out of the decedent’s estate if federal or state estate taxes are a concern.

Each of these strategies require careful consideration but can potentially provide your beneficiaries with income beyond the next decade.  We recommend speaking with your financial advisor or estate planner if you think any of these strategies may be appropriate for you.

 

First Installment: I’m Planning to Leave Assets to Charity – How Does the SECURE Act Change That?

Second Installment: How to Optimize Your Accounts After the SECURE Act

Third Installment: Must-Know Changes for Your Estate Plan After the SECURE Act

Fifth Installment:

Sixth Installment:

 

Disclosure: The material provided is current as of the date presented, and is for informational purposes only, and does not intend to address the financial objectives, situation, or specific needs of any individual investor. Any information is for illustrative purposes only, and is not intended to serve as personalized tax and/or investment advice since the availability and effectiveness of any strategy is dependent upon your individual facts and circumstances.  Investors should consult with a financial professional to discuss the appropriateness of the strategies discussed.

What Pandemics Can Teach Us About Personal Finance

What Pandemics Can Teach Us About Personal Finance

Because economic markets are intrinsically linked across the globe, the impact of a global pandemic can be widely felt. Disturbances in supply chains can impact inflation rates, and an increase in unemployment is a viable risk. Due to this, low inflation rates can impact forex trading and force central banks to reduce country-wide interest rates, resulting in a weaker currency. Despite these changes, it’s vital to take an informed approach when it comes to managing your finances. Here are some ways you can re-strategize in the time of a pandemic:

How to rebalance your portfolio

During epidemics over the last 20 years, the S&P 500 Index tends to exhibit a pattern of dramatically falling then powerfully recovering over a period of approximately six months. A generally prudent strategy to follow is to seek expert advice in redistributing your investment portfolio. In general, selling US growth stocks and buying bonds is suitable for many clients. Selling partial or full positions in order to boost your tax savings is also good advice to follow in the long run. Keeping an eye on your portfolio and avoiding making panicked decisions is crucial in the event of a pandemic.

How to invest according to your current situation

Something else to keep in mind is to invest according to your age group and particular situation. This advice applies whether you’re experiencing the effects of a pandemic or not. If you’re a young investor, it is recommended to hold on to your existing investments and patiently waiting for your returns. If you’re nearing retirement age, you should consider delaying your retirement if possible and focus on building up your funds. Lastly, if you’re already retired, you should hang on to your investments if you can afford it, or attempt to reduce your expenses.

How to re-categorize your budget

During a pandemic, individuals and families are likely to juggle new financial challenges. At this time, it’s a good idea to rethink your priorities. For instance, figure out your new baseline income based on potential pay cuts or unemployment, as well as any benefits you may receive. After this, work on calculating how much you need to pay for the essentials, such as rent, utilities, and food. Finally, you should try eliminating or reducing unnecessary expenses where you can. Dining out, entertainment, clothing, and travel are some areas where you can cut costs during this time.

How to get refunds where you can

In order to limit the spread of illness, it’s common practice that major events, flights, and services like gym memberships will be canceled. Because of this, you’re usually entitled to some form of compensation. If a travel ban has been put into place, airlines are likely to give you a refund or some form of credit if your travel plans were made in advance. Concerts and sports events should have similar policies put into place, so check your spam folder for any emails and updates regarding your refund. If you haven’t received any communication from the relevant organization, reach out and contact them to see what can be done.

In the event of a pandemic, it might be tempting to give in to your emotions and worry about your finances. To prevent this, building up an emergency fund beforehand with approximately three to six months’ worth of expenses and maintaining a strict budget plan will help you maintain peace of mind.

Prepared exclusively for merriman.com
by Danielle Houston

Important Disclosure:
This article is for informational purposes only, and does not intend to address the financial objectives, situation, or specific needs of any individual investor.  The general suggestions provided are not intended to serve as personalized financial and/or investment advice since the availability and effectiveness of any strategy is dependent upon your individual facts and circumstances.  Investors are highly encouraged to work with a financial services professional to discuss their financial situation and suitable solutions.

Psychology of Investing

Psychology of Investing

 

 

“The world makes much less sense than you think. The coherence comes mostly from the way your mind works.”
– Daniel Kahneman, Thinking, Fast and Slow

“It’s not supposed to be easy. Anyone who finds it easy is stupid.”
– Charlie Munger, Berkshire Hathaway

 

In its most basic form, investing involves allocating money with the expectation of some benefit, or return, in the future that compensates us for the risk taken by investing in the first place. Investing is a decision: buy or sell, stock A or stock B, equities or bonds, invest now or later. But as the great Charlie Munger reminds us above, investing is far from easy. Prior to making an investment decision, we create statistical models, build spreadsheets, use fundamental and technical analysis, gather economic data, and analyze company financial statements. We compile historical information to project future return and risk measures. But no matter how much information we gather or the complexity of our investment process, there isn’t one rule that works all the time. Investing involves so much more than models and spreadsheets. It is an art rather than a science that involves humans interacting with each other—for every buyer, there is a seller. At its core, investing is a study of how we behave.

Daniel Kahneman and Amos Tversky are famous for their work on human behavior, particularly around judgment and decision making. Judgment is about estimating and thinking in probabilities. Decision making is about how we make choices under uncertainty (which is most of the time). Kahneman won the Nobel Prize in Economics for their work in 2002, an honor that would have certainly been shared with Tversky had he not passed away in 1996. Their findings challenged the basic premise under modern economic theory that human beings are rational when making judgments and decisions. Instead, they established that human errors are common, predictable, and typically arise from cognitive and emotional biases based on how our brains are designed.

In his book, Thinking, Fast and Slow, Kahneman describes our brains as having two different, though interconnected, systems. System 1 is emotional and instinctive. It lies in the brain’s amygdala and uses heuristics or “rules of thumb” to simplify information and allow for quick gut decisions. In contrast, System 2 is associated with the brain’s prefrontal cortex. It is slow, deliberate, and calculating. As an example, if I write “2 + 2 =”, your mind without any effort will come up with the answer. That is System 1 at work. If I write “23 x 41=”, your mind most likely switches over to the slower moving System 2. While Systems 1 and 2 are essential to our survival as humans, Kahneman found that both systems, and how they interact with each other, can often lead to poor (and sometimes irrational) decisions. We can apply much of what Kahneman and Tversky discovered to investor behavior. Let’s focus on some of the most common biases and how they impact our decision making.

Loss Aversion

Kahneman and Tversky summarized loss aversion bias with the expression “losses loom larger than gains.” The key idea behind loss aversion is that humans react differently to gains and losses. Through various studies and experiments, Kahneman and Tversky concluded that the pain we experience from investing losses is twice as powerful as the pleasure we get from an equivalent gain. This can lead to several mistakes, such as selling winners too early for a small profit or selling during severe market downturns to avoid further losses. Loss aversion, if left unchecked, can lead to impulse decision making driven by the emotions of System 1.

Confirmation Bias

Confirmation bias leads people to validate incoming information that supports their preexisting beliefs and reject or ignore any contradictory information. In other words, it is seeing what you want to see and hearing what you want to hear. As investors, we are prone to spending more time looking for information that confirms our investment idea or philosophy. This can lead to holding on to poor investments when there is clear contradictory information available.

Hindsight Bias

Hindsight bias is very common with investor behavior. We convince ourselves that we made an accurate investment decision in the past which led to excellent future results. This can lead to overconfidence that our investment philosophy or process works all the time. On the flip side, hindsight can lead to regret if we missed an opportunity. Why didn’t I buy Amazon in 2001? Why didn’t I sell before this bear market? As I always say, I would put the results of my “Hindsight Portfolio” up against Warren Buffet’s any day!

Overconfidence

As mentioned above, investors can become overconfident if they have some success. This can lead to ignoring data or models because we think we know better. As Mike Tyson said, “Everyone has a plan until they get punched in the mouth.” Overconfidence can lead to a knockout, and investors must be flexible and open with their process.

Recency Bias

Recency bias is when investors emphasize or give too much weight to recent events when making decisions and give less weight to the past. This causes short-term thinking and allows us to lose focus on our long-term investment plan. It essentially explains why investors tend to be more confident during bull markets and fearful during bear markets.

 

I could write an entire book on investor psychology. The bottom line is that we cannot eliminate these biases. After all, we are all human. Even Kahneman, who made the study of human behavior his life work, admits he is constantly impacted by his own biases. However, there are certain actions or “nudges” that can help address such biases and avoid making costly mistakes. At Merriman, we have built the firm in such a way to use our knowledge about human behavior in the work we perform for our clients. Below are some of the main examples:

Evidence-Based

We build and design our investment strategies based on academic data going back hundreds of years. We are evidence-based rather than emotionally-driven investors. We think long term and do not let short term noise or recent events impact the process. We build globally diversified portfolios across different asset classes to produce the best risk-adjusted returns. That said, we are consistently researching and studying to find data that might contradict our investment philosophy and will make changes if the evidence supports it.

Financial Planning

A well-built financial plan is at the core of our client’s long-term success. It is a living document that requires frequent updates based on changes in our lives—retirement, education funding, taxes, change in job, business sale, and estate planning. This forces us to make investment decisions based on the relevant factors of that plan and not on emotions—because at the end of the day, investing is meant to help reach our goals.

Education

At Merriman, we do our best to help educate our clients on our investment philosophy. Blogs, quarterly letters, seminars, client events, and video content are all examples of tools we use to educate our firm and clients. Knowledge and awareness are powerful tools to help us make sound decisions.

 

We are all going through an extremely stressful situation right now—both personally and professionally. Now, more than ever, we need to lean on each other and show empathy and support through this unprecedented time. Remember, investing is a study of how humans behave. At Merriman, we want to be your resource to guide you through both calm and turbulent markets, helping you reach your financial goals. Please don’t hesitate to contact us if you’d like to discuss how we can help.

 

 

How to Optimize Your Accounts After The SECURE Act

How to Optimize Your Accounts After The SECURE Act

 

The Setting Every Community Up for Retirement Enhancement (SECURE) Act passed in late 2019, creating significant retirement and tax reforms with the goal of making retirement savings accessible to more Americans. We wrote a blog article detailing the major changes from this piece of legislation, which we recommend reading prior to this series.

We’re going to dive deeper into some of the questions we’ve been receiving from our clients to shed more light on topics raised by the new legislation. We have divided these questions into six major themes; charitable giving, estate planning, Roth conversions, taxes, stretching IRA distributions, and trusts as beneficiaries.  Here is our second of six installments. 

 

In light of the SECURE Act, should I convert my IRA to a Roth IRA, and if so, how much of it should I convert?

The answer is maybe. First, some old Roth conversion strategies may still hold true. If you are in an especially low tax bracket for a few years (e.g. you are retired and no longer bringing in employment income, but you haven’t started taking social security yet), then a Roth conversion may make sense for you. It would likely be a good idea to convert as much as possible during those lower income years without pushing yourself into the next bracket. The idea is to pay the least amount of tax possible on that tax-deferred money so more makes it into your pocket. In light of the SECURE Act, there are now additional considerations due to the elimination of the stretch IRA for most non-spouse beneficiaries. These beneficiaries will now have to withdraw inherited IRAs down completely within 10 years, which could have major tax ramifications for them. A Roth conversion might make sense if all the following criteria are met:

  1. You will not need your IRA for your own retirement needs.
  2. You can afford to pay the tax bill out of pocket or with non-retirement assets.
  3. You want to leave the money to someone other than your spouse, your minor child, someone not more than 10 years younger than you, or someone who is chronically ill.
  4. The beneficiary will likely be in a higher tax bracket than you are now.

Example: Gertrude dies in 2020 and leaves her IRA to designated beneficiary Suzie, her granddaughter. Suzie is not an eligible designated beneficiary because she is more than 10 years younger than Gertrude and not her minor child. The balance in the inherited IRA must be paid out within 10 years after Gertrude’s death, which means a large tax bill for Suzie as she is in her prime working years. Had Gertrude converted that IRA money to a Roth, the taxes would have been paid at Gertrude’s much lower bracket, and thus Suzie would have received more money when all is said and done. With the Roth IRA, Suzie must still abide by the 10-year withdrawal rule, but now she can let that money grow tax free in the Roth until year 10 and then withdraw it without paying taxes.

 

I’m still working. Should I be contributing to a Roth IRA / Roth 401(k) / taxable account instead of a pre-tax account now?

It depends, and there are a lot of factors to consider. To start, please see the question and answer directly above and consider whether an IRA or Roth account makes more sense for you today. The analysis will consider your current tax bracket, your estimated future tax bracket, whether or not you will need the money for your own retirement, and who your beneficiaries are.

If you are nearing retirement while in your prime working years, it likely makes sense to contribute to a pre-tax account versus a post-tax account. You are potentially in your highest tax bracket now, so getting the tax break with a pre-tax contribution is generally more valuable. After retirement, when you are in a lower tax bracket, you may decide to make Roth conversions at that time to take advantage of the lower rates.

Taxable accounts are another story completely. Due to their flexibility, having a taxable account is beneficial whether you are also contributing to an IRA or a Roth. If you plan on leaving money to non-spouse heirs, then a taxable account can be a great way to do so. There is no contribution limit on these accounts and there will be a step up in basis upon your death. This will eliminate capital gains as the account passes on to your heirs and they will not have to deal with the forced 10-year withdrawal rule.

Again, this is a loaded question with many moving parts and will be very specific to each individual. It would be best to speak your advisor about which type of account makes the most sense in your situation.

 

As with all new legislation, we will continue to track the changes as they unfold and notify you of any pertinent developments that may affect your financial plan. If you have further questions, please reach out to us.

 

First Installment: I’m Planning to Leave Assets to Charity – How Does the SECURE Act Change That?

Second Installment: How to Optimize Your Accounts After the SECURE Act

Third Installment: Must-Know Changes for Your Estate Plan After the SECURE Act

Fourth Installment: How to Circumvent the Demise of the Stretch: Strategies to Provide for Beneficiaries Beyond the 10-year Rule

Fifth Installment:

Sixth Installment:

 

 

Disclosure: The material provided is current as of the date presented, and is for informational purposes only, and does not intend to address the financial objectives, situation, or specific needs of any individual investor. Any information is for illustrative purposes only, and is not intended to serve as personalized tax and/or investment advice since the availability and effectiveness of any strategy is dependent upon your individual facts and circumstances.  Investors should consult with a financial professional to discuss the appropriateness of the strategies discussed.

How does the CARES Act impact me?

How does the CARES Act impact me?

 Written by: Matt Mathiesen & Phuc Dang, CPA, CFP®

With news about the Coronavirus Aid, Relief, and Economic Security (CARES) Act, people across the country have been wondering what might be contained in the almost 900 pages of legislation. While we can’t cover every provision of the new law, this post highlights some of the sections that will have the biggest impact for individual taxpayers.

Looking specifically at how the $560B dollar portion of the $2T dollar legislation will benefit individual taxpayers during this pandemic, here are the broad highlights for you to consider:

 

“Advance” rebate payment

An “advance” rebate payment of up to $1,200 per adult and $500 per child under 17 will be sent out to households. There are income limits that will start phasing out the rebate base on your adjusted gross income and filing status.

 

These payments are based upon either 2019 (if already filed) or 2018 tax return data. If you don’t receive a rebate payment now due to high income on your prior return, you may still be eligible for a refundable credit on your 2020 tax return if you qualify based on your 2020 income.

You can find out more information about the rebate payment on the IRS website.

 

RMDs are no longer required for 2020

For individuals in their RMD stage – RMDs for all retirement accounts and Inherited IRAs are no longer required for 2020. You may be able to return already distributed RMDs (except from Inherited IRAs) taken within the last 60 days. There are specific steps required to ensure it is done properly, so be sure to consult your advisor.

 

Additional options to use retirement assets to help cover expenses

There are some additional options available to tap retirement assets to help cover expenses. It’s important to note, that some are only for Individuals impacted by the Coronavirus. This is someone who:

  • Has been diagnosed with COVID-19,
  • Has a spouse or dependent who has been diagnosed with COVID-19,
  • Experienced adverse financial consequences from being quarantined, furloughed, being laid off, or having work hours reduced because of the disease,
  • Is unable to work because they lack childcare as a result of the disease,
  • Owns a business that has closed or operate under reduced hours because of the disease, or
  • Meets some other reason the IRS decides is considered impacted.

Impacted individuals can withdraw up to $100,000 in 2020 with modified rules

  • These distributions are not subject to 10% early distribution penalty or mandatory withholding.
  • The taxes on these distributions can be spread evenly over three years.
  • The distributions may be repaid to the retirement account within three years to reduce or eliminate the taxable income.

The retirement plan loan limit increased from $50k to $100k for all borrowers

  • 100% of the vested balance can be used for the loan up to the $100k maximum.
  • Payments on the loan can be delayed for up to 1 year.

Unemployment benefit changes

For individuals who are filing for unemployment, unemployment benefits now start in the first week of the claim. Unemployment Compensation is increased by $600 per week via federally funded dollars, for up to 4 months of claims. Unemployment Compensation is extended for 13 more weeks in addition to what one would normally be eligible for under state law.

 

Federal student loan changes

Required loan payments are suspended through September 30, 2020 and no interest will accrue during this period. The suspensions are not automatic; borrowers should contact their loan provider to pause payments.

 

The pandemic has caused financial hardship for many Americans, and the CARES Act is only the latest in what is sure to be an ongoing battle to help people and businesses get back on their feet. At Merriman, we are dedicated to staying on top of the ever-changing landscape to help your family make the best financial decisions. Please reach out to us if you would like to discuss how any of the above provisions may affect you.

 

Should I Do a Roth Conversion?

Should I Do a Roth Conversion?

 

 

With all the recent changes to the U.S. tax code, it’s a good time to revisit different tax planning strategies. One strategy I’m often asked about is whether a Roth conversion is a good idea. The universal answer to that question is “maybe.” Unfortunately, there isn’t a simple rule of thumb that applies to everyone. There are many factors that need to be examined, and my goal is to tell you the most common reasons you might want to do a Roth conversion.

Before I do that, it’s important to note a particular change in our tax code with the passage of the Tax Cuts and Jobs Act (TCJA) of 2017. In the past, a recharacterization was done if you needed to “undo” the Roth conversion. Starting in 2018 and beyond, this is no longer allowed for Roth conversions. An exception is if you make a Roth contribution, and then learn that you earned too much income during that year. A recharacterization will still be allowed in this case so that you’re not subject to the excess contribution penalty tax. (more…)