We expect most people have a grasp on how to make money in a bull market, but it can be far more challenging to contemplate how to make money during a bear market, when emotions are running high. It’s not all about making money, though. Some of it involves figuring out how to put oneself into a better financial position for the future so that you can heal faster from the losses. There are a handful of key strategies to engage in during a bear market that will help your finances as much as your future, and one of the most important of these is ROTH conversions.
Believe it or not, bear markets represent the best environment into which to make an IRA-to-ROTH conversion. The more negative the equity losses are, the more attractive the conversion becomes. When making a conversion to ROTH, you can either move cash or you can move shares of the stocks or mutual funds that you own in the IRA. When we make a conversion, we choose to move shares for our client families. The tactical benefit here is that we actually get to pick the specific funds to move from the IRA to the ROTH. Whichever funds have the deepest losses for the given year are the ones with the highest priority to move over first.
Think of it this way: if we found ourselves in a sharp bear market, we would expect several equity asset classes to be down, but maybe inside our IRA the US small cap fund went down the most with a -35% loss. Although it may not feel like it, bear market losses are temporary, so it is important to take action and make the conversion to the ROTH while the markets and the news are negative and remain temporarily distressed. If we were to hypothetically move $50,000 of the US small cap fund in our example, we would actually be moving shares that were previously 35% higher in value at $77,000. If we convert the $50,000 of small cap shares right now, we incur the tax liability on those shares on the day they are moved over. Once the shares have arrived in the ROTH, it then becomes a matter of exercising patience. It might take six or nine months for the current bear market to pass; but when the economy improves, those distressed shares should bounce back in value. In a relatively short number of months, the $50,000 that was converted and that you paid tax on might be worth $65,000 or $70,000—but remember, you only paid tax on $50,000. Much like a spring being compressed and then subsequently released, the idea behind the conversion is to move the shares to the ROTH while the spring is compressed. Simply put, the bear market represents a tax-savings opportunity in disguise, so acting now is highly important BEFORE things improve in society. Effectively, ROTH conversions and bear markets coupled together give us a way to legally cheat the IRS out of tax dollars.
The benefits of ROTH conversions are not just effective during a severe bear market but can be utilized nearly every year. If you employ a highly diversified portfolio with multiple asset classes held in your IRA and ROTH, there are lots of opportunities to take advantage of the up and down stock market movements, as many asset classes move at different rhythms. There are a host of financial planning advantages to ROTH accounts and gradually converting IRA money into ROTH each year. Keep in mind, ROTH accounts contain post-tax money; they do not have required minimum distributions, which do apply to traditional IRAs; and all of the future growth on the assets in the ROTH are considered post-tax. All withdrawals from ROTHs are voluntary, and all of the dividends, interest, and earnings in the ROTH are shielded from taxes. Another advantage of a ROTH account is that it can be viewed with your IRA using an overall investment approach that we call Asset Location. Essentially, Asset Location seeks to view the IRA and ROTH accounts as if they were one account holding one investment portfolio but divvies the funds between the accounts to the greatest advantage. Reach out to your advisor if you are curious about conversions and ROTH accounts and learn more about how we advocate for our families.
The IRS announced on Tuesday, June 23, 2020, via Notice 2020-51 (PDF), additional relief relating to Required Minimum Distributions (RMD), allowing you to return RMD funds withdrawn after January 1, 2020.
As it sits now, the CARES Act RMD waiver for 2020 is still in place, meaning that you are not required to take an RMD for 2020. This applies to defined-contribution plans such as 401(k) or 403(b) plans and IRA accounts. Those who have previously taken RMDs are likely familiar with the process; but for those who turned 70 ½ in 2019, this all may be brand new, and it’s important to understand the timeframes. This can easily be confused with the SECURE Act which passed toward the end of 2019, changing the RMD age to 72 going forward. Tuesday’s announcement extends relief to anyone who has previously taken an RMD in 2020 by extending the opportunity to return the funds up through August 31st, 2020. In addition, if you return funds under this new announcement, the notice states that the repayment is not subject to the one rollover per 12-month period or the rollover restrictions with inherited IRAs. This is particularly important because the SECURE Act changed the timeframe in which beneficiaries are required to withdraw inherited IRA funds. To find information about the SECURE Act changes, Paige Lee, CFA, wrote a great article which can be found here. There is a lot going on here, and the overall message is that you have more flexibility than ever on how you treat a 2020 RMD.
What was the original relief for RMDs?
The CARES Act (Coronavirus Aid, Relief, and Economic Security Act) was signed into law on March 27th, 2020, providing relief amidst the COVID-19 pandemic for many American taxpayers and businesses. We posted a blog that summarizes these changes which can be found here. In respect to RMDs, the CARES Act originally allowed individuals to forego taking a 2020 RMD and allowed you to return any RMD taken within the previous 60 days. Despite being a fantastic planning opportunity, anyone who took an RMD earlier that the previous 60 days was left out in the cold. Later in April, the IRS issued a follow-up notice that extended the time period to include those who took an RMD between February 1 and May 15 where the funds could be returned by July 15th. This is no longer the case with the most recent announcement, and now anyone who has taken an RMD from January 1st, 2020, can make the decision to return the funds.
How can you take advantage of this?
This offers a tremendous planning opportunity by providing households with the ability to shift income and take advantage of market conditions. Returning an RMD can lead to a host of strategic financial moves including the following:
Continued growth of tax-deferred assets
Opening room to make Roth IRA conversions
A chance to look at taxable accounts to see if it makes sense to withdraw funds at capital gain rates as opposed to marginal tax rates
Rebalancing—as the funds are returned, holdings can be adjusted to shore up your overall allocation
We help our clients make the best choices with the information available, and now that this new extension has been issued, we view this as an opportunity to review your circumstances, discuss the various options, and decide on whether or not to take action.
Connect with Merriman to discuss.
Here at Merriman, we are very excited about this announcement and strongly encourage you to contact us if you have already taken an RMD from your IRA or Inherited IRA this year. We’ll help you understand and explore your options and determine if taking advantage of this extended RMD relief makes sense for you.
On April 20, Boeing announced a Voluntary Layoff (VLO) program in response to recent economic events. For employees who qualify, this benefit may be an opportunity to meet the goal of retirement sooner than expected. Are you wondering if you should take advantage of this program?
At Merriman, we’ve been helping Boeing employees navigate decisions like this for over 30 years. Here are the main points you should consider:
For eligible employees, Boeing is offering a lump-sum payment of one week’s pay for every year of service completed, up to a maximum of 26 years in most cases.
Employees who accept the VLO offer may also receive a few months of subsidized health insurance benefits and access to other benefits.
While employees who accept the VLO may apply in the future for open employee or contractor positions, accepting the VLO forfeits any first consideration rehire or recall rights. This program is used as a permanent separation from Boeing, causing the employee to lose those rehire benefits.
Boeing has announced the following important dates for this VLO offer:
April 27, 2020 VLO Registration Opens
May 4, 2020 VLO Registration Closes
May 14, 2020 Formal Notification Sent to Employees
June 5, 2020 Last Day on Payroll
Am I in a position to retire?
Many people may be considering the VLO offer but are unclear what retiring now would mean for their future lifestyle. This is a major decision to make in a short amount of time, and there are many factors to consider. What retirement lifestyle are you dreaming of? Are the assets you have saved enough? Will you have other income sources like Social Security or pension benefits? To help weigh your options, we’re offering a complimentary financial analysis for Boeing employees considering the VLO program.
You may have heard about the significant tax and retirement reforms recently signed into law under the catchy name Setting Every Community Up for Retirement Enhancement (SECURE) Act. These sweeping changes were drafted to promote increased retirement savings by expanding access to retirement savings vehicles, broadening options available inside retirement plans, and incentivizing employers to open retirement savings plans for their employees.
Some of these changes have a much wider impact than others, but here is a summary of the key takeaways and provisions of the SECURE Act most likely to affect you.
The age to begin required minimum distributions (RMDs) increased from 70 1/2 to 72. The later RMD age of 72 will only apply to those turning 70 1/2 in 2020 or later. Anyone who turned 70 1/2 in 2019 will still be subject to the original RMD rules. While not a huge delay, individuals could benefit from an extra year and a half of compounding returns if they choose not to withdraw funds from their Traditional IRA. It can also provide additional time to make strategic Roth conversions while in a lower tax bracket. It is important to point out that the Qualified Charitable Distribution age has not changed, so QCDs can still be made starting at age 70 1/2.
The maximum age to contribute to a Traditional IRA has been removed. You may now contribute to a Traditional IRA even if you are over 70 1/2. This is a great benefit to those continuing to work into their 70s, as contributions to a Traditional IRA are tax-deductible. After your RMDs have started, continued contributions allow for an offset of the taxable income realized from these required IRA distributions.
The Stretch IRA rule, allowing non-spouse beneficiaries to “stretch” distributions from an Inherited IRA over the course of their lifetime, has been eliminated. This provision, enacted as the funding offset for the bill, requires that non-spouse beneficiaries distribute all assets from an Inherited IRA within 10 years of the account owner’s passing. Spouses, chronically ill or disabled beneficiaries, and non-spouse beneficiaries not more than 10 years younger than the IRA owner will still qualify to make stretch distributions. Minor children will also qualify for stretch distributions, but only until they reach the age of majority for their state (at which time they would be subject to the 10-year payout rule). These new rules only apply to inherited IRAs whose account owner passed away in 2020 or later.
This change will have the most significant impact on adult children inheriting IRAs, who now will have to recognize income over a 10-year period instead of over their lifetime. For those still in their prime working years, this may mean taking distributions at more unfavorable tax rates. Trusts named as IRA beneficiaries also face their own set of challenges under the new law. Many are now questioning whether they should start converting Traditional IRA assets to a Roth IRA, or significantly increase conversions already in play. Unfortunately, there’s not a one-size-fits-all answer to this question. It’s highly dependent on a number of factors, including current tax brackets, potential tax brackets of future beneficiaries, and intentions for the inherited assets. We’ll explore this and additional estate planning concerns and strategies in more depth in future articles.
Here are a few other changes that are worth mentioning:
Penalty-free withdrawals of up to $5,000 can be made from 401(k)s or retirement accounts for the birth or adoption of a child.
529 accounts can now be used to pay back qualified student loans with a lifetime limit of $10,000 per person.
Tax credits given to small businesses for establishing a retirement plan have been increased.
A new tax credit will be given to small businesses adopting auto-enrollment provisions into their retirement plans.
Liability protection is provided for employers offering annuities within an employer-sponsored retirement plan.
If you have questions or concerns about how the SECURE Act impacts you, please reach out to your financial advisor or contact us for assistance.
As we reach the end of 2019, it’s time to start thinking about your finances for 2020. Many employers will begin open enrollment over the next few weeks, and this is a great time to review your retirement plan contributions.
The IRS announced earlier this month that employees will be able to contribute up to $19,500 to their 401(k) plans in 2020. They also raised the catchup limits (for those over age 50) from $6,000 to $6,500. Lastly, the 2020 contribution limitation for SIMPLE retirement accounts increased to $13,500, up from $13,000. Note that the annual contribution limit to an IRA remains unchanged at $6,000.
Summary of Changes for 2020
The new 2020 retirement contribution limits are as follows:
Taxpayers can deduct contributions to a traditional IRA if they meet certain conditions. If, during the year, either the taxpayer or spouse was covered by a retirement plan at work, the deduction may be reduced (phased out) or eliminated, depending on filing status and income. If neither the taxpayer nor his or her spouse is covered by a retirement plan at work, the phase-outs of the deduction do not apply. Here are the phase-out ranges for taxpayers making contributions to a traditional IRA in 2020:
For single taxpayers covered by a workplace retirement plan, the phase-out range is $65,000 to $75,000.
For married couples filing jointly, where the spouse making the IRA contribution is covered by a workplace retirement plan, the phase-out range is $104,000 to $124,000.
For an IRA contributor who is not covered by a workplace retirement plan and is married to someone who is covered, the deduction is phased out if the couple’s income is between $196,000 and $206,000.
For a married individual filing a separate return who is covered by a workplace retirement plan, the phase-out range is not subject to an annual cost-of-living adjustment and remains $0 to $10,000.
The income phase-out range for taxpayers making contributions to a Roth IRA in 2020 are:
For single taxpayers and heads of household, $124,000 to $139,000.
For married couples filing jointly, the income phase-out range is $196,000 to $206,000.
For a married individual filing a separate return who makes contributions to a Roth IRA is not subject to an annual cost-of-living adjustment and remains $0 to $10,000.
The 2020 income limits for the Saver’s Credit (also known as the Retirement Savings Contributions Credit) are:
$65,000 for married couples filing jointly, up from $64,000
$48,750 for heads of household, up from $48,000
$32,500 for singles and married individuals filing separately.
It is important to note that the IRS has raised the 401(k) and 403(b) contribution limits in 4 of the last 5 years. These have been fantastic opportunities to contribute more into these retirement investment vehicles. So please make sure to adjust your recurring contribution amounts to better take advantage of this increase in limit. If you have any questions, feel free to reach out to us!
Have you received a pay raise, bonus or an inheritance and as a result changed your spending habits? Have you bought things such as expensive items, cars or even a new home because of one of these events? Soon, your lifestyle starts to inflate or creep to where your standard of living resets at this new higher income level. Spending can quickly become unsustainable if your income doesn’t stay at the same pace and continue to rise. Importantly, you’ll need to save substantially more now to continue that lifestyle in retirement than originally planned. From experience, most families continue at near the same spending level if not more in retirement, especially when grandchildren enter the picture!
There isn’t any harm with spending more money if you make more, however you need to also increase your savings for important goals at the same level. For example, if your income is now $250,000 or above, you’ll need to save quite a bit more than the $19,000 401(k) contribution to maintain your lifestyle when you decide to retire. These savings targets increase much more if you want to “make work optional” at an earlier age.
It’s inevitable that your income will rise as you progress through your career, however there are good habits to follow to prepare for the future while still enjoying the “now”:
Prepare and follow a budget
No matter your income level, having a household budget is key to achieving your goals. It allows you to put all your income and expenses on one sheet of paper to determine how much savings you can automate each month. Many households are cash flow “rich” thereby they are best served by figuring out monthly savings targets. This article discusses a budget technique that can be used as a template for your budgeting. It’s especially important to have a cash flow plan for families where cash bonuses and restricted stock make up a large portion of their annual income.
Develop and adhere to a pre-determined plan for extra income
If you receive a bonus, you should have a pre-determined savings allocation for those extra resources. This meaning that of the bonus that you receive after-tax, possibly 25% is allocated to spending (i.e. the fun stuff), 25% to travel and short-term savings, and 50% to long-term savings. That way, you get to spend and enjoy a large portion of your bonus while also saving a large sum towards the future. Too often do people receive a bonus and quickly spend it. Having a pre-determined plan or formula for how to allocate these excess dollars is important as your budget won’t account for this income.
Routinely update your retirement projections
Your financial plan needs to be updated each time your spending level increases as the plan is not going to be successful if it is based on $100,000 of annual spending in retirement when your lifestyle now requires $200,000 a year. Many households attempt to exclude child costs from this figure as they won’t have dependents in retirement, however experience has taught that the spending has been replaced by spending on trips and supporting children and grandchildren.
We suggest reading the book Making Work Optional: Steps to Financial Freedom to learn about how best to prioritize your savings to achieve your long-term goals. Importantly, make sure to read the section about “mistakes to avoid” on your path to financial freedom.
Please contact Merriman if you have any questions about developing a cash flow plan or for any of your other financial planning needs.