As RGT settles into the new normal during the COVID-19 pandemic, monitoring asset allocation and opportunistic rebalancing are underway. Long-term planning continues to be front and center on our radar screen. With the passage of the CARES Act last month and the recent market declines, we would like to share several planning ideas that you may wish to discuss further with your advisory team.
No Required Minimum Distributions (RMDs) for 2020
Last year, the SECURE Act increased the age at which RMDs are required to begin to age 72. The CARES Act has suspended all RMDs for IRAs, Inherited IRAs and tax-qualified defined contribution plans for 2020. This is a meaningful benefit for account holders who have seen their retirement balances decline, hopefully providing time for their investments to recover. If the RMD was made within the last 60 days, the distribution may be rolled back into an IRA account and will not be subject to income taxation. Please note, the 60-day rollover exception does not apply to Inherited IRAs.
Impacted Account Holders Eligible for Coronavirus-Related Retirement Plan Distributions
The CARES Act offers a penalty-free withdrawal (up to a $100,000 maximum) from an employer-sponsored retirement plan and/or an Individual Retirement Account (IRA) for those qualified individuals who have not yet reached age 59.5. The term qualified requires the account holder (or their spouse) to have been diagnosed with COVID-19 or have experienced certain other financial consequences due to being quarantined, furloughed or laid off (or other factors).
This distribution is not subject to the 10% early withdrawal penalty or to the 20% mandatory tax withholding. The taxation of the distribution may be ratably spread over the next three years. Additionally, this distribution can be paid back within three years without recognition of taxable income. If some, or all, of this distribution is going to be paid back but taxes have been paid on the distribution, an amended return may need to be filed to obtain a refund.
On a side note, the CARES Act also includes an increase in the loan amount from employer-sponsored retirement plans to 100% of the vested balance, up to a maximum of $100,000 for qualified account owners. As the Coronavirus-Related Retirement Plan Distribution and the increased loan amount are not automatic benefits, please check with your plan administrator to confirm that these options are available to you.
Converting Traditional IRAs to ROTH IRAs
Given current declines in the value of retirement accounts and the elimination of the stretch IRA benefit via the SECURE Act, converting a Traditional IRA to a ROTH IRA may be something to consider. While this conversion is subject to ordinary income tax rates in the year of conversion, doing so when asset values are depressed will help lower the income tax impact. Additionally, ROTH IRAs will not be subject to any further taxation nor are there any RMDs required for the ROTH IRA account owner. Investments in the ROTH IRA accumulate tax-free over the account owner’s lifetime. Once the ROTH IRA transfers to a non-spouse beneficiary (e.g., children), the account must be fully distributed within 10 years, also on a tax-free basis.
Increased AGI Threshold for Charitable Cash Contributions
The CARES Act has temporarily increased the 60% Adjusted Gross Income limit for deducting cash contributions to public charities to 100%, which may allow taxpayers to eliminate their 2020 tax liability. It is important to note that gifts of highly appreciated securities (or other property) or contributions to Donor Advised Funds do not qualify. An interesting planning opportunity arises when considering a ROTH IRA conversion along with increased charitable giving. It may be possible to offset the income tax liability generated from the ROTH conversion by making qualified charitable cash contributions. However, before breaking out your checkbook, make sure to consult your CPA so they can help determine the best solution for the timing of your charitable contributions.
Gifting and Other Wealth Transfer Strategies
Depressed asset valuations coupled with the current estate tax exemption amount ($11.58 million per person) presents an estate planning opportunity. Interest rates are at historic lows and business valuations may continue to decline due to the economic impact of COVID-19. The current estate tax exemption limits are set to decrease to $5 million per person in 2026 (adjusted for inflation) unless new legislation is passed prior. The timing may be ideal to coordinate with your estate planning team to review generational wealth transfer strategies and asset freezing techniques such as gifting or selling assets to Irrevocable Trusts.
We welcome an opportunity to review these planning strategies with you.
“There are decades where nothing happens; and there are weeks where decades happen.” Vladimir Ilyich Lenin.
The quote above has been revisited quite a bit these days because it seems to perfectly capture our current situation. Just a few short weeks ago we had 110 successive months of job growth in the U.S., a bull market in excess of 10 years, the world economy was globalized, companies managed inventories ‘just-in-time,’ we had traffic jams, meetings, and corporate debt. And then, just like that, the world changed. There were roughly 10 million jobless claims in two weeks, we entered a bear market in a record 16 trading days, the world economy is becoming more decoupled, companies (and people) are stockpiling, freeways are all but empty, meetings for many are exclusively online, and corporate debt is in the process of being replaced by government debt. And that’s just a fraction of what has happened in the last few weeks.
On February 19 the S&P 500 closed at 3386.15, up 5.1% for the year, the Russell 2000 was up 1.6%, and the MSCI-EAFE was down -0.8%. Then the trajectory of financial markets reversed. The S&P 500 ended the quarter down -19.6%, the Russell 2000 was down -30.6%, and the MSCI-EAFE was down -22.8%. But these quarter-end numbers bely the severity of the intra-quarter collapse. From its intraday peak on February 19 to its intraday low on March 23 the S&P 500 dropped -35.4%. After the passage of a $2 trillion plus economic rescue package by Congress and aggressive monetary easing by the Federal Reserve, the S&P 500 rebounded 15.2% prior to quarter’s end.
The market sell-off was indiscriminate with all sectors of the market suffering deep losses. But as the market settled a bit, there began to emerge more distinct differences in performance across market sectors. By the end of the quarter Technology (-11.9%), Health Care (-12.7%), and Consumer Staples (-12.7%) were the best performing sectors. Energy (-50.5%) which was clobbered by the one-two punch of both the abrupt cessation of economic activity and a price war between OPEC and Russia, Financials (-31.9%), and Industrials (-27.0%) were the worst performing sectors. And the long-standing outperformance of growth stocks relative to value stocks continued, with the Russell 1000 Growth dropping -14.1% while the Russell 1000 Value fell -26.7%.
Bonds fared better; but still experienced a volatile quarter. The Bloomberg Municipal Bond 7-Year Index was down -1.0%, while the Bloomberg U.S. Aggregate was up 3.2%, largely based on a strong rally in the price of U.S. Treasuries. The 10-Year Treasury yield stood at 1.56% on February 19. As Treasury prices soared due to a swift and sudden flight to quality, yields on 10-Year U.S. Treasuries plummeted to a low of 0.54% on March 9, rose back to 1.18% on March 18, before falling again to 0.70% by quarters end. Corporate bonds, however, fared worse than municipal bonds and U.S. Treasuries due to fears over their credit risk. The Bloomberg Barclays U.S. Corporate Investment Grade Index fell -3.6% for the quarter. High yield bonds declined even more, with the Bloomberg Barclays High Yield U.S. Corporate Index falling -12.7%.
We posted a piece on February 28 addressing the looming threat of the Coronavirus. We still do not know how long this crisis will last or how severe it will be when all is said and done. But the key takeaways from our earlier piece still hold true today, and we would like to reiterate those points as we look forward today. Asset allocation is valuable and is meant to lessen the impact of stock market losses, not eliminate them entirely, so that you don’t succumb to the urge to sell stocks into weakness. Cash reserves earn very little, but we don’t believe that taking on additional risks to achieve marginally higher yields on cash is worth that extra risk. Rebalancing and tax loss selling are opportunities, and you don’t have to get the timing exactly right to take advantage. Remember, you own stocks for a multi-year time horizon, not for what happens in a week, a month, or a year. Market corrections and bear markets can be an opportunity to put cash to work at lower valuations or to rebalance a portfolio into higher quality opportunities at lower prices than were available until recently.