2019’s final edition of Your Money / Our Thoughts
Quote of the Week
“We make a living by what we get, but we make a life by what we give.” – Winston Churchill
U.S. stocks rallied slightly last week to a fresh new high. Bank of America came out with a prediction last week of a “stock market melt up”. I am sure that they were basing their predication on three issues that have dominated the market narrative for most of 2019.
Issue number one is the “phase one” of a new trade deal with China easing fears of further trade escalation. The agreement, which has not yet been finalized, includes China making agricultural purchases from the U.S. or otherwise known as the “bean deal” plus some tariff relief. The “agreement” really doesn’t lower the tariffs already in place except for the lowering of the latest tariff increase from 15% to 7.5% on a small portion of the overall trade with China. I think this is just a deal to get a deal. The damage has already been done to the old trade arrangements with China. Also, this deal still does not give American businesses any real guidance as to expanding capital expenditures on hiring and plant expansion.
Issue number two is the U.K. prime minister, Boris Johnson, received a strong mandate after his party won the majority in the general elections, which reduces some of the political uncertainty as the country negotiates its exit from the European Union. Every economist that I have read says this should be an economic disaster for the U.K.
Issue number three is the Federal Reserve (Fed) left interest rates unchanged last week, signaling a pause through 2020. I think the Fed is behind the curve and should lower interest rates because the dollar is too high in comparison to other currencies around the world. Remember, with a strong dollar, our goods and services are less competitive, so will sell less in competition with other countries.
With the recent headlines like “Melt up” and “Buy High and Let It Fly” (Barron’s) what could possibly go wrong? Well, let’s count the ways. According to Hedgeye, the fourth-quarter GDP is now forecast to come in around +0.39%. Corporate earnings for S&P 500 companies are expected to be negative for the fourth quarter. Stock valuations are stretched due to the market value increase and declining earnings. Industrial production is down and the “PMI Bounce” hopes ran into a no-bounce Market PMI of 52.5 in December. U.S. retail sales dropped to a 7-month low as per the U.S. Retail Sales Control Group.
I certainly don’t know what the future will bring for the markets. As Yogi Berra says, “Predicting is hard, especially about the future”. But this is setting up as 1999 and we all know what happened from 2000 to 2002. So, we are going to maintain our cautious positions and take advantage of inflation-sensitive investments such as REITs, Utilities, Energy, Gold, and TIPs.
Next year in Larry’s Thoughts I will be explaining in detail the investment system we use to manage your assets.
I wish everyone a Happy Holiday Season.
The last time I penned the “Thoughts” section, I mentioned that my husband had recently retired. It’s been about six months now, and since then, I look at expenses very differently. I’ve always tried my best to be frugal, or a cheapskate as my kids would tell you, and I am more so now! It’s a relief that I am still able to contribute to our savings while we figure out this retirement gig!
The following article offers some strategies for living off your savings in your retirement years.
Converting Savings to Retirement Income
During your working years, you’ve probably set aside funds in retirement accounts such as IRAs, 401(k)s, or other workplace savings plans, as well as in taxable accounts. Your challenge during retirement is to convert those savings into an ongoing income stream that will provide adequate income throughout your retirement years.
Setting a withdrawal rate
The retirement lifestyle you can afford will depend not only on your assets and investment choices, but also on how quickly you draw down your retirement portfolio. The annual percentage that you take out of your portfolio, whether from returns or both returns and principal, is known as your withdrawal rate. Figuring out an appropriate initial withdrawal rate is a key issue in retirement planning and presents many challenges. Why? Take out too much too soon, and you might run out of money in your later years. Take out too little, and you might not enjoy your retirement years as much as you could. Your withdrawal rate is especially important in the early years of your retirement, as it will have a lasting impact on how long your savings last.
One widely used guideline on withdrawal rates for tax-deferred retirement accounts that emerged in the 1990s stated that withdrawing slightly more than 4% annually from a balanced portfolio of large-cap equities and bonds would provide inflation-adjusted income for at least 30 years. However, more recent studies have found that this guideline may be too generalized. Individuals may not be able to sustain a 4% withdrawal rate, or may even be able to support a higher rate, depending on their individual circumstances. The bottom line is that there is no standard guideline that works for everyone — your particular withdrawal rate needs to take into account many factors, including, but not limited to, your asset allocation and projected rate of return, annual income targets (accounting for inflation as desired), investment horizon, and life expectancy. 1
Which assets should you draw from first?
You may have assets in accounts that are taxable (e.g., CDs, mutual funds), tax deferred (e.g., traditional IRAs), and tax free (e.g., Roth IRAs). Given a choice, which type of account should you withdraw from first? The answer is — it depends.
For retirees who don’t care about leaving an estate to beneficiaries, the answer is simple in theory: withdraw money from taxable accounts first, then tax-deferred accounts, and lastly, tax-free accounts. By using your tax-favored accounts last, and avoiding taxes as long as possible, you’ll keep more of your retirement dollars working for you.
For retirees who intend to leave assets to beneficiaries, the analysis is more complicated. You need to coordinate your retirement planning with your estate plan. For example, if you have appreciated or rapidly appreciating assets, it may be more advantageous for you to withdraw from tax-deferred and tax-free accounts first. This is because these accounts will not receive a step-up in basis at your death, as many of your other assets will.
However, this may not always be the best strategy. For example, if you intend to leave your entire estate to your spouse, it may make sense to withdraw from taxable accounts first. This is because spouses are given preferential tax treatment with regard to retirement plans. A surviving spouse can roll over retirement plan funds to his or her own IRA or retirement plan, or, in some cases, may continue the deceased spouse’s plan as his or her own. The funds in the plan continue to grow tax deferred, and distributions need not begin until the spouse’s own required beginning date.
The bottom line is that this decision is also a complicated one. A financial professional can help you determine the best course based on your individual circumstances.
Certain distributions are required
In practice, your choice of which assets to draw first may, to some extent, be directed by tax rules. You can’t keep your money in tax-deferred retirement accounts forever. The law requires you to start taking distributions — called “required minimum distributions” or RMDs — from traditional IRAs by April 1 of the year following the year you turn age 70½, whether you need the money or not. For employer plans, RMDs must begin by April 1 of the year following the year you turn 70½ or, if later, the year you retire. Roth IRAs aren’t subject to the lifetime RMD rules. (Beneficiaries of either type of IRA are required to take RMDs after the IRA owner’s death.)
If you have more than one IRA, a required distribution is calculated separately for each IRA. These amounts are then added together to determine your RMD for the year. You can withdraw your RMD from any one or more of your IRAs. (Your traditional IRA trustee or custodian must tell you how much you’re required to take out each year, or offer to calculate it for you.) For employer retirement plans, your plan will calculate the RMD, and distribute it to you. (If you participate in more than one employer plan, your RMD will be determined separately for each plan.)
It’s important to take RMDs into account when contemplating how you’ll withdraw money from your savings. Why? If you withdraw less than your RMD, you will pay a penalty tax equal to 50% of the amount you failed to withdraw. The good news: you can always withdraw more than your RMD amount.
If you’ve used an annuity for part of your retirement savings, at some point you’ll need to consider your options for converting the annuity into income. You can choose to simply withdraw earnings (or earnings and principal) from the annuity. There are several ways of doing this. You can withdraw all of the money in the annuity (both the principal and earnings) in one lump sum. You can also withdraw the money over a period of time through regular or irregular withdrawals. By choosing to make withdrawals from your annuity, you continue to have control over money you have invested in the annuity. However, if you systematically withdraw the principal and the earnings from the annuity, there is no guarantee that the funds in the annuity will last for your entire lifetime, unless you have separately purchased a rider that provides guaranteed minimum income payments for life (without annuitization).
In general, your withdrawals will be subject to income tax — on an “income-first” basis — to the extent your cash surrender value exceeds your investment in the contract. The taxable portion of your withdrawal may also be subject to a 10% early distribution penalty if you haven’t reached age 59½, unless an exception applies.
A second distribution option is called the guaranteed* income (or annuitization) option. If you select this option, your annuity will be “annuitized,” which means that the current value of your annuity is converted into a stream of payments. This allows you to receive a guaranteed* income stream from the annuity. The annuity issuer promises to pay you an amount of money on a periodic basis (e.g., monthly, yearly, etc.).
If you elect to annuitize, the periodic payments you receive are called annuity payouts. You can elect to receive either a fixed amount for each payment period or a variable amount for each period. You can receive the income stream for your entire lifetime (no matter how long you live), or you can receive the income stream for a specific time period (ten years, for example). You can also elect to receive annuity payouts over your lifetime and the lifetime of another person (called a “joint and survivor annuity”). The amount you receive for each payment period will depend on the cash value of the annuity, how earnings are credited to your account (whether fixed or variable), and the age at which you begin receiving annuity payments. The length of the distribution period will also affect how much you receive. For example, if you are 65 years old and elect to receive annuity payments over your entire lifetime, the amount of each payment you’ll receive will be less than if you had elected to receive annuity payouts over five years.
Each annuity payment is part nontaxable return of your investment in the contract and part payment of taxable accumulated earnings (until the investment in the contract is exhausted).
Copyright 2019 Broadridge Investor Communication Solutions, Inc
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These are the opinions of Larry Lof and Stephanie Mayoral and not necessarily those of Cambridge, are for informational purposes only, and should not be construed or acted upon as individualized investment advice. Past performance is not indicative of future results. Due to our compliance review process, delayed dissemination of this commentary occurs.
The S&P 500 is an index of stocks compiled by Standard & Poor’s, a division of The McGraw-Hill Companies, Inc. The index includes a representative sample of 500 leading companies in leading industries of the U.S. economy. Indices mentioned are unmanaged and cannot be invested into directly.
Technical analysis represents an observation of past performance and trend, and past performance and trend are no guarantee of future performance, price, or trend. The price movements within capital markets cannot be guaranteed and always remain uncertain. The allocation discussed herein is not designed based on the individual needs of any one specific client or investor. In other words, it is not a customized strategy designed on the specific financial circumstances of the client. Please consult an advisor to discuss your individual situation before making any investments decision. Investing in securities involves risk of loss. Further, depending on the different types of investments, there may be varying degrees of risk including loss of original principal.