Quote of the Week

“In the stock, a bargain is not a bargain if it remains a bargain.” – Marty Whitman

Technical Corner

Last week the markets hit a new all-time high on Thursday but sold off Friday with the Dow down 112 points. Today (Monday) the markets are selling off again with the Dow down 267 points which is the worst down day since October 8th. Stocks are being pulled lower by a disappointing U.S. Manufacturing Survey (ISM) data report that pointed to a fourth straight month of contraction for the sector. The ISM index unexpectedly declined to 48.1 in November. Readings below 50 reflect business conditions worsening.

The report wasn’t encouraging, especially if you look at the new orders component. Construction also came in on the downside. Adding to the jitters in the last few days are higher U.S. stock valuation levels, which can make the market prone to sudden and fast corrections.

The economy has been in what we call Quadrant III, which is characterized by growth slowing and inflation rising. If history is any guide, stock markets have always topped out in Quadrant III. With the economy slowing as reflected by the declining GDP, trade tensions, and with stock market valuations stretched, I wouldn’t be surprised if we are either at a top or nearing a top in the stock market. Now is not the time to take on risk chasing the markets.

As a result of the changing conditions of rising inflation and slowing, we have made some changes to the portfolio. We are still maintaining our high dividend positions in REITs, and Utilities plus we are still holding a position in precious metals. Due to inflation increasing we have shortened the duration of our bond exposure. With inflation increasing we have probably seen the lows in long-term interest rates for a while, so we are now invested in short-term U.S. Treasuries and TIPs which are inflation protected U.S. bonds whose interest rates rises with inflation.

Continuing on the rising inflation theme, we have taken a new position in Energy and Canada. Energy has been down for quite a while, but is now rallying off its lows. The position in Canada is also inflation themed due to the large energy exposure in Canada.

The last change we made was taking a small position in Cocoa. The Cocoa market is rising due to disease in the Cocoa trees in Africa where we get most of our Cocoa. It doesn’t appear that there is going to be a decline in the demand for chocolate in the future, especially during the Holiday Season.

The one thing I consider most in portfolio designs is not to take risk when the economy is declining. I do not under any circumstances want to ruin anyone’s retirement. There will be a time when the economy starts to expand. Then we will consider growth investing in the stock market like we did in 2017 and the first three quarters of 2018.

Lisa’s Thoughts

Required Minimum Distributions

What are required minimum distributions (RMDs)?

Required minimum distributions, often referred to as RMDs or minimum required distributions, are amounts that the federal government requires you to withdraw annually from traditional IRAs and employer-sponsored retirement plans after you reach age 70½ (or, in some cases, after you retire). You can always withdraw more than the minimum amount from your IRA or plan in any year, but if you withdraw less than the required minimum, you will be subject to a federal penalty.

The RMD rules are designed to spread out the distribution of your entire interest in an IRA or plan account over your lifetime. The purpose of the RMD rules is to ensure that people don’t just accumulate retirement accounts, defer taxation, and leave these retirement funds as an inheritance. Instead, required minimum distributions generally have the effect of producing taxable income during your lifetime.

Which retirement savings vehicles are subject to the RMD rules?

In addition to traditional IRAs, simplified employee pension (SEP) IRAs and SIMPLE IRAs are subject to the RMD rules. Roth IRAs, however, are not subject to these rules while you are alive. Although you are not required to take any distributions from your Roth IRAs during your lifetime, your beneficiary will generally be required to take distributions from the Roth IRA after your death.

Employer-sponsored retirement plans that are subject to the RMD rules include qualified pension plans, qualified stock bonus plans, qualified profit-sharing plans, including 401(k) plans. Section 457(b) plans and Section 403(b) plans are also subject to these rules. If you are uncertain whether the RMD rules apply to your employer-sponsored plan, you should consult your plan administrator or a tax professional.

When must RMDs be taken?

Your first required distribution from an IRA or retirement plan is for the year you reach age 70½. However, you have some flexibility as to when you actually have to take this first-year distribution. You can take it during the year you reach age 70½, or you can delay it until April 1 of the following year.

Since this first distribution generally must be taken no later than April 1 following the year you reach age 70½, this April 1 date is known as your required beginning date. Required distributions for subsequent years must be taken no later than December 31 of each calendar year until you die or your balance is reduced to zero. This means that if you opt to delay your first distribution until April 1 of the following year, you will be required to take two distributions during that year — your first year’s required distribution and your second year’s required distribution.

Example(s): You have a traditional IRA. Your 70th birthday was December 2, 2018, so you will reach age 70½ in 2019. You can take your first RMD during 2019, or you can delay it until April 1, 2020. If you choose to delay your first distribution until 2020, you will have to take two required distributions during 2020 — one for 2019 and one for 2020. This is because your required distribution for 2020 cannot be delayed until the following year.

There is one situation in which your required beginning date can be later than described above. If you continue working past age 70½ and are still participating in your employer’s retirement plan, your required beginning date under the plan of your current employer can be as late as April 1 following the calendar year in which you retire (if the retirement plan allows this and you own 5% or less of the company). Again, subsequent distributions must be taken no later than December 31 of each calendar year.

Example(s): You own more than 5% of your employer’s company and you are still working at the company. Your 70th birthday is on December 2, 2018, meaning that you will reach age 70½ in 2019. So you must take your first RMD from your current employer’s plan by April 1, 2020 — even if you’re still working for the company at that time.

Example(s): You participate in two plans — one with your current employer and one with your former employer. You own less than 5% of each company. Your 70th birthday is on December 2, 2018 (so you’ll reach 70½ on June 2, 2019), but you’ll keep working until you turn 73 on December 2, 2021. You can delay your first RMD from your current employer’s plan until April 1, 2022 — the April 1 following the calendar year in which you retire. However, as to your former employer’s plan, you must take your first distribution (for 2019) no later than April 1, 2020 — the April 1 after reaching age 70½.

How are RMDs calculated?

RMDs are calculated by dividing your traditional IRA or retirement plan account balance by a life expectancy factor specified in IRS tables. Your account balance is usually calculated as of December 31 of the year preceding the calendar year for which the distribution is required to be made.

Example(s): You have a traditional IRA. Your 70th birthday is November 1 of year one, and you therefore reach age 70½ in year two. Because you turn 70½ in year two, you must take an RMD for year two from your IRA. This distribution (your first RMD) must be taken no later than April 1 of year three. In calculating this RMD, you must use the total value of your IRA as of December 31 of year one.

Caution: When calculating the RMD amount for your second distribution year, you base the calculation on the IRA or plan balance as of December 31 of the first distribution year (the year you reached age 70½) regardless of whether or not you waited until April 1 of the following year to take your first required distribution.

For most taxpayers, calculating RMDs is straightforward. For each calendar year, simply divide your account balance as of December 31 of the prior year by your distribution period, determined under the Uniform Lifetime Table using your attained age in that calendar year. This life expectancy table is based on the assumption that you have designated a beneficiary who is exactly 10 years younger than you are. Every IRA owner’s and plan participant’s calculation is based on the same assumption.

There is one exception to the procedure described above. If your sole designated beneficiary is your spouse, and he or she is more than 10 years younger than you, the calculation of your RMDs may be based on the longer joint and survivor life expectancy of you and your spouse. (These life expectancy factors can be found in IRS Publication 590.) Consequently, if your spouse is your designated beneficiary and is more than 10 years younger than you, you can take your RMDs over a longer payout period than under the Uniform Lifetime Table. If your beneficiary is a nonspouse or a spouse who is not more than 10 years younger than you, you are subject to the shorter payout period under the simplified general rule.

Tip: In order for the younger spouse rule to apply, your spouse must be your sole beneficiary for the entire distribution year. The final regulations specify that your spouse will be considered your sole beneficiary for the entire year if he or she is your sole beneficiary on January 1 of the year, and you do not change your beneficiary during the year. In other words, even if your spouse dies, or you get divorced after January 1, you can use the younger spouse rule for that distribution year (but not for distribution years that follow). In the case of divorce, however, if you designate a new beneficiary prior to the end of the distribution year, you cannot use the younger spouse rule (since your former spouse will not be considered your sole beneficiary for the entire year).

If you have multiple IRAs, an RMD is calculated separately for each IRA. However, you can withdraw the required amount from any one or more IRAs. Inherited IRAs are not included with your own for this purpose. [Similar rules apply to Section 403(b) accounts.] If you participate in more than one employer retirement plan, your RMD is calculated separately for each plan and must be paid from that plan.

Should you delay your first RMD?

Your first decision is when to take your first RMD. Remember, you have the option of delaying your first distribution until April 1 following the calendar year in which you reach age 70½ (or April 1 following the calendar year in which you retire, in some cases).

You might delay taking your first distribution if you expect to be in a lower income tax bracket in the following year, perhaps because you’re no longer working or will have less income from other sources. However, if you wait until the following year to take your first distribution, your second distribution must be made on or by December 31 of that same year.

Receiving your first and second RMDs in the same year may not be in your best interest. Since this “double” distribution will increase your taxable income for the year, it will probably cause you to pay more in federal and state income taxes. It could even push you into a higher federal income tax bracket for the year. In addition, the increased income may cause you to lose the benefit of certain tax exemptions and deductions that might otherwise be available to you. So the decision of whether to delay your first required distribution can be important, and should be based on your personal tax situation.

Example(s): You are unmarried and reached age 70½ in 2018. You had taxable income of $25,000 in 2018 and expect to have $25,000 in taxable income in 2019. You have money in a traditional IRA and determined that your RMD from the IRA for 2018 was $50,000, and that your RMD for 2019 is $50,000 as well. You took your first RMD in 2018. The $50,000 was included in your income for 2018, which increased your taxable income to $75,000. At a marginal tax rate of 22%, federal income tax was approximately $12,440 for 2018 (assuming no other variables). In 2019, you take your second RMD. The $50,000 will be included in your income for 2019, increasing your taxable income to $75,000 and resulting in federal income tax of approximately $12,359. Total federal income tax for 2018 and 2019 will be $24,799.

Example(s): Now suppose you did not take your first RMD in 2018 but waited until 2019. In 2018, your taxable income was $25,000. At a marginal tax rate of 12%, your federal income tax was $2,810 for 2018. In 2019, you take both your first RMD ($50,000) and your second RMD ($50,000). These two $50,000 distributions will increase your taxable income in 2019 to $125,000, taxable at a marginal rate of 24%, resulting in federal income tax of approximately $24,175. Total federal income tax for 2018 and 2019 will be $26,985 — $2,186 more than if you had taken your first RMD in 2018.

What if you fail to take RMDs as required?

You can always withdraw more than you are required to from your IRAs and retirement plans. However, if you fail to take at least the RMD for any year (or if you take it too late), you will be subject to a federal penalty. The penalty is a 50% excise tax on the amount by which the RMD exceeds the distributions actually made to you during the taxable year.

Example(s): You own one traditional IRA and compute your RMD for year one to be $7,000. You take only $2,000 as a year-one distribution from the IRA by the date required. Since you are required to take at least $7,000 as a distribution but have only taken $2,000, your RMD exceeds the amount of your actual distribution by $5,000 ($7,000 minus $2,000). You are therefore subject to an excise tax of $2,500 (50% of $5,000).

Technical Note: You report and pay the 50% tax on your federal income tax return for the calendar year in which the distribution shortfall occurs. You should complete and attach IRS Form 5329, “Additional Taxes on Qualified Plans (Including IRAs) and Other Tax-Favored Accounts.” The tax can be waived if you can demonstrate that your failure to take adequate distributions was due to “reasonable error” and that steps have been taken to correct the insufficient distribution. You must file Form 5329 with your individual income tax return, and attach a letter of explanation. The IRS will review the information you provide and decide whether to grant your request for a waiver.

Can you satisfy the RMD rules with the purchase of an annuity contract?

Your purchase of an annuity contract with the funds in your IRA or retirement plan satisfies the RMD rules if all of the following are true:

  • Payments are made at least yearly
  • The annuity is purchased on or before the date that distributions are required to begin
  • The annuity is calculated and paid over a time period that does not exceed those permitted under the RMD rules
  • Payments, with certain exceptions, are nonincreasing

You may also be able to use up to 25% of your non-Roth IRA and retirement plan account balances (up to a maximum of $130,000 from all accounts, indexed for inflation) to purchase a qualifying longevity annuity contract (or QLAC). The value of the QLAC is disregarded when you calculate the amount of RMDs you are otherwise required to take from your account each year. Payments from the QLAC can be delayed up to age 85, and are treated as satisfying the RMD rules when paid. The rules can be complicated, and QLACs are not right for everyone, so be sure to consult a qualified professional for further information. (Note: Any annuity guarantees are subject to the claims-paying ability and financial strength of the annuity issuer.)

Tax considerations

Income tax

Like all distributions from traditional IRAs and retirement plans, RMDs are generally subject to federal (and possibly state) income tax for the year in which you receive the distribution. However, a portion of the funds distributed to you may not be subject to tax if you have ever made after-tax contributions to your IRA or plan.

For example, if some of your traditional IRA contributions were not tax deductible, those contribution amounts will be income tax free when you withdraw them from the IRA. This is simply because those dollars were already taxed once. You should consult a tax professional if your IRA or plan contains any after-tax contributions. [Special tax rules apply to Roth IRAs and Roth 401(k)/403(b) contributions.]

Caution: Taxable income from an IRA or retirement plan is taxed at ordinary income tax rates even if the funds represent long-term capital gain or qualifying dividends from stock held within the plan. There are special rules for capital gain treatment in some cases on distributions from retirement plans.

Gift and estate tax

You first need to determine whether or not the federal gift and estate tax will apply to you. If you do not expect the value of your taxable estate to exceed the applicable exclusion amount, then federal gift and estate tax may not be a concern for you. However, state death (or inheritance) tax may be a concern. In some cases, your assets may be subject to more than one type of transfer tax — for example, the generation-skipping transfer tax may also apply. Consider getting professional advice to establish appropriate strategies to minimize your future gift and estate tax liability.

For example, you might reduce the value of your estate by gifting all or part of your required distribution to your spouse or others. Making gifts to your spouse can sometimes work well if your estate is larger than your spouse’s, and one or both of you will leave an estate larger than the applicable exclusion amount. This strategy can provide your spouse with additional assets to better utilize his or her applicable exclusion amount, thereby minimizing the combined gift and estate tax liabilities of you and your spouse. Be sure to consult an estate planning attorney, however, about this and other possible strategies.

Caution: In addition to federal gift and estate tax, your state may impose its own estate or death tax (or other transfer taxes). Consult an estate planning attorney for details.

Inherited IRAs and retirement plans

Your RMDs from your IRA or plan will cease after your death, but your designated beneficiary (or beneficiaries) will then typically be required to take minimum required distributions from the account. A spouse beneficiary may generally roll over an inherited IRA or plan account into an IRA in the spouse’s own name, allowing the spouse to delay taking additional required distributions until he or she turns 70½.

As with required lifetime distributions, proper planning for required post-death distributions is essential. You should consult an estate planning attorney and/or a tax professional.

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.

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