Sequels are Never As Good – Are They?

Sequels are never as good – are they? Well, that may just hold to movies. There’s plenty of new tax & retirement planning implications from SECURE Act 2.0, passed Dec. 29, 2022.

The original 2020 act had many impactful provisions, but we’ll remind everyone of one very significant change: money in retirement plans that is inherited by non-spouse beneficiaries generally must be taken out (and taxed) within 10 years. Previously, tax law allowed distributions from inherited retirement money to be stretched over the course of the beneficiary’s lifetime.

The retirement and tax planning implications from the SECURE Act 2.0 are far broader – there are over 100 provisions – but no single change is as impactful as the elimination of the stretch IRA in the first bill. Given the breadth of provisions, we’ll focus on three of the most important areas for our clients and their families.

Required Minimum Distributions:

The first Secure Act pushed the required age at which distributions must be taken from retirement plans back from age 70.5 to 72. If you were was born before 1951, there’s no change since you’re already taking distributions. For those born between 1951 and 1959, RMDs now begin at age 73. If you were born after 1960, the first RMD has been pushed back to age 75.

What’s the impact on me?

  • For those who started taking RMDs in 2022 and prior, there’s no impact.
  • For everyone else, there will be a longer gap of time between retirement and your RMD age. The potential for lower income during that “gap” allows for additional tax planning – such as Roth conversions, taking capital gains at 0% or 15%, and even taking a distribution from a retirement plan voluntarily while in a low tax bracket. It also means your tax rate on distributions from age 73/75 through the end of your life could be higher, since there will be more income those years.

There are a number of other provisions relating to distributions as well – two of which we discuss below.

  • For those that are charitably inclined: there’s no impact to the age at which a “qualified charitable distribution” (QCD) can be made (age 70.5). However, the wider gap between when someone may take RMDs and their age 70.5 opens the door to more tax planning opportunities.
    • There are several other provisions related to QCDs that don’t apply to many retired givers, such as an inflation-indexed maximum and a one-time ability to fund a split-interest entity (e.g., a Charitable Remainder Annuity Trust).
  • Lastly, we’ll note that there’s a provision allowing a spouse to elect to take RMDs as if he/she was the original IRA’s owner. It gets complicated, but this could make sense for the older spouse to elect before a younger spouse passes away so that the older, surviving spouse can use the decedent’s life expectancy to delay and stretch out required distributions.

Next up: there were many provisions related to Roth contributions. Notably, this bill did not close the ability to make “back-door Roth IRA” contributions. Rather than restricting Roth access, the bill’s various provisions expand access to or in some cases even require Roth contributions instead of the traditional “pre-tax” contributions. The idea behind why Congress is expanding Roth features is straightforward: it benefits the government via higher current tax revenue, and it helps savers via additional opportunities to grow tax-free wealth. Here are some details on two of the more interesting provisions:

Catch-up Contributions:

Effective in 2024 and for plans offering a Roth option, high wage earners will be required to contribute after-tax money via the Roth option of a retirement plan for any catch-up contributions. High wage earners are defined as making at least $145,000 from the employer whose plan the catch-up contributions are being made into. Catch-up contributions are allowed for employees age 50+. For 2023, after contributing the regular maximum of $22,500 into a retirement plan, employees age 50+ can still make their optional catch-up contributions of $7,500 with pre-tax money.

  • Further, catch-up contributions for participants aged 60-63 will be bumped up to a maximum of 150% of the regular catch-up amount. Though this provision takes effect in 2025, if it did apply to 2023 contributions, the “bumped up” maximum would be $11,250. Keep in mind that all this would have to be after-tax wages going into the Roth portion of the plan starting next year.

529-to-Roth Transfers

Starting in 2024, it will now be possible to transfer money leftover in a 529 plan to a Roth IRA for the beneficiary. In the past it usually didn’t make sense to fully fund a 529 plan since earnings on non-qualified withdrawals are subject to taxes and a 10% penalty. But now that there’s a release hatch for excess dollars, there will be more client situations where attempting to fully fund college with 529 plans will make sense. There is still some cloudiness that the IRS will clarify but as the law is written this release hatch is here to stay. Here are some major restrictions on this new ability:

  • The transfer must be a direct rollover into the Roth IRA of the 529 plan’s beneficiary. It can’t go to the owner’s Roth IRA.
  • The beneficiary must have earned income during the year of the rollover. However, the income limit that normally applies for Roth IRA contribution eligibility will not apply for these rollovers.
  • The IRA contribution limit still caps the total amount that can go into the Roth IRA each year ($6,500 in 2023). The maximum applies to the combined total of contributions and rollovers from a 529 plan – no doubling up!
  • The 529 plan must have been maintained for at least 15 years and money contributed within the last 5 years cannot be moved into the Roth IRA.
  • A lifetime transfer maximum of $35,000 applies to each beneficiary.

As you can see, these limitations mean that 529 plans should still be used with education funding as the intent. But this provision will provide flexibility to fund a 529 plan more aggressively if considered along with cash flow, retirement plan strength, and estate planning considerations.

There are over 100 provisions in the SECURE Act 2.0 – so we’ve only scratched the surface when it comes to the breadth of new changes. However, these are some of the most applicable changes for Boardwalk clients. Please let us know if you’re interested in learning more about the SECURE Act 2.0 and how it applies to your situation. But rest assured, we will be bringing planning considerations to you as we meet – including any financial planning recommendations based on the other provisions not outlined here.

Six Financial Best Practices for Year-End 2022

Picture of Mike Rodenbaugh

Mike Rodenbaugh

Founder

To say the least, there’s been plenty of political, financial, and economic action this year—from rising interest rates, to elevated inflation, to ongoing market turmoil.

How will all the excitement translate into annual performance in our investment portfolios? Markets often deliver their best returns just when we’re most discouraged. So, who knows!

Over the past few weeks, we have taken these six action steps on behalf of our clients. However, if you are not a client of Boardwalk Financial Strategies, now is a good time to take action before 2022 is a wrap.

1. Revisit Your Cash Reserves

Where is your cash stashed these days? After years of offering essentially zero interest in money markets, savings accounts, and similar platforms, some banks are now offering higher interest rates to savers. Others are not. Plus, some money market funds may have quietly resumed charging underlying management fees they had waived during low-rate times.

It might pay to …

Shop around: If you have significant cash reserves, now may be a good time to compare rates and fees among local institutions, virtual banks, and/or online services that shift your money around depending on best available offers (for a fee). Double check fees; make sure your money remains FDIC-insured; and remember, if it sounds too amazing to be true, it probably is.

2. Put Your Money to Work

If you’re sitting on excess cash, you may be able to put it to even better use under current conditions.

Here are three possibilities:

Rebalance: You can use cash reserves to top off investments that may be underweight in your portfolio. Many stock market prices have been depressed as well, so this may be an opportune time to “buy low,” if it makes sense within your investment plans.

Lighten your debt load: Carrying high-interest debt is a threat to your financial well-being, especially in times of rising rates. Consider paying off credit card balances, or at least avoid adding to them during the holiday season.

Buy some I bonds: For cash you won’t need for a year or more, Treasury Series I bonds may still be a good deal, as described in this Humble Dollar post.

3. Replenish Your Cash Reserves

Not everybody has extra money sitting around in their savings accounts. Here are a couple ways to rebuild your reserves.

Earning more? Save more: To offset inflation, Social Security recipients are set to receive among the biggest Cost-of-Living Adjustments (COLAs) ever. Or, if you’re still employed, you may have received a raise or bonus at work for similar reasons. Rather than simply spending these or other new-found assets, consider channeling a prescribed percentage of them to saving or investing activities, as described above. If you repurpose extra money as soon as it comes in, you’re less likely to miss it.

Tap Required Minimum Distributions (RMDs): If you need to take required minimum distributions (RMDs) from your own or inherited retirement accounts, that’s a must-do before year-end. Set aside enough to cover the taxes, but the rest could be used for any of the aforementioned activities. Another option during down markets is to make “in-kind” distributions: Instead of converting to cash, you simply distribute holdings as is from a tax-sheltered to a taxable account. Or, to avoid being taxed on the distribution, you also could donate the assets through a Qualified Charitable Distribution to your favorite non-profit organization.

4. Make Some Smooth Tax-Planning Moves

Another way to save more money is to pay less tax. Here are a couple of year-end ideas for that.

It’s still harvest season: Market downturns often present opportunities to engage in tax-loss harvesting by selling taxable shares at a loss, and promptly reinvesting the proceeds in a similar (but not identical) fund. You can then use the losses to offset taxable gains, without significantly altering your investment mix. When appropriate, we’ve been helping [firm name] clients harvest tax losses throughout 2022. There still may be opportunities before year-end, especially if you’ve not yet harvested losses year to date. We encourage you to consult with a tax professional first; tax-loss harvesting isn’t for everyone, and must be carefully managed.

Watch out for dividend distributions: Whether a fund’s share price has gone up, down, or sideways, its managers typically make capital gain distributions in early December, based on the fund’s underlying year-to-date trading activities through October. In your taxable accounts, if you don’t have compelling reasons to buy into a fund just before its distribution date, you may want to wait until afterward. On the flip side, if you are planning to sell a taxable fund anyway—or you were planning to donate a highly appreciated fund to charity—doing so prior to its distribution date might spare you some taxable gains.

5. Check Up on Your Healthcare Coverage

As year-end approaches, make sure you and your family have made the most of your healthcare coverage.

Examine all your benefits: For example, if you have a Health Savings Account (HSA), have you funded it for the year? If you have a Flexible Spending Account (FSA), have you spent any balance you cannot carry forward? If you’ve already met your annual deductible, are there additional covered expenses worth incurring before 2023 re-sets the meter? If you’re eligible for free annual wellness exams or other benefits, have you used them?   

6. Get Set for 2023

Why wait for 2023 to start anew? Year-end can be an ideal time to take stock of where you stand, and what you’d like to achieve in the year ahead. 

Audit your household interests: What’s changed, and what hasn’t? Have you welcomed new family members or bid others farewell? Changed careers or decided to retire? Received financial windfalls or incurred capital losses? Added new hobbies or encountered personal setbacks? How might these and other significant life events alter your ideal investment allocations, cash-flow requirements, insurance coverage, estate plans, and more? Take an hour or so to list key updates in your life, so you can hit the ground running in 2023.

How We Help?

At Boardwalk Financial Strategies, we do all of this and more for our clients. We are with them through every transition and help them navigate life’s changes. We ensure every component that contributes to their financial well-being is well positioned—today, and throughout the years ahead.

How Much Does Your Attention Impact Your Finances?

Many of the most recent breakthroughs in financial research have been discovered by psychologists rather than economists or investment researchers.  The branch of study they’ve pioneered is known as “behavioral finance.”  This was evidenced in 2002, when the Nobel Prize in Economics was given to psychologist Daniel Kahneman.  The insights gained from research in behavioral finance reveal how our brains process decision making and how this can heavily impact our finances – in both helpful and harmful ways.  Of the many behavioral biases that we can have, many are rooted in how we apply our attention.

As humans, we tend to avoid “headline” risks (like those on the front page of the newspaper or widely discussed in public).  While this seems appropriate, this tendency often causes us to take on larger but lesser known risks.  A good example of this occurred in the aftermath of September 11, 2001.  Due to the “headline risk” of flying, more people opted to drive instead of fly even though air travel is much safer than driving – especially over long distances.  Professor Gerd Gigerenzer, the director of the Harding Center for Risk Literacy in Berlin, estimates that an extra 1,595 Americans died in car accidents in the year after the attacks due to this tendency.  Because of our poor understanding of danger, the maxim “out of the frying pan into the fire” often applies to our behavior.  This holds true in our financial decisions.  If the stock market crashes, it is understandable that many people don’t want their portfolios to suffer the same fate.  Avoiding this risk by holding excess bonds or cash in advance may accomplish that, but at a near certain risk of their portfolio failing to generate sufficient inflation-adjusted returns.  Even more, deciding amid a downturn to offload risk by selling stocks in favor of bonds or cash poses an even more significant risk to the portfolio’s recovery.  It matters where we focus our attention – are we just “seeing” headline risks or are we focused on our exposure to real risks and actively working on what we can control?

Just how it’s easy to focus on “headline” risks, we also tend to commit our attention to seeking complex solutions rather than embracing simple, powerful ones.  As a derivative of this behavioral bias, we often try to “outsmart” the system.  A study, “The Left Hemisphere’s Role in Hypothesis Formation,” published by The Journal of Neuroscience in 2000, examined how humans and animals “guess” when certain probabilities are in place.  In one experiment, 80% of the time a light would appear on the right.  The remainder of the time it was on the left, but the sequence was random.  Prior to each trial, the subject would predict which side the light would be on.  Rats, discovering that the light on the right would appear most times, continually selected that side.  On the other hand, humans tried to use frequency matching to guess when the left light would appear – with minimal success!   Human subjects chose a less optimal strategy than rats because of our desire to find patterns and outsmart the system.  Like in this study, we tend to overlook the simple solutions to investing intelligently.  Instead, we attempt to beat the rest of the market with exotic or complex solutions.

The simple but powerful index fund doesn’t have all the bells and whistles that actively managed mutual funds tout, but they have outperformed most active managers over the past decade.  According to S&P Dow Jones’s 2017 SPIVA (“S&P Indexes Vs. Active”) scorecard, 63.43% of actively managed funds invested in U.S. stocks underperformed their benchmark in 2017 – over a three-year period the number of underperforming funds jumps to 83.40% and at 10 years reaches 86.65%.  In some categories, like funds invested in U.S. “small-cap” stocks, less than 5% of actively managed funds outperform their benchmark over a period of 10 years.  Despite not offering all the expertise of fund managers and their bold predictions, a simple strategy for diversification – the index fund – almost always wins out.  Our human desire for complexities is seen even more in the appeal of hedge funds and the way pensions and endowment funds typically invest.  As a testimony to simple, powerful investing solutions, my alma mater, Carthage College, was featured in numerous articles for having better returns than Harvard’s $37 billion endowment fund over the 10-year period leading up to June 30, 2017.  When asked why reliance on indexing isn’t more common among the nation’s endowments, Carthage’s endowment manager replied, “Maybe it’s too simple.” 

At Boardwalk Financial Strategies, one of our goals is to help you focus your attention on the important things and not let behavioral biases negatively impact your wealth.  Where we focus attention often gets the better of us: humans focus on avoiding “headline risks” (even if we take on larger but lesser known risks) and overlook simple, powerful solutions because of our desire for complex solutions.  It can be hard at times to not let our impulses dictate how we invest money or handle financial decisions.  But we believe focusing our attention on the things we can control – like financial planning – and utilizing an academic, data-driven (though simple) investment philosophy are ways we can help you build wealth, remove financial stress, and find the time and peace to enjoy what matters most to you in life.