Return of the RMDs (2021)

“All good things must come to an end” (Geoffrey Chaucer, 14^th Century). Alas, it rears its ugly head again on January 1, 2021, with the return of Required Minimum Distributions (RMDs) from Qualified Retirement Accounts.

As an optimist, I was hoping that the 2020 RMD “sabbatical” might be repeated in 2021, due to ongoing COVID-19 economic difficulties. Our incredible market rebound since March of this year has virtually eliminated any chance of a second year of reprieve, and RMDs remain slated to resume their mandate in January 2021.

Although about 80% of Qualified Retirement Account owners withdraw more than their required withdrawals annually, a smaller, significant, population was grateful for the 2020 suspension. We hoped that another year of RMD reprieve would follow, reducing taxable income again next year, and not influencing the income-based cost of Medicare Parts B and D. That prospect is not looking good, so we have to plan accordingly. But, there is good news for some age groups. Here are a few highlights:

• For taxpayers born after June 30, 1949, initial RMDs are not required for another year, as the Required Beginning Age was raised from 70-1/2 to 72, eliminating 2021 RMDs for affected taxpayers
• Life Expectancy Tables have been revised to reflect longer average life spans, lowering the amount of all RMDs (unfortunately, this provision does not take effect until January 1, 2022)
• Proposals now in front of Congress would increase maximum purchases of Qualified Longevity Annuity Contracts (QLACs) from $135,000 to $200,000; a brief explanation of these contracts and their potential RMD-reducing impact follows

Qualified Longevity Annuity Contracts, or QLACs, are insurance products designed for Retirement Account owners who wish to reduce their RMDs for a period of time. Maximum values of QLACs have been raised from $130,000 to $135,000; however, those values continue to also be limited to 25% of the Retirement Account value, and so maybe reduced. The QLAC does not pay dividends or interest, so QLAC returns are totally based on reduced RMDs. This reduces current income, and, ipso facto, also reduces current taxes on income.

QLAC maturity (date of the first annuity payment) is flexible and is set by the account owner at contract purchase, with a maximum maturity age of 85. Upon maturity, the QLAC pays a taxable annual distribution to the account owner until death, similar to an RMD. The original contract value is guaranteed by the insurance carrier, so any unpaid premium dollars will be returned to the account prior to the account being inherited.

We assume that the 2020 RMD suspension has come to an end, but not without some additional benefits for many owners of Qualified Retirement Accounts. Rattling around the hallowed halls of Congress is a proposal to increase the Required Beginning Distribution Age to 75 from the recent 72. An optimist can always hope for the passage of this helpful change.

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Last week we explored some history regarding the transaction known as a “Roth IRA Conversion,” whereby funds in tax-deferred, or Qualified, Retirement Accounts can be converted to a tax-free Roth IRA. Later on, withdrawals from the Roth IRA would not only be tax-free, but they would be voluntary during the owner’s entire life. These are powerful incentives for some people, and many taxpayers annually participate in the Roth Conversion process.

The downside is that Roth IRA Conversions are 100% taxable as ordinary income in the year of the Conversion, so the costs and benefits have to be carefully weighed before making a good financial decision.

For several years, Congress continued to make changes in the Tax Code favoring Roth conversions. Elimination of income limits for making Roth Conversions increased their availability. Reducing income tax rates in 2018 provided further financial incentives. Lately, however, Congressional changes are clouding the benefits of Roth IRA Conversions.

Strangely, the new rules were not implemented with an eye toward reducing Roth IRA Conversions, with one exception. The Tax Cuts and Jobs Act of 2017 (TCJA) eliminated the process of Recharacterizing (essentially undoing) a Roth IRA Conversion in the following year. Ending this provision reduced the tax predictability of making the Conversion in the first place, and has severely limited Roth IRA Conversions as a Financial Planning tool.

Other recent changes further decreased the functionality of Roth IRA Conversions for many taxpayers. In response to the COVID-19 pandemic of 2020, Congress passed the CARES Act and the SECURE Act. Under these laws, all Required Minimum Distributions (RMDs) were suspended for the year 2020, and the Required Beginning Date (RBD) for RMDs was raised from 70-1/2 to 72 for taxpayers born after June 30, 1949. Proposals currently before Congress would further raise the RBD from 72 to 75 for the same population. The most prominent of these proposals is dubbed SECURE Act 2.0. If this passes, we will report the change immediately.

Also, Congress introduced a change to the Life Expectancy Tables used to determine the amount of the RMD. Americans are living longer, and the changes reflect an increase in average life span. The new tables will reduce all future RMDs. IRS accepted the changes, but they were proposed too late for 2021, and will not be effective until 2022.

Delayed and reduced RMDs diminish the current economic value of paying current taxes on Roth IRA Conversions. Savings from a Roth IRA Conversion in 2020 will not begin to have a positive financial effect until later in life.

One further disincentive for making Roth IRA Conversions was elimination of the “Stretch” provision for most beneficiaries, part of the recent SECURE Act. No longer can a Roth IRA be inherited and “Stretched” over the lifetime of the inheritor. In place of the “Stretch” provision, Inherited IRAs today must be emptied out within 10 years, but there are no RMDs during that period. Many people were unaware that all Inherited IRAs, including Roths, were required to start RMDs in the year after death of the original owner. Over time, those RMDs were also larger than from a non-inherited IRA, as a separate formula was used for each annual withdrawal. All withdrawals from a Roth IRA remain tax-free.

Whatever your opinion regarding loss of the “Stretch” provision, today’s rules are, to me at least, less conducive to the Roth Conversion.

Further contributing to the declining value of Roth Conversions are changes to the Qualified Longevity Annuity Contract, or QLAC, which provide the account owner with a method of deferring partial RMDs for one or more years. Under the proposed SECURE Act 2.0, the maximum QLAC would be raised from $125,000 to $200,000.

No financial planning tool is suitable to everyone, but a qualified CFP® has answers for particular problems, and the training to apply available tools to your personal situations.

Van Wie Financial is fee-only. For a reason.

Once in a while I peruse my archives, assembled over nearly 20 years as a Certified Financial Planner™. Through the miracle of modern electronics, I can quickly search my writings and notes about any subject I have covered in that time, whether for clients, radio, or publications.

Lately, the topic of Roth Conversions has come up quite often, due to past changes in the tax structure that more or less encouraged making Roth Conversions. This week’s search of the topic brought up my original magazine article called Roth IRA Conversion Considerations, which was published in 2009. Reading my “old” analysis, I was surprised how negative I was on the process at that time. Until I remembered why.

Eleven years ago, taxpayers were in much higher income tax brackets. A couple filing jointly entered the 25% marginal tax bracket at the modest income level of $67,900, and the 28% bracket at $137,051. Roth Conversions add to taxable income dollar-for-dollar. In 2009, narrow tax brackets and a highly “progressive” individual tax rate structure resulted in Roth Conversions of any significance elevating tax brackets. Fortunately, income limitations probably prevented some potentially bad choices. These limits were repealed starting January 1, 2010.

Also in my archives was a 2012 update on the topic of Roth Conversions. With the re-election of President Obama, we were faced with the real possibility of higher future tax brackets. The oldest argument in favor of Roth Conversions was to guard against higher future tax rates.

Since income limits for Conversions had been lifted, there were good and valid reasons to do Conversions. Future tax-free withdrawals, coupled with the absence of future Required Minimum Distributions (RMDs), indicated a bias toward doing the Conversion for those in position to do so.

Beginning on January 1, 2018, passage of the Tax Cuts and Jobs Act of 2017 (TCJA) further favored Roth Conversions. Individual Tax Rates were lowered, and tax brackets were made much wider. The same couple reaching the 25% bracket in 2009 with income of only $67,900 could now earn up to $321,450 and still be in the 24% bracket. High earners, who likely would have significant assets for retirement, could perform relatively painless Roth Conversions, and be spared the necessity of taking unwanted RMDs in the future.

Next week we will explore recent developments that are now clouding the desirability of performing Roth Conversions.

No planning tool is suitable for everyone, but a qualified CFP® has solutions to your personal situation.

Van Wie Financial is fee-only. For a reason.

According to statisticians, the huge Baby Boomer generation is enrolling in Medicare at the rate of about 10,000 per day. Those who are not yet collecting Social Security benefits receive a monthly premium bill for Medicare Part “B.” Some are also charged for voluntary Medicare Part “D” (Prescription Drugs). These people know exactly what they are being charged for their Medicare participation.

Those who are collecting Social Security monthly benefits get their Medicare premium costs deducted from Social Security before their monthly benefit is deposited. Too often, these people are not aware of their own costs for Medicare “B” and/or Medicare “D.”

Both groups have exposure to being overcharged for their Medicare premiums. This is not a clandestine plot by the government to confiscate their money. Rather, it is a function of the paperwork flow among and between IRS, Social Security, and Medicare. IRS provides Social Security with your income figure, which is always a year behind your most recent tax filing. That amount is then applied by Social Security to next year’s Medicare premium determination. By then, the information is 2 years old.

The problem occurs when new Social Security recipients are receiving a substantially reduced amount of annual income, versus their 2-year-old Tax Returns. Reasons for income reduction can include retirement or reduction of hours, marriage or divorce, and other significant life-changing events. The U.S. Government doesn’t take responsibility for asking if your circumstances have changed. That is 100% up to you. That’s the bad news.

Here’s the good news; you are in control, but you may not know that. If you are like many people, you have a lower income in your first Medicare year than you had 2 years before. Whatever the reason, retirement being the most common, Social Security acknowledges your changes, once you inform them.

Unknown to most people is that Medicare costs more for some people than for others, based on income. Everyone is charged the “Base Rate” ($148.50 in 2021), and higher income people are also assessed a surcharge. The extra amount is called “IRMAA,” which stands for Income-Related Monthly Adjustment Amount.

Around Thanksgiving every year, Social Security mails an Informational Letter to all recipients. This letter itemizes on Page 1 your next-year charges beginning in January, including the Base Rate, and also any IRMAA surcharges you will be assessed. If you aren’t paying anything under IRMAA, you are not being overcharged.

If you are being charged under IRMAA, dig deeper to see if it is correct for your current circumstances. IRMAA brackets are itemized on page 2 of your Information Letter. If your total income has dropped, or will drop, into a lower IRMAA bracket, you may be able to get a reduction in your Medicare premiums. In fact, the process is included in your annual Information Letter, but almost nobody actually reads the entire letter.

Correcting your own Medicare pricing is not a particularly fun process, but we are talking serious money for many taxpayers. Entering your later years, saving money should be a very high priority.

There is no difference in Medicare benefits, only in costs. Medicare Part “B” has been the fastest rising cost for seniors since 2000, having risen 149% faster than inflation. Don’t make it worse. If you are confused, a qualified Certified Financial Planner® may be able to help you.

Van Wie Financial is fee-only. For a reason.

Soon, the year 2020 will be over, but will not be missed by most of us. COVID-19, wild market fluctuations, an unsettled election, a quarantined population, business closures; all will be remembered far longer than we prefer. Yet, there were some positives. Some of 2020’s good news applies to both savers and investors.

From both a business and a personal perspective, two of the highlights were passage of the CARES Act and the SECURE Act. CARES suspended all 2020 Required Minimum Distributions (RMDs) from Qualified Retirement Accounts for the year. SECURE raised the age for RMDs from 70-1/2 to 72. Both made other beneficial changes as well.

As 2020 winds down, Congress is considering revisions to the SECURE Act. The revisions have been dubbed SECURE Act 2.0. A summary of the original SECURE Act (we call it 1.0) and the proposed changes (2.0) include:

• (1.0) Repealed Age Limits for Traditional IRA Contributions. Many Americans today are working beyond the age of 70-1/2, and those workers were formerly not able to make Traditional IRA contributions. (1.0) enabled contributions from working people after age 70-1/2. (2.0) No change.
• (1.0) Raised Required Minimum Distribution (RMD) Age. Owners of Traditional IRAs and other tax-qualified retirement accounts were formerly mandated to begin taking taxable withdrawals at age 70-1/2, but (1.0) postponed beginning mandatory withdrawals until age 72. This affects anyone who was born after June 30, 1949. (2.0) Further elevates the RMD age to 75, affecting the same population.
• (1.0) Repealed and replaced “Stretch IRAs” for beneficiaries. For owners’ deaths after 2019, beneficiaries are no longer be able to take annual RMDs based on their own life expectancy. Instead, (1.0) requires the entire Inherited Account to be emptied in 10 years, with no annual requirement. (2.0) No change.
• (1.0) Proposed smaller RMDs for all. IRS agreed to update Life Expectancy tables to reflect our increasing lifespans. This would keep more money in Retirement Accounts for a longer period. Unfortunately, the tables were released too late in 2020 to take effect in 2021. (2.0) No changes proposed at this time, but the new RMD tables take effect for RMDs in 2022 (except for 2021 RMDs delayed until early 2022, which must use the old tables).

Our Federal Government claims to be in favor of the citizenry providing for themselves later in life. Financial behavior is easily influenced by the U.S. Tax Code. CARES and SECURE (1.0) made a large difference in taxation and self-reliance. We applaud the passage of both, and strongly support passage of SECURE Act (2.0). Follow this Blog, and we will report progress as it happens.

Van Wie Financial is fee-only. For a reason

Four years ago, on the Van Wie Financial Hour radio program, we discussed the economic power of fear and greed, and how mass media headlines are often designed to appeal to those emotions. Far too many headlines espouse wild claims that defy established economics, crossing over to the murky area of economic theory, practice, and real-world experience. My term for these dubious claims is Bizarro Economics.

The year 2020, being a Presidential election year, means that economic policies of both sides were and are on display. One side proposes further tax cuts to stimulate a COVID-19-related soft economy. After all, they claim, tax cuts worked every time they were tried, and as a result employment rose, as did government revenue.

Competing would-be political powers claim that they will achieve fairness by raising taxes on the rich. After all, they claim, our economy was “built from the bottom up.” That qualifies as Bizarro Economics, as there are no known instances where workers went out and hired themselves a boss. This false claim of power fosters greed.

Further “Bizarro” examples abound, such as offshoring factories to reduce the cost per unit of manufactured goods, therefore (supposedly) improving general prosperity. This pipe dream has been in place for many years, and results from the Bizarro concept that “free trade” apparently means not charging tariffs on imports, but allowing foreign companies to impose harsh tariffs on our exports to them. “Free trade” may sound good, but as millions of Americans lost solid Middle-Class employment, the American standard of living took a downturn. Declining domestic purchasing power resulted in fewer and fewer consumers, and fostered widespread economic fear. We now realize that “free trade,” as implemented prior to 2016, was not “fair trade.”

In recent years, new trade policies have resulted in factories closing overseas and reopening here. Employment was rising, wages increasing, and productivity escalating. Unfortunately, COVID-19 caused a sudden, but temporary, setback to our progress.

COVID-19 also exposed another truly frightening feature of Bizarro Economics, when we discovered that our necessary pharmaceuticals are manufactured overseas, in countries that don’t necessarily share our national security concerns. This created real, rather than politically motivated, fear. Solid economic policy must assure that our national sovereignty remains intact. Bizarro Economics apparently does not consider this a priority.

Following an election that still is not decided, the two sides are staking out their positions, and they could not be more different. I would much prefer to return to an early 2020, pre-COVID-19 economy, than to implement Bizarro Economic Theory on the false premise that it will create some hypothetical version of fairness. That simply plays to greed. Good luck, America.

Van Wie Financial is fee-only. For a reason.

It seems that nearly every fiduciary, fee-only financial planner has the same reaction when the subject of annuities arises; “I hate annuities.” While that is not acceptable, many clients will agree with them. As with most generalizations, hating a concept, such as annuities, does not constitute a true analysis of annuities or the client’s individual situation. Understanding the reasons requires a definition of the term annuity.

What annuities are is easily understood; they are transfer of risk products that supply income streams for people who need them. The income can last for life, or for a guaranteed period of time. For that purpose, they are invaluable to those who need them. Nothing else works like an annuity.

What annuities aren’t is more complicated; they are not investments, though they can be financially rewarding. Salespeople who claim that annuities are investments are misleading the public. Similarly, the home you bought to live in is not an investment, per se, but may well turn out to be financially rewarding. Not all financially rewarding purchases are investments.

Today we look at the decision-making process involving consideration of an annuity purchase.

• Step 1 is “WHEN.” By far the most common use for annuities is WHEN retirement or other events permanently curtail your stream of income. The product of choice in this circumstance is called a Single Premium Immediate Annuity, or SPIA. With a SPIA, you pay a predetermined amount of cash to an insurance company, and that company immediately begins to pay you a monthly benefit that has been determined in advance by length of guaranteed payments, prevailing interest rates, and your demographic characteristics.
• Step 2 is “HOW.” No longer do annuities have to be purchased from captive agents who represent only one insurance company. As with all capitalistic endeavors, competition can result in the best purchase being selected by the consumer. Today, annuities can be purchased through websites, independent brokers, and large custodians such as Schwab, TD Ameritrade (now part of Schwab), Vanguard, Fidelity, etc.
• Step 3 is “WHY.” The amount and nature of assets available to a person approaching retirement is as varied as our population. Desired lifestyle in retirement is just as diverse, and the result is a complicated retirement planning process. Some people already have sufficient lifetime income and/or assets to preclude any additional income needs. Others will fall short of the income goals.

In certain situations where existing assets and cash flows are insufficient for retirement, annuities can help satisfy the goal of income for life. This may be the opportune time to advocate for independent financial advice from a fee-only fiduciary. Annuities can be part of a comprehensive personal financial plan. Actually, most Americans already have an excellent annuity; Social Security. WHY someone might need another annuity is simply to solve his or her (or their) problem of providing sufficient lifetime income.

Rather than falling for a sales pitch in a fancy restaurant, it is smarter to seek comprehensive advice from a qualified CF®.

Van Wie Financial is fee-only. For a reason.

Last week we addressed investors’ expectations, reasonable and otherwise, and the potential to affect long-term success and happiness. Today, we move ahead to “adulting” your money. This step begins once the groundwork has been laid and accomplished in your investment portfolio. Typically, this stage comes when the investable assets are north of $100,000 by a comfortable margin.

At that time, most investors would benefit from establishing a relationship with a fee-only, fiduciary, Certified Financial Planner® (CFP® ), organized and operating as a Registered Investment Advisor (RIA). Many RIAs have minimum account sizes, but most will accommodate at no cost an investor who requests a meeting to discuss his or her situation. Some planners will take on smaller accounts held by serious, dedicated savers and investors. There are also planners who work on an hourly basis.

Expect a visit with a CFP® to include a comprehensive overview of your own situation, as well as an education regarding investment risk and return. Today’s financial software is very advanced, measuring your personal risk profile, your long-term goals, and planning portfolio design and construction to best fill your expectations. We suggest meeting with at least three fee-only planners or planning firms before making a decision. A long-term relationship is based on trust and respect, which must exist on both sides.

As a direct result of an initial meeting (Van Wie Financial refers to our initial discussion as the “Suitability Meeting”), further diversification should be justified and implemented. As we explained earlier, there are seven fundamental Asset Classes, and the goal should be to select assets from as many of those classes as needed to satisfy expected risk and return goals. This is integral to a comprehensive personal financial plan.

No longer is a financial plan in the form of a written document with pretty pictures, graphs, and charts, nicely bound in a three-ring binder and placed in a drawer in the den. Instead, modern software is online, accessible, and flexible enough to accommodate a changing life, changing markets, and a changing world.

Many recent studies have shown that a relationship with a fee-only CFP® produces investment results well in excess of the fees paid to that planner or firm. Don’t limit your own future by shying away from paying a professional advisor. Fees are normally deducted from the investment account, and do not require the client to write periodic checks out-of-pocket.

Van Wie Financial is fee-only. For a reason.

Last week we addressed investors who have accumulated sufficient assets to have diversified into positions in Bonds and Foreign Stocks. No longer should these investors be considered novices, but they are far from experienced. As their accounts grow, more diversification can further spread their risk, as well as improving their chances of long-term success.

Today, we are examining expectations among investors. This may be the most controversial subject we have discussed to date. Many an investor is unhappy today because of his or her unreasonable expectations. Having an understanding of long-term investment returns and principles may save a lot of future headaches.

Things you need to understand include:

• You will not “beat the market,” so don’t try (more on this below).
• Individual stocks are very risky. Good things happen to bad companies, and bad things happen to good companies. Spread the individual stock risk through diversification.
• Annuities are not investments, but rather transfer-of-risk products. This does not mean that they are useless by any means. They solve certain problems for certain people, but are historically over-sold.
• Commissioned salespeople are not required by law to place your interests ahead of their own. Fiduciaries (such as Van Wie Financial) are required to place your interests first.
• The market always over-reacts to events, so don’t be a lemming and blindly follow. Greed and fear, when acted upon, cause investors a great deal of pain.
• Losses feel worse than gains feel good, so minimize losses for long-term success.
• Make a plan before you invest. A “starter” plan can be simple, but it must remain flexible to accommodate growth and changing personal situations over time. A Financial Plan is not a document; it is a process.

“Beating the market” implies that your personal returns would be higher that the major market indices, which are comprised only of Domestic Stocks. You may outperform common market indices over a short time period, but don’t count on doing that for too long. A reasonable goal for investors involves understanding and accepting both a targeted return, and corresponding risk, over a long time period.

The Dow-Jones Industrial Average represents only 30 very large companies. The S&P500 Index contains 500 large company stocks, and the NASDAQ Composite contains a motley assortment of over 2500 company stocks. They sample only the first of our seven Asset Classes, Domestic Stocks. True diversification into several asset classes renders irrelevant any direct comparison between stock indices and an investor’s portfolio.

Nest week we will discuss the necessary relationship between risk and return in various portfolios.

Van Wie Financial is fee-only. For a reason.

For the past couple of weeks, we have chronicled the steps that new investors should take to begin investing for the long term. Review those Blogs if you are catching up and interested in one of the most important aspects of “adulting” – preparing for personal long-term financial independence. Today we further explain the reasoning behind our recommendations in the last two Blog entries.

Last week we addressed investors who have accumulated between $50k and $100k in long-term investment assets. While technically no longer ranked novices, these people are unlikely to have a good understanding of the fundamental goals of portfolio diversification. In a previous Blog, we addressed the “why” aspect, so today we will begin explaining the “how.”

As we noted last week, the investing universe is comprised of 7 fundamental classes of assets; Domestic Stocks, Domestic Bonds, Foreign Stocks, Foreign Bonds, Cash (and Equivalents), Real Estate, and Hedges. Most are self-explanatory, and we will deal with hedges in a future Blog.

“How” to include more Asset Classes in a portfolio requires an understanding of some basic mathematical principles. In this case, the term in the spotlight is “correlation.” When two variables move together, they are called “correlated.” The closer movements are to each other over time, the higher the correlation. When two variables move in opposite directions, they are called “inversely (or negatively) correlated.” The “correlation coefficient” scale runs from -1.0 to +1.0. A diversified portfolio seeks to achieve a correlation coefficient that is low, or even negative.

As markets move, a low correlation means that as some items go down in value, the portfolio does not go down as much, if at all, because other assets may rise. Over time, multiple Asset Class portfolios will generally experience smaller losses then a 100% stock portfolio. When resultant declines are lower, and the recovery period shortened. Regaining lost ground quickly is the essence of long-term successful investing success.

The novice investor who has accumulated shares in a broad market Exchange-Traded Fund (ETF – see last week’s Blog for explanation) is participating only in the first Asset Class, Domestic Stocks. Somewhere between account values reaching $50,000 and $100,000, it is time to add at least one other Asset Class. As discussed last week, this is generally done by introducing bonds in the portfolio.

We also mentioned that our current interest rate environment is not conducive to holding a large percentage of bonds. Therefore, to enhance diversification, we must choose yet another Asset class. Right now, we are interested in Foreign Stocks. Again, we are not suggesting placing a large percentage of Foreign Stocks in a portfolio; about 10% is enough to influence results.

In the Foreign Stock Asset Class, we often use actively managed mutual funds, as fund managers have more time and expertise to make their stock selections. When contemplating any mutual fund, be sure to do some research. Begin by only looking only for “no-load” funds, meaning there is no sales charge to buy or sell shares. Look at the track record of the managers, the reputation of the affiliated company, and the internal costs of the fund itself. There is much to learn, but learning and adhering to the fundamentals will improve your chances of success.

Van Wie Financial is fee-only. For a reason.