Welcome to another edition of Notes Along the Path!
This month's topics:
- Secure Act 2.0 - proposed legislation
- Market Update: Stocks Reach New Highs - again.
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Secure Act 2.0
In late 2019, the president signed the SECURE (Setting Every Community Up for Retirement Enhancement) Act.
The starting age for required minimum distributions (RMDs) for employer-sponsored plans and IRA accounts was raised from 70 ½ to 72 years old. It was a welcome change. The act also included more minor changes that aided workers in saving for retirement.
But the SECURE Act also changed the rules which govern inherited IRAs, or so-called stretch IRAs. The change in this provision was more controversial because it required faster distributions, at least in most cases.
Although the changes are recent, Congress is already considering what many are calling SECURE Act 2.0. As the bill winds its way through Congress, there is no guarantee of passage. But it enjoys widespread bipartisan support, and both the Senate and the House have drafted similar bills.
The devil is always in the details, but we are monitoring progress and believe now is an excellent time to provide a high-level overview of the proposals.
Please feel free to check in with your tax advisor on tax-related matters.
- Easing the RMD bite, again:
As already mentioned, an RMD from a traditional IRA isn't required until 72. SECURE Act 2.0 would raise the RMD to 73 in 2022, 74 in 2029, and 75 in 2032.
Taking your first distribution from a tax-deferred retirement account will depend on many factors. Still, if the funds are not needed, it is usually a good idea to defer withdrawals until required.
By delaying a withdrawal, the investments maintain their tax-exempt status. Or, if you need cash before RMDs are required, you decide how much to withdraw. An arbitrary rule does not bind you.
The exception to this logic comes late in life. If it looks likely that you will leave a significant legacy to your children or other heirs, you should remember that inherited IRAs do not get a step-up in basis, but taxable accounts do. The optimal withdrawal strategy may change if the heir's position is given priority, so talk to your advisor about the differences when you reach age 80 or so.
- A more favorable catch-up provision:
If Secure Act 2.0 is passed into law, employees 50 and older can make extra catch-up contributions to a 401(k) or similar plan. The limit for 2021 is $6,500, which is indexed to inflation.
As proposed, Secure 2.0 maintains the catch-up limits for those aged 50 but increases the annual catch-up provision to $10,000 for participants ages 62 through 64. The new limit begins in 2023. This new maximum is indexed to inflation.
However, all catch-up contributions must be placed in a Roth IRA, which would disallow a tax deduction. Starting in 2022, all catch-up contributions must be made into a Roth IRA.
Presumably, it's a way for the government to capture revenue. Nonetheless, ROTH IRAs are not subject to RMDs, and withdrawals are exempt from federal income taxes.
- Student loan matching:
SECURE Act 2.0 would permit employers to make matching contributions to their 401(k) plans tied to the employee's student loan payments. The goal: encourage younger employees to save for retirement.
It would also help employers pass nondiscrimination tests that prevent plans from favoring higher-income employers.
While we recognize this provision will probably complicate the administration of a 401(k) plan, we applaud the proposal simply because we know that the sooner one begins saving for retirement, the sooner one may enjoy the power of compounded returns. As we always counsel, it's never too early to start saving.
The proposed changes discussed are the more critical components of the proposed act, in our view. But we also wanted to mention some of the additional provisions briefly.
SECURE Act 2.0 would also:
- Allow Roth contributions to SEP and SIMPLE plans
- Accelerate part-time workers' participation in 401(k) plans
- Extend to 403(b) retirement plans some of the features of 401(k) plans
- Require the Treasury secretary to increase awareness of the Retirement Savings Contributions Credit (also known as the saver's credit), which is available to low- and moderate-income workers
- Eliminate some impediments to offering lifetime income annuities as a retirement plan investment option
It would also place limits on employers who attempt to capture excess plan payments from a participant.
SECURE Act 2.0 may pass as proposed, changes could be made, or the bill could run into unforeseen obstacles that prevent it from being enacted into law.
As we have already said, the review is a high-level peek at what is being proposed. Any advice we may provide will be tailored to your circumstances.
We suspect changes to the proposed law will probably be made, but odds favor passage. We are happy to entertain any questions.
The Seemingly Unstoppable Bull Market
Whether from clients or acquaintances, there has been no shortage of inquiries about the market's astounding rise.
During August, we saw multiple highs on the broad-based S&P 500 Index, while the tech-heavy NASDAQ Composite topped 15,000 for the first time, according to data provided by Yahoo Finance.
Let's offer a simple perspective. On August 18, 2020, the S&P 500 Index closed at a new high of 3,389.78, erasing all the losses incurred during the lockdowns and the Covid recession, according to S&P data from the St. Louis Federal Reserve. The S&P 500's prior peak of 3,386.15 occurred on February 19, 2020.
Since eclipsing its former high, the S&P 500 Index has racked up a gain of 33.4%, excluding reinvested dividends, through August 31, 2021 - an advance of over 30% in just over one year.
Sure, it's a back-of-the-envelope analysis, but it illustrates a straightforward idea: the rise in the stock market has been impressive.
That said, let's get back to the question about the market's astounding rise. Most folks don't understand it. I've heard it in casual conversations, and you have probably heard it, too. And many seem to expect (or want) a significant pullback.
We get it. While we believe that a diversified approach to stocks helps one participate in the long-term upward bias of stocks, we are hesitant to try to time the market or predict where a major index might be in one month, six months, or one year. However, we'd never discount the possibility of a market pullback over the near term.
I often say that the next correction is coming because a correction is always coming. We just don't know how long we have to wait for it to arrive.
You may have heard the phrase that "stocks are priced for perfection." I disagree.
Stocks are undoubtedly expensive by historical standards, but those standards will continue to change over time. More and more, millennials are driving the economic bus, and surveys show they are much more comfortable with the volatility of the stock market and willing to pay more for a dollar of earnings.
Still, when stocks are expensive, we subscribe to the idea that the market could be vulnerable to a selloff since any negative surprises can broadside overly optimistic investors.
We have seen it happen before, but it has not happened over the last year. Declines have been minor and short-lived.
During August, the rise in Covid cases tied to the Delta variant briefly caused volatility. Still, investors are not on board with the idea that the health crisis will substantially slow the economic recovery and dampen corporate profits.
While some locales are re-implementing mask requirements, we have yet to see the type of restrictions that were in place in 2020 and early 2021. For now, the market is viewing the vaccines as an inoculation against a rapid slowdown in the economy.
We also saw tragic events play out in Afghanistan. While the images have been difficult to see and the geopolitical ramifications are unknown, simply put, investors don't expect the US withdrawal to have an impact on US economic growth over the next six to nine months.
I recognize that's a harsh way of viewing an unsettling situation that is tragic for many. But investors, both large and small (who continually and collectively make buy and sell decisions), have a very narrow lens. That lens is primarily targeted toward future economic growth, profits, Federal Reserve policy, and interest rates.
Let's look at it from a more practical angle. Will consumers decide to delay a vacation, a big purchase, or simply eat at home rather than dining in a restaurant because of what's happening in Asia? It's improbable.
Are stocks priced for perfection? In hindsight, all the ingredients for a strong rally have been in place over much of 2021: a robust economic recovery, much better-than-expected corporate profits, plenty of liquidity, and extremely low interest rates. Companies that trade on the stock market continue to take a larger slice of America's economic pie at the expense of small businesses.
Let's review one of the pillars that have been significant support for shares: low interest rates.
Low interest rates not only help fuel market gains but also help support higher valuations.
While we will spare you a mind-numbing explanation of discounted cash flows, a quick way to explain how low rates influence equity prices is with a simple example. Low interest rates provide very little competition to stocks.
Low rates encourage investors to look at stocks and other riskier investments rather than settle for safe but paltry returns.
This is especially true when the economy is expanding, corporate profits are soaring, and analysts ramp up future earnings estimates. In other words, it is not simply low rates, but low rates combined with solid profit growth.
Today, there are few signs that economic growth is set to slow much.
Looking ahead, Fed Chief Jerome Powell said last month in a late August speech that the Fed is openly pondering a cutback in its monthly purchases of bonds; however, he did not provide a firm timetable.
Many analysts expect something more concrete will be forthcoming this year. But the Fed hasn't committed, which gives it wiggle room in the event economic growth or job growth unexpectedly slows. But any reduction in bond buys will be well telegraphed.
Furthermore, Powell insisted last month that rate hikes are not on the table right now, and the hurdle to raise interest rates is higher than cutting back on its monthly bond buys.
As we have said before, the pace of economic growth, employment growth, and what happens to inflation will likely have the most significant influence on when and how quickly interest rates might rise.
As we enter September, investors will consider whether lofty valuations can hold up to the unwinding of fiscal stimulus and the potential for a reduction in Federal Reserve bond buys later in the year. Eventually, a market pullback is inevitable. For now, powerful tailwinds have been supportive.
I trust you've found this review to be educational and informative.
If you have any questions or would like to discuss any matters, please feel free to give me or any of my team members a call.
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I remain honored and humbled that my clients have allowed me to serve as their financial advisor. Thank you for your support.
All the Best!
Gordon Achtermann, CFP®