Perhaps a Silver Lining – Time to Refinance?

The coronavirus has been brutal. There are now over 1 million cases and 54,000 deaths worldwide.  Left to itself, the covid-19 pandemic doubles every few days. Millions have lost their jobs. Most of America is on lockdown. We’re certainly in a recession right now. Worse yet- there continues to be a huge uncertainty as to when the coronavirus will stop its path of destruction and when we can all start to return to some form of normalcy.

We sincerely hope you and your family are safe and healthy. And, we hope all the other Americans and fellow citizens of Planet Earth that have been impacted will get through this crisis quickly and successfully.

At the same time, the equity markets have crashed since February 19th, ending an 11 year bull run. We were probably due for a pullback or correction after the huge run-up in 2019. The coronavirus seemed to provide the tipping point.  Economic growth in 2020 will certainly be less than 2019, though we don’t know how much less.

With all of this gloom, here is one possible “Silver Lining.”

With many investors running for safety into bonds and the Fed dropping rates, the fixed income markets are showing huge drops in interest rates.  10 year treasuries are near .6%.  30 year U.S. treasuries are at 1.25% interest.  These rates foretell less economic growth and lower inflation in the future.

The Mortgage Bankers Association is forecasting lots of business this year for new purchases and refinancings.  They expect $2.6 trillion in new mortgages this year, a 20% gain over 2019. Refinancings are the key drivers of the change and are expected to be up 37% in 2020.  Bloomberg reported yesterday that the average rate for a 30-year mortgage loan was 3.33%, down from 3.5% last week.

Because there are typically costs to refinancing, doing so makes the most sense for people who plan to stay in their house for some time and where the cost to refinance is less than the interest expense that can be saved.  In addition, if inflation will be lower in the future, then nominal investment returns should be lower as well.  For example, if your nominal investment return is 6% and inflation is 3%, then your “real” return is 3% (the amount above inflation).  If inflation is 1.5%, then a 4.5% nominal return produces the same 3% real return.

If you have a mortgage with an interest rate of 4% or more, you likely should be looking at refinancing it or paying it off.  Because of the increase in the standard deduction and the limitations on state and local income taxes, 90% of households no longer itemize deductions. If you are in that 90%, you get no tax benefit from your mortgage interest.

So, if it is time to look into refinancing, check around and keep your eyes open for low mortgage rates.  At this point, there is no reason to believe that rates will be going up anytime soon.  And, if you would like a second set eyes to help you determine if it is time to refinance, give us at DWM a call.  We are always happy to talk.  Stay well.

Stay safe and stay healthy during this pandemic. And, if appropriate, take advantage of one of the few silver linings of the pandemic by refinancing at a new low rate.

https://dwmgmt.com/

CARES Act Brings “Pennies From Heaven”

We hope each and every one of you and your families are safe and healthy. In response to the unfolding COVID-19 global pandemic, Congress passed the Coronavirus Aid, Relief, and Economic Security (“CARES”) Act last Friday. This $2 trillion emergency fiscal stimulus package (“Pennies from Heaven”) was designed to help ease the economic damage caused by the virus. Below are some of the key provisions that can offer relief to individuals, families and businesses. In a number of situations, it’s important for you to act quickly. Items with time urgency are underlined. The objective is to provide short overviews of the provisions. If there are any questions, we at DWM will try to help.

Recovery Rebates. Perhaps 90% of Americans should receive some amount of Recovery Rebate. The rebate can be as much as $1,200 for a single, $2,400 for a married couple plus $500 for each child under age 17. The only limitation is your Adjusted Gross Income (“AGI”). Singles with AGI of $75,000 or less will receive $1,200 plus extra for eligible children. Married couples with AGI of $150,000 or less will receive $2,400 plus extra for eligible children. Incomes above that will get a lesser amount until completely phased out. The IRS will use the latest tax return filed to make their calculation. If your 2018 tax return has a lower AGI, wait to file your 2019 tax return until the rebates are made. If 2019 is a lesser year than 2018, get 2019 filed immediately. Please understand that the rebate will be “trued up” based on your 2020 return. So, if your income in 2018 and/or 2019 disqualified you from the rebate, you can still get the rebate in 2021 if your 2020 tax return shows you are below the $75,000 or $150,000 threshold. And, for those who received a rebate but ultimately had a larger income in 2020 that would have disqualified them-no worries. The IRS will not “clawback” any rebates. Checks and direct deposits are promised “as soon as possible” which hopefully will be in April.

Covid-19 Distributions from IRAs and Loans from 401ks. Distributions up to $100,000 from IRAs and $100,000 loans from 401ks can be made without tax penalty for those impacted by the virus. The income tax of the distribution can be split evenly over 2020-2022. Distributions are not subject to withholding and can be repaid (rolled back in) in 3 years, in a lump sum or installments which will produce a refund of the tax paid.   Loans from Company Retirement Plans can be made up to 100% of the vested balance up to $100,000. Repayments on the loan may be delayed for up to one year.

Required Minimum Distributions (“RMDs”) are waived and can be returned. RMDs for 2020 are specifically eliminated for owners and beneficiaries. Owners, not beneficiaries, that have already taken a 2020 RMD and would like to return it, need to act quickly. If the distribution took place in the last 60 days, you can roll the money back in (note, if withholdings were made, you’ll need to “gross up” the net distribution) and save paying the tax. If the 60 day window has passed, you can still complete a valid rollover for up to 3 years if you can show you were impacted by the coronavirus crisis.

Charitable Contributions. To encourage contributions to charity, Congress has provided that individuals can make and deduct contributions up to and in excess of 100% of their AGI. Hence, they could wipe out their taxes and even get a carryforward for 5 years. In addition, individuals who use the standard deduction (90% of taxpayers) can get up to a $300 charitable contribution deduction “above the line” in the addition to their standard deduction.

Relief for Student Loan Borrowers. Required payments on Federal student loans are deferred until September 30, 2020, during which time no interest will accrue. Furthermore, this period of time will continue to count towards any loan forgiveness. Hence, any student borrower who intends to qualify for a program that will ultimately forgive the entirety of their Federal student debt should immediately pause payments. Any payments made in this period will simply reduce principal and therefore are reducing a debt that will be forgiven. In addition, through the end of the year, employers who provide employees with up to $5,250 of student debt payments may exclude those payments from the employee’s W-2.

Additional Unemployment Compensation Benefits. Unemployment benefits have been increased from 26 to 39 weeks. Futher, Self-employed individuals will now be eligible. Plus there will not be the typical one week of “waiting time” for unemployed employees of self-employed individuals without work. Additionally, the weekly benefit is increased by $600 per recipient for up to 4 months. Since the average weekly unemployment benefit is about $400, this will increase the average benefit to $1,000 for those 4 months. Therefore, employees and self-employed individuals who have lost their job or don’t have work, could qualify for up to 9 months of unemployment benefits, with an extra 17 weeks of $600 payments – meaning, an average worker could get as much as $26,000 in the first 9 months.

Paycheck Protection and Forgivable Loans.  Businesses, including sole proprietorships, with less than 500 employees can apply for an SBA loan to help with economic suffering on their business caused by coronavirus. The loan is the lesser of $10 million or 2.5 times the monthly payroll costs over the past year and must be applied for by June 30, 2020. Loans will be made on a first come-first serve basis until the total maximum of $10 Billion has been loaned. So, a company with a 2019 monthly qualified payroll of $40,000 could borrow $100,000. And, as long as the business maintains the same number of employees, the loan will be forgiven for all payroll, rent, utilities and healthcare costs incurred in the first 8 weeks after receiving the loan. For example, if payroll remained $40,000 per month, rent was $6,000 per month, utilities $2,000 per month and health care costs $2,000 per month, virtually the entire loan would be forgiven. And, any debt forgiven is not included in taxable income for the year. For the portion of the loan that is not forgiven, interest on the loan will be at 4% or less over a term of 10 years and payments will be deferred for at least 6 months and no longer than one year.

Employee Retention Credit. Businesses who doesn’t qualify for the SBA loan above but suffered a reduction in quarterly revenues in 2020 to 50% or more for the same quarter in 2019, may qualify for a $5000 employee retention credit.

Deferral of payroll taxes. Most employers, other than those who receive the special SBA loans above, qualify to defer the employer portion of payroll taxes for over one year. Their 2020 employer payroll taxes can be paid half by December 31, 2021 and half by December 31, 2022.

Net operating loss rules are loosened. The CARES act allows losses in 2018, 2019 or 2020 to be carried back five years producing tax refunds that can be used now.

Conclusion. The CARES act provides significant funds, programs and tax benefits for individuals, families and businesses. Some of the provisions have time limits as outlined above. DWM will be individually contacting our clients who we think might be able to take advantage of these programs and get their rightful share of the “Pennies from Heaven.” We will also alert them to other financial and/or tax strategies, including Roth conversions and tax loss harvesting, given the CARES provisions and the state of the current markets. If you have any questions, please contact us.

We hope that you, your family and your community stay healthy and we all can get back to normal as soon as possible.

https://dwmgmt.com/

Technology and Real Estate Collide: Will we be trading homes like stocks in the next several years?

The total wealth of Americans is $113 trillion. The major categories are real estate, both homes and commercial, of $50 trillion and stocks and stock funds of $35 trillion.

Technology has had a huge impact on stock trading. 50 years ago, selling or buying company shares was opaque, illiquid and expensive. Now, technology has taken over more and more aspects of trading. Markets are transparent and liquid. The cost of equity trades is zero or close to it.

Real estate not so much. Of course, while every common share of Amazon is identical, no two houses are identical. Throw in emotion, 5-6% commissions and time delays and hassles in buying and selling and it’s no surprise that the real estate market has had low volumes and heavy transaction costs. As a result, only 7% of American homes change hands every year.

American homeowners traded property worth only $1.5 trillion in 2019, paying out about $75 billion in commissions. About $40 billion of stocks are traded each year with less than $10 billion in commissions, which are shrinking. The real estate transaction model is still opaque, illiquid, expensive and stressful. More owners are staying put and this is contributing to the decrease in homeownership in the US to 64%, lower than it was in the early 1990s.

In the last decade, technology has started to gain traction in real estate transactions providing more transparency, more liquidity, less cost and quicker and easier moves. The old real estate model may be replaced by a new one, with lower fees (on a percentage basis) but more turnover and more customer satisfaction. The last decade has seen the birth of a new industry- property tech or “prop tech.” It has attracted $40 billion in venture capital in the last three years. The four biggest firms, Zillow, Redfin, Compass and Opendoor have a combined valuation of $23 billion. Prop tech is fundamentally changing how the real estate sector operates.

Zillow’s “Zestimate’s” 2006 algorithm for pricing used traditional metrics; such as number of bedrooms and baths, square footage etc. Today Zestimate goes deeper and has become more accurate. Homeowners listing with Zillow upload pictures and provide additional detail information. The new Zestimate model has an error of less than 2% (of the home’s actual selling price) as compared to a 14% error back 13 years ago. The next wave of Prop tech could include more hyper-local automated valuation model (“AVM”) elements to their valuation models. Zestimate’s hyper-local AVM algorithm in Washington, D.C. has only a 1.2% error. Zillow’s AVM won’t replace appraisers for mortgages that are needed. However, Zillow believes it could transform appraisers from evaluators to fact-checkers.

Prop tech has also sped up transactions. Discovering listings used to take days. Now Redfin (and others) notifies customers with its “Updates” faster than anyone else about new listings and price changes. Using just a couple of clicks on their smartphone, Redfin customers can “Book it Now” and request a home tour, almost like making an online restaurant reservation.

Another trend is instant buying- or iBuying, offered by both Zillow and Redfin. Sellers can sell in a few days. The companies make prompt, algorithm-driven offers, pay in cash, and sell homes themselves- sometimes after some minor upgrades. Opendoor takes it one step farther. It buys using iBuyer and then resells through the Opendoor app, backing sales with a 90 day guarantee. Opendoor says home buying and selling can be “as easy as buying and selling cars.” Knock is another iBuyer who buys houses for cash and then helps sellers find their dream house. Knock even handles repairs and updates on the old house.

Prop tech may even provide a complete solution. (Think of Amazon meets real estate). Jen Chao, executive at Redfin sees prop tech heading towards such a comprehensive offering. She believes that the overall management of buying and selling a house, including finding the house, negotiating the contract, finding the mortgage, an attorney, a mover and more is a very big deal to many. So much so, that many just don’t move. Chao feels that Redfin can become a one-stop shop, providing a seamless home-buying (and/or selling) experience.

Chao says this automation will not do away with the work of agents and other real estate professionals. “Real estate is a highly personal business,” says Chao. Technology is being used to streamline and get rid of the tasks that software can do really well, to free up time for agents and others to focus on things that require the human touch.

Prop tech proponents believe the future of real estate is rooted in precision and personalization. At DWM, we believe our total wealth management process is very similar. We use technology to streamline and perform tasks that software can do and we use our combined knowledge, experience and communication skills to provide the personalization that is so important. In short, that is how value is maximized for our clients.

https://dwmgmt.com/

 

At 80, “Successful Ager” Jack Nicklaus Remains As Relevant As Ever

Golfing great Jack Nicklaus turned 80 last week. His drives aren’t as long anymore- Gary Player can now outdrive him.  Jack stepped away in 2018 from day-to-day operations of his companies which build golf courses all over the world.  You might think Mr. Nicklaus is slowing down.  But to hear Jack tell it, he got rid of the things he was tired of doing and is focusing on all the activities he likes; including public speaking engagements, occasional golf exhibitions, course design and fundraising with his wife.

Nicklaus started designing courses in 1969.  He’s completed over 300. He’s become a grandfather to the “kids” on the PGA tour such as Rickie Fowler and Justin Thomas. Rory McIlroy says that Nicklaus “has the best advice on how to play golf- not how to swing but how to play the game.”  Jack’s wife of 60 years, Barbara, is chair of the Nicklaus Children’s Health Care Foundation and together they have raised over $50 million for pediatric care in Ohio and Florida.  They just pledged to raise another $100 million over the next five years.  Yes, Jack Nicklaus remains relevant as ever and, by any definition, is successfully aging.

Much has changed since Social Security was started in 1935.  Back then, the average life expectancy was 61 years old.  In 1947, the poet Dylan Thomas encouraged the elderly: “Do not go gentle into that good night, old age should burn and rage at close of day.” It’s starting to happen. With greater longevity and medical advances, it’s no surprise that the term “successful aging” has grown in popularity over the past few decades.  Back in 1987, John Wallis Rowe and Robert Kahn published a book entitled “Successful Aging.”  They felt there were three key factors: 1) being free of disability or disease, 2) having high cognitive and physical abilities, and 3) interacting with others in meaningful ways.

Now comes a new NYT bestseller; Dr. Daniel Levitin’s “Successful Aging; a neuroscientist explores the power and potential of our lives.”  Today more people who are in the last quarter of their lives are engaged with life as much as they’ve ever been, immersed in social interactions, spiritual pursuits, hiking and nature, charitable work and even starting new professional projects.  Dr. Levitin remarks:  “They may look old, but they feel like the same people they were 50 years ago and this amazes them.”

Successful aging involves focusing on what is important to you, and being able to do what you want to do in old age. While successful aging may be one way to describe how well we age, the concept of meaningful aging might be another important way to consider how to age well.   Certainly, some of our faculties may have slowed, yet “seniors” are finding strength in compensatory mechanisms that have kicked in – positive changes in mood and outlook, punctuated by the exceptional benefits of experience.  Baby boomers and their elders may process information more slowly than younger generations but they can intuitively synthesize a lifetime of information and make smarter decisions based on decades of learning, often from their mistakes.

Combining recent developments in neuroscience and psychology, “Successful Aging” presents a novel approach to how we think about our final decades. The book demonstrates that aging is not simply a period of decay but a unique time, like infancy or adolescence, which brings forth its own demands, surprises and happiness.

Until about thirty years ago, older people in the workforce were forced/encouraged to retire; a tremendous economic and creative loss.  However, since the 1990s, the tide has been turning for seniors. Employers and organizations are awakening to the eastern idea that the elderly may not only be of some value but may provide superior enhancements to a group.   New medical advances and positive lifestyle changes can help us to find enhanced fulfillment that previous generations may not have been able to do.

Research now shows, for example, that fending off Alzheimer’s disease involves five key components:  1) a diet rich in vegetables, 2) moderate physical exercise, 3) brain training exercise, 4) good sleep hygiene, and 5) an appropriate regimen of supplements.  In addition, research shows that social stress can lead to a compromised immune system. We don’t need to be victims; we just need to take advantage of modern medicine and make some lifestyle changes.

When older people look back on their lives and are asked to pinpoint the age at which they were the happiest, what do you think they say? The age that comes up most often, according to Dr. Levitin, as the happiest time in one’s life is 82. And, that number is rising.

At DWM, we work with clients from 0 to 96.  As total wealth managers, we understand life cycle planning, financial and investment strategies and proactively provide value-added services.  Of course, we focus on making sure our clients have enough money for their entire lives.  In addition, and as important, we pay particular attention to helping them experience the best life possible with the money they have.  Their fulfillment is our fulfillment. Their happiness is our happiness.

Jack Nicklaus’s longtime PR man Scott Tolley says Jack still only operates at two speeds, “go and giddy-up.”  Gary Player calls retirement a death warrant.  It doesn’t need to be.  Successful aging is getting easier and more fun and fulfilling.  C’mon baby boomers- let’s giddy-up.

https://dwmgmt.com/

MLK Would Have Loved Finland

We hope everyone enjoyed the Martin Luther King, Jr. holiday on Monday. We hope you spent at least a few minutes thinking of Dr. King and his legacy. His stirring words and writings remain as relevant today as they were 50 years when he was alive. I am always moved by his comments, particularly on equality, such as:

  • “We may have all come on different ships, but we’re in the same boat now,”
  • “We must learn to live together as brothers or perish together as fools,”
  • “The time is always right to do what is right,” and
  • “In some not too distant tomorrow the radiant stars of love and brotherhood will shine over our great nation with all their scintillating beauty.”

As I thought about these quotes, it made me think of Finland, recently deemed a “Capitalist Paradise” by the NYT and lauded by the Economist for slashing homelessness while the rest of Europe is “failing.”

As many of you know, my maternal grandmother was Finnish and Elise and I spent a wonderful homecoming in Finland this past summer, meeting relatives and experiencing life first-hand in Finland. Dr. King certainly would have loved a country like Finland that provides a real-life example of a system that works to provide equality and happiness to all.

Finland hasn’t been operating independently all that long. Located between Sweden and Russia, Finland was under Swedish rule from 1250-1809. In 1809 it became a Grand Duchy in the Russian Empire until it declared its independence in 1917. In 1918, Finland experienced the Finnish Civil War; the “whites” were primarily Swedish descendants who were anti-socialists and the “reds” who supported Russian socialism. The whites won and established a republic. World War II saw Finland under attack from Russia and ultimately joining forces with Germany.

After WW II, Finland did not want to become a socialist country. Its capitalists cooperated with government to map out long-term strategies and discussed these plans with unions to get workers on board. Finnish capitalists realized that it would be in their best interests to accept progressive tax hikes. The taxes would help pay for new governmental programs to keep workers and their families healthy, educated and productive. Fast forward to today, the capitalists are still paying higher taxes and outsourcing to the government the responsibility of keeping workers healthy and educated.

The NYT article “A Capitalist Paradise” was authored by a couple who moved from Brooklyn to Helsinki two years ago. Both are US citizens, experienced professionals and enjoyed a privileged life in the States. However, they were both independent consultants with uneven access to health insurance, and major concerns about funding for day-care, and education, including college. What may come as a surprise to some, is that they have experienced since the move an increase in personal freedom.

In Finland, everyone is covered by taxpayer-funded universal health-care that “equals coverage in the U.S. but without piles of confusing paperwork or haggling over huge bills.”   Their child attends a “fabulous, highly professional and ethnically diverse” public day-care that costs about $300 per month. If they stay in Finland, their daughter will attend one of the world’s best K-12 education systems at no cost to them, regardless of the neighborhood they live in. College would also be tuition free.

Many Americans may consider the Finnish system strange, dysfunctional or authoritarian, but Finnish citizens report extraordinarily high levels of life satisfaction. The World Happiness Report announced recently that Finland was the happiest country in the world, for the second year in row, leading Norway, Denmark, Switzerland and Iceland in the poll.

Finland has also become one of the world’s wealthiest countries and, like other Nordic countries, home to many highly successful global companies. A spokesman for JPMorgan Asset Management recently concluded that “The Nordic region is not only ‘just as business friendly as the U.S,’ but also better on key free-market indices, including greater protection of private property, less impact on competition from government controls and more openness to trade and capital flows.” “Furthermore, children in Finland have a much better chance of escaping the economic class of their parents than do children in the U.S.”

Finland’s form of capitalism has worked for businesses and citizens alike. Since Independence, Finland has remained a country and economy committed to free markets, private businesses and capitalism. Its growth has been helped, not hurt, by the nation’s commitment to providing generous and universal public services that support basic human well-being. Finland and the Nordic countries as a whole, including their business elites, have arrived at a simple formula: “Capitalism works better if employees get paid decent wages and are supported by high-quality, democratically accountable public services that enable everyone to live healthy, dignified lives and to enjoy real equality of opportunity for themselves and their children.”

This system works. Over the last 50 years, if you had invested in a portfolio of Nordic equities, you would have earned a higher annual real return than the American stock market according to Credit Suisse research. It’s not a surprise since Nordic companies invest in “long-term stability and human flourishing while maintaining healthy profits.” We made a similar point in our September blog “Reinvent Capitalism?”

Dr. King’s quotes resonate loudly today. We Americans are a country of immigrants- “We came on different ships, but we’re in the same boat now.” In a time of tribal politics- “We must learn to live together as brothers or perish together as fools.” However, since “The time is always right to do what is right,” let’s keep optimistic that “In some not too distant tomorrow the radiant stars of love and brotherhood will shine over our great nation with their scintillating beauty.”

https://dwmgmt.com/

Breaking News- How the SECURE Act Will Impact Retirement Plans

Happy New Year!! We hope everyone had a great holiday. Everyone at DWM certainly did. In late December, Congress’s year-end spending package was signed into law and it included the SECURE Act which has made some significant changes to retirement plans. It’s a mixed bag. Major items impacted are 1) “stretching rules” for IRAs, including Roth IRAs, inherited by non-spouse beneficiaries 2) age limits for IRA contributions and 3) Required Beginning Date (“RBD”) for Required Minimum Distributions (“RMD”) for retirees.

In the past, owners of IRAs and Roth IRAs could leave them to much younger heirs, including grandchildren, who could “stretch” the IRA by taking out the minimum distribution, typically until they were 85 years. This was particularly valuable for Roth IRAs, where the income tax had already been paid and the account continued to grow tax-free for 50 years or more. For example, a grandchild who received a $100,000 Roth IRA from her deceased grandparent at age 30, who invested the money and earned 6% annually and withdrew only the required amount each year, could eventually receive $741,000 in distributions over 55 years, all tax-free. The same applied to IRAs, except there would be taxes to be paid on the distributions each year. This was a great wealth succession strategy.

Now, the “Big Stretch” is gone. The distribution period has been reduced generally to 10 years for non-spouse beneficiaries. Surviving spouses are still covered by the old rules. However, a non-spouse IRA or Roth IRA heir can postpone any distributions until the end of the 10 years to maximize tax-free or tax-deferred growth. A surviving spouse who inherits a Roth IRA can put the account in his or her name, not take any distributions in their lifetime and then leave the accounts to younger heirs who get a 10 year stretch.

The Big Stretch is gone but Roth conversions can still make lots of sense, in the right circumstances. Here’s a real life example of a program we are just putting into place with clients. A Roth conversion is where you voluntarily move all or a portion of an IRA to a Roth account and pay income tax on the amount transferred. The Roth account is tax-free thereafter. Over a 10 year period one of our client couples is converting $1 million of traditional “pre-tax” IRA money to Roth. We do an installment Roth conversion each year, with larger amounts in the beginning. At the end of the conversion, using a 6% annual investment growth, their Roth accounts total $2 million. It has cost about $250,000 of federal tax (they live in a state with no income tax) to do the conversion. At that point, our clients are 70 years old. They have no RMD requirements on their Roth accounts and, assuming the second to die of the couple passes away at 95 years of age, the $2 million would have grown to $8.5 million over those 25 years. After that, the beneficiaries can allow the money to grow for 10 more years under the new rules and then take tax-free distributions on the roughly $15 million of Roth money. The effective tax rate on the conversion and growth was less than 2% tax ($1 million of IRA money eventually became $15 million of Roth money). Conversions don’t work for everyone but for the right situation, it is a key part of the legacy and wealth succession strategy, even without the Big Stretch.

Under the SECURE ACT, savers can continue to make contributions to a Traditional IRA past the age of 70 ½ (the age limit of 70 ½ has been repealed). Roth contributions were never subject to an age limit. They still have to meet the requirements of earned income to make contributions.

Lastly, starting dates, or RBDs, have been revised from 70 ½ to age 72 for RMDs. Obviously, people are living longer and many would prefer to start their RMDs later. Again, traditional IRAs have RMDs so that the IRS can finally start collecting tax on the money. The initial withdrawal rate is 3.6% and the withdrawal rate increases each year to 16% at age 100, for example. Roth IRAs have no RMDs for owners and their spouses. Now, if the owner reaches 70 ½ after 12/31/19, the first RMD year is the year in which the owner reaches 72. The RBD is April 1 of the year that follows the year in which the owner reaches 72 ½. Here’s an example, IRA owner was born in April, 1950. She will be 70 ½ in October, 2020 (after 12/31/19). So, she can take his first RMD either in 2022 or by April, 2023 (under the old rules she would have had a RBD of 2020 or April 2021.) However, if the first RMD is taken in April 2023, then the 2023 RMD for her will be taken that year as well. Doubling up may not be advantageous, as it may push you into a higher tax bracket.

Those are the key issues in the SECURE ACT. If you have any questions, please let us know. We love working with retirement plans, traditional IRAs and particularly Roth IRAs. Even with the new changes in the SECURE Act, there are still some great planning opportunities available.

https://dwmgmt.com/

The “Nastiest, Hardest Problem” in Retirement

Running out of money in retirement is, according to Nobel Prize winning economist William Sharpe, the “nastiest, hardest problem” in retirement. Professor Sharpe has spent his career thinking about risk. His work on the Capital Asset Pricing Model and systemic risk produced in 1966 the Sharpe ratio, which measures risk-adjusted returns. Now, he’s tackling a much broader subject, extremely important to everyone, about possibly outliving your money in retirement. Similar to the Monte Carlo analysis that DWM uses to provide a probability of success for your financial plan, Dr. Sharpe created a computer program with 100,000 retirement-income scenarios to calculate the probability of not running out of money. He’s published a free 730 page e-book “Retirement Income Scenario Matrices.”

In short, there are three key variables that impact your retirement income; your spending, your investment returns and your eventual age (when your plan “ends.”)

The first variable, spending, is the one you can most control. Your spending before retirement will generally determine how much money you accumulate while working. What you don’t spend becomes savings/investments and these annual additions and their appreciation increase your investment portfolio overtime. Your spending in retirement will determine how much you need to withdraw from your investment pot. As your earnings during the working years increase, you need to save a larger percentage of your income in order to accumulate an investment pot at retirement time that will support the lifestyle you’ve created. Withdrawals from your investment portfolio during retirement typically should not exceed 4% of the total investment pot. It’s an easy calculation. For example, if you determine you will need to withdraw $100,000 from the portfolio in your first year of retirement, you’ll need a portfolio of $2.5 million.

Now let’s look at investment returns. No one can predict the future. Historically, we know there is a relationship between inflation, asset allocation and returns. Hypothetically, let’s assume that a diversified fixed income portfolio over the long term would produce a return of 1% above inflation. The return above inflation is called the “real return.” Equities, because of their higher risk, have earned an “equity risk premium” of roughly 3 to 7% above the inflation rate over the long term. Again, hypothetically, let’s assume that in the long-run equities earn 5% above inflation. Alternatives have a shorter historical track record but are designed to produce returns comparable to fixed income returns over time. Therefore, a portfolio with 50% fixed income holdings and 50% equity holdings might hypothetically produce a 3% real return over time. If long-term inflation is expected to be 2.5%, the nominal return could be expected to be 5.5%. A larger allocation to equities will likely produce a larger real return and a smaller (more defensive) allocation of equities would likely produce a smaller real return.

Lastly, longevity. Certainly, we can look at actuarial tables, such as those used by insurance companies and social security, to calculate life expectancy. These charts show that a male age 60 might be expected to live another 22 years; a female age 60, another 25 years. However, we suggest you not use these actuarial tables. Harvard Professor David Sinclair‘s “Lifespan- Why we Age- and Why We Don’t Have To” shows that the increases in technology and medicine are going to give those individuals who want to live a longer and healthier life the opportunity to do so. It is very possible that many of our clients and friends will live a healthy 100 plus years and younger generations, such as millennials and Gen Z, may live to 110 or longer. Accordingly, we suggest using an eventual age of at least 100 when doing your financial planning.

Dr. Sharpe’s final section in the book is about advice. He indicates that many people will need help. He outlines the “ideal financial advisor” and compares a “good financial advisor” to a “fine family doctor” who has “deep scientific knowledge, can assess client needs, habits and willpower and is able to provide scientific diagnoses and can communicate results to the client in simple terms so that the best treatments can be applied.” We like the analogy, we use it all the time.

Yes, running out of money in retirement would be a nasty, hard problem. It’s doesn’t have to be that way. You need a solid financial plan based on realistic values for investment returns and longevity. You also need to focus on spending and savings.   And, you might need some help from a “good financial advisor” that operates like a “fine family doctor,” a firm like DWM.

https://dwmgmt.com/

DAFS, QCDS, ROTHS AND 2019 TAX PLANNING-2020 IS COMING

Hope everyone had a great Halloween. Now, it’s time to finish your 2019 Tax Planning. You know the drill. You can’t extend December 31st– it’s the last day to get major tax planning resolved and implemented. This year we will focus on three key areas; Donor Advised Funds, Qualified Charitable Distributions and Roth accounts. And, then finish with some overall points to remember.

Donor Advised Funds (“DAFs”). For charitable gifts, this simple, tax-smart investment solution has become a real favorite, particularly starting in 2018. The concept of DAFs is that taxpayers can contribute to an investment account now and get a current deduction yet determine in the future where and when the money will go.

The Tax Cuts and Jobs Act of 2017 increased the standard deduction (up to $24,400 in 2019 for married couples). Couples with itemized deductions less than the standard deduction receive no tax benefit from their contributions. However, they could get a benefit by “bunching” their contributions using a DAF.   For example, if a couple made annual charitable contributions of $10,000 per year, they could contribute $40,000 to the DAF in 2019, e.g., and certainly, in that case, their itemized deductions would exceed the standard. The $40,000 would be used as their charity funding source over the next four years. In this manner, they would receive the full $40,000 tax deduction in 2019 for the contribution to the account, though they will not receive a deduction in the years after for the donations made from this account.

Now, what’s really great about a DAF is that if long-term appreciated securities are contributed to the DAF, you won’t have to pay capital gains taxes on them and the full fair market value (not cost) qualifies as an itemized deduction, up to 30% of your AGI. Why use after tax dollars for charity, when you can use appreciated securities?

Within the DAF, your fund grows tax-free. You or your wealth manager can manage the funds. The funds are not part of your estate. However, you advise your custodian, such as Schwab, the timing and amounts of the charitable donations. In general, your recommendations as donor will be accepted unless the payment is being made to fulfill an existing pledge or in a circumstance where you would receive benefit or value from the charity, such as a dinner, greens fees, etc.

Many taxpayers are using the DAF as part of their long-term charitable giving and estate planning strategy. They annually transfer long-term appreciated securities to a DAF, get a nice tax deduction, allow the funds to grow (unlike Foundations which have a 5% minimum distribution, there are no minimum distributions for DAFs) and then before or after their passing, the charities they support receive the benefits.

Qualified Charitable Distributions (“QCDs”). A QCD is a direct transfer of funds from your IRA to a qualified charity. These payments count towards satisfying your required minimum distribution (“RMD”) for the year. You must be 70 ½ years or older, you can give up to $100,000 (regardless of the RMD required) and the funds must come out of your IRA by December 31. You don’t get a tax deduction, but you make charitable contributions with pre-tax dollars. Each dollar in QCDs reduces the taxable portion of your RMD, up to your full RMD amount.

For taxpayers 70 ½ or older, their annual charitable contributions generally should be QCDs and if their gifting exceeds their RMDs, they can either do QCDs up to $100,000 annually or, instead of QCDs,fund a DAF with long-term appreciated securities and bunch the contributions to maximize the tax deduction.

Roth Accounts. A Roth IRA is a tax-advantaged, retirement savings account that allows you to withdraw your savings tax-free. Roth IRAs are funded with after-tax dollars. They grow tax-free and distributions of both principal and interest are tax-free. Roth IRAs do not have RMD requirements that traditional pre-tax IRAs have. They can be stretched by spouses and beneficiaries without tax. They are the best type of account that a beneficiary could receive upon your passing.

A taxpayer can convert an IRA to a Roth account anytime, regardless of age or income level- the IRS is happy to get your money. A Roth conversion is especially appealing if you expect to be in a higher marginal tax bracket in retirement. Conversions make sense when taxable income is low or negative. In addition, some couples interested in Roth conversions make DAFs in the same year to keep their taxes where they would have been without the conversion or the DAF.

2020 is coming. You still have almost two months to resolve your 2019 tax planning and get it implemented. Make sure you and your CPA review your situation before year-end to make sure you understand your likely tax status and review possible strategies that could help you. At DWM, we don’t prepare tax returns. However, we do prepare projections for our clients based on our experience and knowledge to help them identify key elements and potential strategies to reduce surprises and save taxes. Time is running out on 2019. Don’t forget to do your year-end tax planning. And, of course, contact us if you have any questions.

https://dwmgmt.com/

Old Adages Die Hard: What Worked in the Past May Not Work Today!

More people are renting (not buying) houses, particularly millennials. The old adage that “paying rent is foolish, own your house as soon as you can” is no longer being universally followed.  Lots of reasons: cost of college education, student debt, relative cost of houses, flat wages, more flexibility and others.  Today we 327 million Americans live in 124 million households, of which 64% (or 79 million) are owner-occupied and 36% (or 45 million) are renter-occupied. In 2008, homeownership hit 69% and has been declining ever since.

It starts with the increasing cost of college.  Back in the mid 1960s, in-state tuition, fees, room and board for one year at the University of Illinois was $1,100.  Annual Inflation from 1965 to now has been 4.4% meaning $1,100 would have increased 10 times to $11,000 in current dollars.  Yet, today’s in-state tuition, room & board at Champaign is $31,000, a 28 times (or 7.9% average annual) increase.  Yes, students often get scholarships and don’t pay full price, but even a $22,000 price tag would represent a 20 times increase.

It’s no surprise that in the last 20 years, many students following the old adage “get a college education at any price” found it necessary to incur debt to complete college.  Today over 44 million students and/or their parents owe $1.6 trillion in student debt.  Among the class of 2018, 69% took out student loans with the average debt being $37,000, up $20,000 each since 2005.  And here is the sad part: according to the NY Fed Reserve, 4 in 10 recent college graduates are in jobs that don’t require degrees.  Ouch. In today’s changing economy, taking on “good debt” to get a degree doesn’t work for everyone, like it did 50 years ago.

At the same time, houses in many communities have increased in value greater than general inflation.  Elise and I bought our first house in Arlington Heights, IL in 1970 when we were 22.   It was 1,300 sq. ft., 3 bedrooms and one bath and cost $21,000.  I was making $13,000 a year as a starting CPA and Elise made $8,000 teaching.  Today that same house is shown on Zillow at $315,000.  That’s a 15 times increase in 50 years. At the same time, the first year salary for a CPA in public accounting is now, according to Robert Half, about $50,000-$60,000. Let’s use $60,000.  That’s less than a 5x increase.  Houses, on the other hand, have increased at 5.6% per year. CPA salaries have increased 3.1%.  The cost of living in that 50 years went up 3.8%. Wages, even in good occupations, have lagged inflation. Our house 50 years ago represented about one times our annual income.  Today the average home is over 4 times the owners’ income.  That makes housing a huge cost of the family budget.

In addition, today it is so much more difficult to assemble the down payment. We needed 20% or $4,200; which came from $3,500 savings we accumulated during our first year working full-time and a $700 gift from my mother. A “starter” house today can cost $250,000 or more.  20% is $50,000, which for many is more than their first year gross income.  And, from that income, they have taxes, rent, food and other expenses and, in many cases, student debt, to pay before they have money for savings. Saving 10% is great, 20% is phenomenal.  But even at 20%, that’s only $10,000 per year and they would need five years to get to $50,000.  No surprise that it is estimated the 2/3 of millennials would require at least 2 decades to accumulate a 20% down payment.

Certainly, houses can become wealth builders because of the leverage of the mortgage.  If your $250,000 house appreciates 2% a year, that is a 10% or $5,000 increase on your theoretical $50,000 down payment. But what happens when real estate markets go down as they did after the 2008 financial crisis?  The loss is increased.  Many young people saw siblings or parents suffer a big downturn in equity 10 years ago and are not ready to jump in.

Furthermore, young people who can scrape up the down payment and recognize the long term benefits of home ownership, may not be willing to commit to one house or one location for six to seven years.  With closing costs and commissions, buying, owning and selling a house in too short a period can be costly and not produce positive returns.

Lastly, many people want flexibility and don’t want to be tied to a house. They want flexibility to change locations and jobs.  They want flexibility with their time and don’t want to spend their weekends mowing the grass or perform continual repairs on the house. In changing states like Illinois, with a shrinking population and less likelihood of significant appreciation, their house can be a burden.  For them, renting provides them flexibility and peace of mind.

It’s no surprise then that the WSJ reported last week that a record number of families earning $100,000 a year or more are renting.  In 2019, 19% of households with six-figure income rented their house, up from 12% in 2006.  Rentals are not only apartment buildings around city centers, but also single-family houses.  The big home-rental companies are betting that high earners will continue renting.

Yes, the world has changed greatly in the last 50 years and it will keep changing.  When I look back, I realize we baby boomers had it awfully good.  The old adages worked for us. But today, buying a house is not the “slam dunk” decision we had years ago, nor is a college degree.  The personal financial playbook followed by past generations doesn’t add up for many people these days.  It’s time for a new plan customized for new generations and that’s exactly what we do at DWM.

Equity Trades are Free – But there is no Free Lunch

Broker price wars

Before 1975, brokers had it really good. Commissions were fixed and regulated-at very high levels. It would sometimes cost hundreds of dollars to buy 500 shares of a blue-chip stock. That changed in 1975 when the SEC opened commissions to market competition.   A young Chuck Schwab and others became discount brokers- often charging ½ or less of the old rates. Since then, fees have continued to fall and earlier this year, trades could be made for $5 or less. Now, Charles Schwab & Co. as well as TD Ameritrade, E*TRADE and others have cut stock and ETF trades to zero. Free trading of equities has arrived.   Please be advised, though, that there is no free lunch- brokers profit from you even if they don’t charge for equity trades.

Here are some the main sources of income for brokerage firms:

  • Trade commissions
  • Brokerage fee- to hold the account
  • Mutual fund transaction fee-charges when you buy or sell a fund
  • Operating Expense Ratio-an annual fee charged by mutual funds, index funds and exchange-traded funds (“ETFs”)
  • Sales load- A sales charge or commission on some mutual funds paid to the broker or salesperson who sold the fund
  • Uninvested cash- brokers become bankers and lend it out

Let’s focus first on uninvested cash. In 2018, 57% of Schwab’s income came from loaning out its customers’ cash. As is typical in the brokerage business, uninvested cash is swept to an interest bearing account. However, sweep accounts typically earn almost nothing- usually ½ to ¼ of 1% or lower to the investor.

Schwab had a total of $3.7 trillion of deposits, with about 7% of it ($265 billion) in cash earning nice returns for them. Assuming a return of 2.5 % on the uninvested cash, that’s a return of $6.6 billion. The cost of that money was likely ½% or about $1 billion, with Schwab netting about 2%. $5.7 billion of Schwab’s $10 billion net revenue in 2018 was earned on its customers’ cash. Virtually all the brokers use the same model with uninvested cash.

Robo- advisors generally use the same format. Virtually all of them charge lower fees but require a certain amount of cash, between 4% and 30% in their pre-set asset allocations. Yes, there is a small sweep account interest paid on those funds, but not much. And, this is all typically disclosed. The rate paid on clients’ cash “may be higher or lower than on comparable deposit accounts at other banks” is a typical warning.

The use of uninvested cash is income for the brokers and reduction in performance for the investors. Let’s say your portfolio has 10% cash generating a 0% return. If your annual return on the invested 90% in your portfolio is 6%, then the return on 100% of the account is only 5.4%. A huge difference over time. As an example, the difference between earning 5% per year versus 6% a year on $100,000 for 30 years is $142,000.

Now, let’s look at the operating expense ratio (OER). OERs are charged by mutual funds, index funds and ETFs. If a fund has an expense ratio of 1%, that means you pay $1 annually for each $100 invested. If your portfolio was up 6% for the year, but you paid 1% in operating expenses, your return is actually only 5%. The OER is designed to cover operating costs including management and administration.

The first mutual funds were actively traded, meaning that the portfolio manager tried to beat the market by picking and choosing investments. Operating expenses for actively managed funds include research, marketing and significant administration with OERs often at 1% or more. Index funds are considered passive. The manager of an index fund tries to mimic the return of a given benchmark, e.g. the S&P 500 Index. Index funds should have significantly lower operating expense ratios. Evidence shows that actively managed funds, as a whole, don’t beat the indices. In fact, as a group, they underperform by the amount of their OER.

Operating expense ratios, primarily because of increased use of index funds and ETFs to minimize costs, have been getting smaller and smaller. In fact, we have seen some funds at a zero operating expense ratio. However, for these funds, a substantial amount (10% to 20%) of cash is maintained in the fund.

Conclusion: Set a target of 1-2% cash in your portfolio. Stay invested for the long term.   In addition, the investments in your portfolio should have very low OERs, wherever possible. However, in selecting investments, you need to look at both the OERs and the typical cash position of the mutual fund, index or ETF. Even if the OER is zero and the security holds 10% in cash, your performance on that holding will likely only be 90% of the benchmark, at best. Remember, when equity trades are free, brokers will continue to look for ways to make money, often at your expense.