Spending Retirement Money When You're Not Retired

We’re almost five months into the aftermath of the coronavirus stay-at-home orders and our economic recovery is uneven at best. Some companies have been doing extremely well and their stock prices are up a ton due to having some sort of pandemic narrative (more people streaming Netflix, buying from Amazon, and so forth). This can absolutely continue so long as hopes of further economic stimulus remain.

Some individuals are doing fine, all things considered, in their work and financial lives. Others are retired and work issues are less relevant. But for others the work problems and financial woes are just beginning.

We’re all familiar with the many small retail-oriented businesses that have permanently closed following the confusion of temporary shutdowns. Recent data from Yelp lists California as having the third highest amount of permanent and temporary business closures per capita in the US (behind Hawaii and Nevada, I think). Many of these closures have been within the Bay Area, even our own county. Each of us probably knows at least one person whose financial life has been thrown into shutdown-induced chaos.

But lately I’ve been hearing from folks who had been feeling insulated from much of this. They’re not in retail or the restaurant business but nonetheless are finding themselves facing reduced hours or even an outright layoff. They’ve been mid- or late-career professionals who have saved money but not enough to pull the trigger on early retirement. They have young kids or are getting their kids through college. They’ll soon need cash but the only buckets they can draw from are their retirement accounts. They’re worried about taxes and penalties, not to mention needing to spend “future dollars” for current needs.

So, the following are some thoughts and rule changes related to drawing money from retirement accounts when you’re younger than 59.5 (an important cutoff for the IRS).

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Rewriting the Rules

Rules of thumb are helpful at distilling complex information into understandable tidbits of advice. They’re not intended to be an accurate application of all relevant information, just general guidance. The problem is that if left unchallenged long enough, rules of thumb can begin to seem like infallible truths. Helpful and important details can get glossed over or left out entirely. This happens a lot in the complex world of financial planning and investing.

Case in point is the rule of thumb that retirement savers should put as much as possible into tax-deferred accounts, like 401(k) plans and IRAs. These “traditional” accounts help folks save for retirement with the bonus of tax deductions along the way. Everybody likes a tax deduction, right? Then the account isn’t taxed until later and your savings can compound over time to create a sizeable nest egg if you play your cards right.

That’s the good part. The bad part, and what the rule of thumb glosses over, is how every dollar you withdraw in the future gets taxed as ordinary income. It glosses over mandatory distributions beginning at age 72. And it glosses over the taxes that your beneficiaries will have to pay when they ultimately withdraw. All of this is traded for the powerful incentive of a tax deduction on contributions. It works well, don’t get me wrong. But it’s imperfect.

The alternative is investing in a Roth IRA. I’m sure you’ve heard of these. They function like traditional accounts with the difference being when you pay taxes. With a Roth you don’t take a tax deduction as you save so you don’t need to pay taxes on the money in the future, maybe ever. Roth accounts were created in the late-90’s and took a while to get traction, so retirement savers haven’t had as much time to accumulate money in these accounts. This is probably a big part of why the old rule of thumb didn’t include them.

But this is changing as retirement researchers (and your humble financial planner) question some of the industry’s core assumptions. For example, researchers at JPMorgan demonstrate how the younger someone is and the lower their tax bracket, the more value they get from Roth accounts. Savers should only think about contributing to a traditional account as they age and make more money (and pay more taxes). The following chart illustrates this.

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An Updated Pass for 2020 RMDs

Managing taxes is completely boring to most people. This is understandable because the tax code is immensely complicated, there are frequent changes, and the language used is, well, anything but exciting. That said, the adage of “it’s not what you make, it’s what you keep”, is important to remember when saving for and living in retirement. To me this means not paying a penny more in tax than you have to.

As we end another wild quarter today, let’s look at an important change that could be an opportunity for some: RMD forgiveness in 2020.

Congress passed the CARES Act relief package during March in response to the coronavirus. Among its many provisions was one allowing folks to skip taking a Required Minimum Distribution (RMD) from their IRA during 2020. I think the idea was not to force folks age 72 and older to withdraw from accounts that were likely losing money. This was also geared toward older savers who are forced to withdraw from their IRA each year even though they may not necessarily need the money to spend. Maybe they have other savings and would prefer to leave their IRAs alone as much as possible.

Under the CARES Act Congress said that if you had already taken an RMD you could pay it back within 60 days. And if you hadn’t yet taken one you could skip it. RMDs are taxed as ordinary income in the year taken, so not being forced to take one means less tax to pay, maybe keeping you in a lower tax bracket, and potentially other positive ramifications.

This was great news except that Congress, in its infinite wisdom, started this as of February 1st, meaning RMDs taken during January wouldn’t qualify and would still be taxable. Congress also left out non-spousal beneficiaries who are required to take RMDs. This seemed unfair at the time, but the thinking was maybe Congress would come back and fix this problem later, as often happens after some time has passed and errors are noticed.

Well, last week the IRS beat them to it. The tax authority released guidance allowing all 2020 RMDs to be paid back by August 31st, regardless of who took them and when. It’s unclear what authority the IRS has to make this change, which seems to rewrite the law and is Congress’s job, but I don’t know if anyone will complain.

So, last week’s IRS update was meant to level the playing field for folks who can, one way or another, do without their RMD this year. If that’s not you, you don’t need to consider this at all.

But if it is you, it’s a good idea to reevaluate your RMD for 2020. Have you already taken one but can afford to pay it back? If you haven’t taken an RMD yet, do you financially need to do so? Avoiding it this year could save thousands in taxes while leaving your retirement savings to hopefully grow a little longer. This is tax management made simple, at least for this year.

Have questions? Ask me. I can help.

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Summertime Greetings

Greetings from your team here at Ridgeview Financial Planning. As I’m sure is the case for you, we’re adjusting to the recent re-shutdown of certain business categories including non-essential offices. Our building remains closed to the public, but we can still access it as needed. Fortunately much of what we do is already in the virtual world, so it’s been a relatively simple pivot for us these past several months. Now we just need to keep doing it a little longer.

As has been my routine in recent years, I’m taking the next few weeks off from writing my blog. I’m still working every day on your behalf, of course. I’m just harvesting extra time to spend with my family during what remains of summer.

I wish you all the best during these turbulent and anxious times. Little in our lives has been untouched by this crisis but I am optimistic about our future. (Repeat that last part like a mantra.) I hope you create opportunities to enjoy the beautiful summer weather.

The following few-minute read is from Liz Ann Sonders, Chief Investment Strategist at Schwab. It’s especially challenging these days to find voices of reason, and Liz Ann is one of them. In this article she reiterates how our economic recovery is likely to be lumpy and bumpy and protracted, what she refers to as “rolling W’s” instead of looking like a “V”. She explains that while some economic metrics showed a dramatic positive shift in June, which is great, they’re off historic lows and shouldn’t be expected to continue in the same way.

https://www.schwab.com/resource-center/insights/content/all-right-now-but-long-way-to-go-to-recover?cmp=em-QYD

Have questions? Ask me. I can help.

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Quarterly Update

In what has already been in many ways a historic year, it’s fitting that the second quarter (Q2) of 2020 would be a standout for stocks. The first quarter was one of the worst on record while the second ended as one of the best turnarounds in market history. This was a snapback from deeply oversold levels in March and, in hindsight, makes good sense. News related to the pandemic (which needs no explanation) was trending positive, economies here and abroad were reopening, and investors were pricing in a so-called “V-shaped” recovery.

Massive waves of selling shifted abruptly in late-March in the wake of historic Federal Reserve programs and fiscal stimulus from Congress. The rally was impressive, to say the least, but uneven and still not enough to bring the broad market positive for the year. Here’s a roundup of how major markets performed during Q2 and year-to-date, respectively:

  • US Large Cap Stocks – up 20%, down 3%
  • US Small Cap Stocks – up 26%, down 13%
  • US Core Bonds – up 4%, up 6%
  • Developed Foreign Markets – up 15%, down 11%
  • Emerging Markets – up 18%, down 10%

Growth stocks continued to outperform during Q2, and a handful of large companies buoyed markets for much of the quarter. At the industry level, tech hardware stocks did best, up about 37%, as employers and consumers rushed to “go virtual”. Autos also saw a boost, up 36%, with consumers taking advantage of major discounting as dealerships reopened. Both industries are up around 20% this year. Retail stocks also did well, up about 31%, after getting trounced in the first quarter.

Bonds performed well during Q2 as investors sought shelter from stock market volatility. A persistent issue during much of our recent bull market has been the general malaise of retail investors regarding stocks. Investors have for years been reporting “bearishness” while moving money into bonds even as stocks continued higher. This trend continued during Q2 and helped bonds rise about 4% during the quarter and around 6% so far this year. Federal Reserve programs, alluded to above, helped support bonds as well.

The positive performance of some stocks contrasts with broad underperformance of the energy sector during Q2. In a dramatic but thankfully short-lived event, the price of oil went negative in April for the first time in modern history. The fear at the time was that a growing supply of oil coupled with a dramatic drop in demand due to shelter-in-place orders here and around the world would leave us with nowhere to store the commodity. This, among the general craziness of the moment, led oil traders to pay others (through negative prices) to buy their oil. Fortunately, global demand picked up, cooler heads prevailed, and oil prices got back to something like normal within a few weeks. The energy sector had been so volatile due to virus fears and pricing issues that, although the sector was up 32% during Q2, it’s still down 35% for the year.

Small company stocks also had a good run during Q2 but not enough to bring the category back to even. The issue with “small caps” is that these companies historically perform well over long periods of time but are more volatile in the short-term. They are also overwhelmingly domestic, lacking the global diversification of large multinationals. So, during a time of great fear for the health of our economy, small caps quickly took it in the teeth. After getting hammered in the first quarter the category charged back by 26% in Q2 but is still down 13% year-to-date.

Economic numbers showed signs of continued improvement during Q2 with unemployment levels declining to 11% at quarter’s end. This was down from 15% but sill about 8% higher than where we began the year. We created around 5 million jobs during June, but still just a dent in the well over 40 million jobs lost. Other measures of economic activity turned positive as well. Business sentiment is improving. The Institute for Supply Management reported its index reached over 52 in June after dropping to 43 in May (scores of 50+ indicate an expanding economy). Consumers are also spending again after a few months’ hiatus. But, like the stock market’s performance, this activity is uneven and highly susceptible to changes in the virus outlook.

While Q2 ended on a high note for stocks and there is reason for optimism, our troubles are far from over. As we entered July single-day infection rates hit records around the country and the nascent reopening is being put on hold in many areas. Unfortunately, the dark cloud of uncertainty still looms as we enter the third quarter. There is likely to be more market volatility, so best be prepared for it.

Have questions? Ask me. I can help.

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The Uncertainty Principle

Uncertain - An adjective describing something unable to be relied upon; not known or definite (thanks to Google for the definition and the physicist Werner Heisenberg for the title).

Lately I’m reminded a bit of the grind coming out of the Great Recession. By late-2009 and into 2010 stocks had been rising for some months even as many Americans were suffering terribly. Unemployment had hit 10%. Foreclosure rates were climbing steadily and would ultimately peak in 2010. Trillions of dollars had been lost from the nation’s housing market. It seemed like the situation was going from worse to horrible.

I used the word “uncertainty” a ton back then when talking with clients. I recall on more than a few occasions speaking to groups and getting pushback on how a vague term could possibly play such a large role in the stock and bond markets, and even our daily lives. Some couldn’t believe that human psychology impacts everything from the shopping habits of everyday consumers to investment decisions being made in Fortune 500 boardrooms.

But it’s true. When we feel certain we’re optimistic and can plan. We invest for the future and feel confident in our actions. Uncertainty, however, and rising amounts of it, undermines all aspects of our daily lives and economy. It makes us anxious and fretful. So, the word gets used a lot these days because maybe it best describes our current predicament. There are so many unknowns and much of what we’d ordinarily rely upon, no matter how mundane, seems to be in flux.  

Even though I feel like I’m squinting to see the light at the end of the tunnel, hope springs eternal. During the darkest days of ’09 and ‘10 that I mentioned above, tiny so-called “green shoots” were popping up everywhere within the economy. There was still lots of pain, of course, but ironically the recession had already technically ended (in June 2009, as a matter of fact – it’s always defined afterward) and the economy would soon come roaring back.

Here are two quick pieces from JPMorgan regarding recent market volatility and the health of the banking system. Both address questions being bandied about in the media and some of you, so I wanted to share these perspectives.

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