I hope you are staying cool in our July heat. The second half of 2024 promises to be eventful with the upcoming presidential election. Let’s dive into our updates and thoughts.

Market Outlook: Don’t Get Carried Away with Last 9 Months, Clouds Are Gathering

The market’s rally over the last 9 months has far exceeded expectations.  Yet, most stocks have not participated in this rally.  (For instance, until this week, small cap was flat for the year and well below its peak.)

Some other assets like precious metals have done well due to hopes of interest rate cuts and concern over economic and geopolitical stability.  Traditional fixed income, small cap stocks, and base commodities have not performed as well.

The relevant question is not simply looking at the past, but rather considering what to do now and in the near future?

Particularly for those of you in or about to enter retirement, you cannot afford to simply chase the herd.  Potential red signs are flashing.  As much as we seek returns, we also must guard against risks that could hurt your nest egg.

Concerns we see include:

• Potential turning point on the US economy (US consumer health deteriorating, jobs sputtering, commercial real estate declining)
• The Fed still has not cut interest rates (unclear if inflation is actually improving that much)
• Bubbly market behavior (bloated concentration of market performance in less than a dozen names, speculation in limited areas at the neglect of others, “everyone is in the pool” technicals, valuations extreme for the winners relative to history, though the losers appear much less overvalued)
• Geopolitical tension (US November elections, EU elections portend change)

AI is the one thing powering the market – but there exist some similarities to the Internet rage leading up to the year 2000.  (Does anyone remember AOL or Yahoo?  They were some of the darlings in 1999, but we hardly hear of them today.  That is because new winners emerged.)

As a reminder, after NASDAQ peaked in 2000, it sold off and did not recover for nearly 14 years.  Most of you in retirement (and many approaching retirement) simply do not have that much time for your savings to recover from such a potential drawdown if it were to happen again.

Questions exist as to the ultimate economic returns that most companies would actually get on current AI development.  Cost synergies appear feasible, but revenue growth less so.  Undoubtedly, there are many menial, mental processes that could be automated.  Yet, replacing a human worker with a humanoid robot powered by the state of the art chips is nearly double current employee cost.  Robo taxis are the rage, but the reality is that other players in the auto industry rely on the same data and, thus, over time, competitive advantage gets whittled away.

We maintain a defensive stance while looking for opportunities to grow your portfolio even with risks out there.  Your accounts continue to be invested in a variety of sleeves, including growth, income, and diversification.

What Do I Own in the Income Bucket?

“Why do I need anything but NASDAQ stocks?”  Today they rise, but that is no guarantee in the future they will keep rising.  In fact, especially if stocks become overvalued and/or earnings disappoint expectations, the stocks possibly might even fall.  Just remember the year 2000 followed 1999.  After the decline, it took over a decade for investors to recoup losses.

Except for those with the longest time horizons and most aggressive risk appetite, most of you own investments in the “income” bucket.  (Recall in the last newsletter that we discussed the “diversification” bucket.)

The Income bucket is designed to allow you to clip coupons by being paid interest, yet with potentially limited (up or down) appreciation on your principal.  The Income bucket functions to fund short-term needs for cash and potentially stabilizes the total portfolio when volatility rises and risk markets decline.

US Government T-Bills are the primary exposure in those of you with the Income bucket.  Low duration (less than 2-year maturity) and minimal credit risk (US government) along with a mid-single-digit coupon offer potentially attractive risk-adjusted returns.  The greatest risk to returns on T-Bills is the possibility and extent to which the Fed decides to reduce interest rates in response to a weaker economy.  Lower interest rates mean lower (but not negative) returns on T-Bills.  In fact, a cut in interest rates near-term benefits the value of your principal.  However, the bad news is that future yield on new T-bills is lower.

Our hunch is that the Fed might make a moderate cut in rates over the next 18-24 months if and as the economy continues to weaken.  However, we doubt it brings us back to the near zero rates of pre COVID; fiscal spending and debt are at much higher levels.  Lower interest rates might also add gasoline to the fuel of a possible resumption in inflation.

For the most part, we have avoided buying bonds with high duration or credit risk.  (A few accounts with high cash needs might own some highly rated corporate bonds in limited amounts.)  Risk of inflation and economic weakness coupled with low rates relative to the risk one takes in owning the bonds keeps us cautious.

While not officially part of the Income bucket, one mutual fund strategy might provide slightly higher returns with a risk profile similar to fixed income.  This fund utilizes an event driven strategy (officially classified in the Diversified bucket).  We described it briefly in our last newsletter, but here is a brief description.  Roughly 2/3 of the strategy is merger arb, where the fund buys the securities (equities or bonds) of a company that has announced it will be acquired.  The fund hedges its exposure by selling short the equity of the buying company.  These trades tend to be low return but low risk and mostly short term (3-6 months).  The other 1/3 of the strategy is classic event driven, where the fund conducts a variety of short-term strategies around corporate events (one example might be announcements on investor days, where the fund might purchase both calls and puts to anticipate a strong stock reaction positive or negative).  The fund does not generate income in the literal sense.  Yet the fund’s strategies potentially result in low volatility similar to traditional fixed income with the potential for higher returns (and lower correlation to the direction of interest rates).

Keep Your IRA Beneficiaries Up to Date

Why Beneficiary Forms Matter

You’ve spent years building up your IRA, watching it grow, and perhaps even rolling over funds from a company plan. But have you thought about what happens to your IRA after you die? Many people mistakenly believe their will controls who inherits their IRA. In reality, the beneficiary designation form you filled out with your IRA custodian determines who receives your IRA funds.

Completing and Updating Your Beneficiary Form

When you set up your IRA, you named primary and contingent beneficiaries on a beneficiary designation form. This form decides who gets your IRA if something happens to you. It’s crucial to update this form after major life changes, like marriage, divorce, or the birth of a child, to ensure it reflects your current wishes.

Regular Reviews Are Essential

Regularly check your beneficiary form to make sure it’s accurate. Clear identification of all beneficiaries and their shares is vital. If the form is missing or outdated, update it immediately. Problems can arise if the form is lost due to bank mergers or other issues. Completing a new form now can prevent complications later.

Take Action Now

To protect your hard-earned IRA funds and ensure they go to your intended heirs, keep your beneficiary designation form updated and accurate. Regular reviews and updates can prevent legal battles and ensure a smooth transfer of assets to your loved ones.

Sincerely,

Petr Burunov, CFP®
President / Wealth Strategist

The post Client Newsletter 3Q24 appeared first on AWM.

Advisors can show their added value by focusing on these seven specific topics:

1. Required Minimum distributions (RMDs).
   

   While this annual IRA ritual is well known among financial advisors, it’s just as common to miss distributions or deal with computational errors. Remember, clients who don’t take their required minimums will get hit with a hefty 50% penalty on any distribution amounts they should have taken. This fee in some special circumstances could be waived by the IRS, but why add stress to you or your client.

   Advisors should be aware of every client who is or will be subject to RMDs by the end of the year. Most have the experience with regular clients who are over 70½ years old and are taking their RMDs annually. Even though it’s not obvious, you will have clients who sneak up as newcomers to the 70½ club or sophomores who might need to take two RMDs this year (their first and second) and required distributions for IRAs or Roth IRAs that they inherited (these include trusts that are IRA beneficiaries). Roth 401(k) plans are also subject to required minimum payouts (Roth IRAs owners are not). This is an important conversation to have with clients if a Rollover is appropriate.

2. Qualified charitable distributions.

   The Tax Cuts and Jobs Act of 2017 provided help for taxpayers through an expansion of standard deductions. That being said, clients who do not itemize their deductions will no longer be able to deduct their charitable contributions. If any of your clients have IRAs subject to RMDs, it’s not too late to contact them and suggest the qualified charitable distributions (QCD) provision. They should also consider making their contributions directly from their IRA.

   The amount your client contributes will count towards their RMD amount and be excluded from income. This creates an “effective” tax deduction on top of the standard deduction. The QCD only applies to IRAs—not plans and IRA owners or beneficiaries who are at least 70½ years old. Donor-advised funds and private foundations are not eligible for the qualified charitable distribution and nothing is given in return for the gift. The annual limit per person is $100,000.

   When contemplating a one-time large donation, clients can still do the QCD even though the gift might exceed the RMD amount, so long as the amount is below the $100,000 limit. Giving more than the RMD removes more IRA funds that will then not fall under income and might even lower the RMD amount for the next year. QCDs will lower adjusted gross income, which may help you with other tax benefits or deductions. Qualified charitable deductions lower tax bills and must be completed before year’s end in order to count for the same tax year.

3. Roth conversions.
   

   The biggest change for IRA planning affected Roth conversions. As of January 1, 2018, conversions are no longer allowed to be reversed. They are permanent and taxes will be due as soon as the funds are converted. Roth conversions are still valuable for certain clients, but going forward, conversions need to be carefully and accurately thought through. In order to qualify for a Roth conversion this year, the funds must leave the IRA or plan by year’s end. Some people confuse Roth conversions deadline (year’s end) with Roth IRA contributions which can be made until April 15th of next year.

   Other tax changes should become a factor when projecting the tax on a Roth conversion. This is in addition to the usual items like taxability of Social Security, increases in Medicare Part B and D premiums, student financial aid eligibility, to name a few. Also, be aware that some clients will lose state tax deductions (the cap is now $10,000, also known as SALT) and the increased standard deduction might not make up the difference. All 2% miscellaneous deductions are also gone.

   For business clients, the new 20% deduction for qualified business income (the section 199A deduction) and the effect a Roth conversion should be reviewed carefully. While some might think these are reasons to avoid a Roth conversion, when looking at long-term financial and tax planning strategies, they are short-term bumps as the additional taxes would only be for the year in which conversion takes place. These issues should be considered carefully, Roth conversions no longer can be undone.

4. Check estimated taxes on RMDs.
   

   Double check to make sure any clients that are new to RMDs had enough money withheld or paid in through estimated tax payments to avoid any penalties. If they did come up short, it might be a good idea to withhold taxes from year-end IRA distributions. This would help satisfy the estimated tax payment timing requirement.

   Add this item to your end-of-the-year checklist for clients with RMDs. Some of our clients will even withhold projected taxes due for the year of their required minimum distributions—taking one more step to avoid penalties. We make it a practice to get to know our client’s network of other professionals, especially their tax advisors. This can build trust and loyalty while also providing holistic services for your clients. IRA withholdings can sometimes be used to cover other income items. RMD money is not usually needed for a large number of clients, which is why the IRA withholdings work so well. The required minimum distribution will often go straight into an investment account. Instead of writing checks for taxes owed, use IRA withholding strategy to satisfy tax liabilities.

   It’s easy for older clients (or even the family members caring for them) to forget or make quarterly estimated payments late and trigger penalties. This is where the IRA withholding works. It eliminates penalties and additional taxes during tax season. Do what you can to relieve some pressure from your clients and their families. This is your time to shine.

5. Split inherited IRAs by year’s end.
   

   If one of your clients, who owned an IRA with multiple individual beneficiaries, passed away during 2017, it’s time for you to help their family make sure all necessary paperwork is completed timely. Each named beneficiary can use their own life expectancy to calculate required minimum distributions (known as the stretch IRA) if the inherited IRAs are split into separate shares before the end of this year. It’s important to get this done in order to use the Stretch IRA. If not, all beneficiaries will be stuck using the age of the oldest, named beneficiary—even if they decide to split their shares later on. The split must be completed by the end of the year after the IRA owner’s death. (We strongly encourage our clients to split the IRAs as soon as possible to avoid forgetting and missing the deadline).

6. You should know how to time a 10% penalty exception.
   

   If your client had to take an early withdraw from their IRA, they may qualify for an exception to the 10% penalty. If they do, the payment must be made in the same year as the IRA (or plan) distribution. This is easily missed at the end of the year, which voids the exception and forces the client to pay a huge penalty that could easily have been avoided. This situation usually affects those who need the money and cannot afford the extra penalties on top of their tax bill.

   Here’s a theoretical example: your client is 54 and needs to help her son pay a college tuition bill by the end of the year. She adds the charge to her credit card in December of 2018. In January, when the credit card bill comes in, she takes an early distribution from her IRA—thinking she qualifies for the education exception to the 10% early distribution penalty for IRAs. Only to find out, she doesn’t actually qualify.

   Your client still has to pay the 10% penalty because the tuition payment (made in December 2018) and the January 2019 IRA distribution were not in the same year.

   Check to make sure your clients who took, or are planning to take an early withdrawal will actually qualify for an exception and not run into similar situations with this “same year” rule. This is a more common issue than most people realize and as advisors, it’s our job to protect our clients.

7. Check the state of lump-sum distributions for the net unrealized appreciation tax break.

   Don’t forget about net unrealized appreciation (NUA) in employer securities. This can dramatically cut your client’s tax bill down. This tax break is for clients who own a share of their companies’ stock through their 401(k). Depending on the stock’s appreciation, it might qualify for the lump-sum distribution tax break on NUAs. Generally, this is triggered by an event: the employee leaves the company, they reach the age 59½, they pass away, or becomes disabled. Under any of these situations, the company funds must be distributed within one year of this life-altering event taking place. If any of your clients qualify for this tax break, check with them to make sure all their plan funds have been withdrawn before the year’s end.

   Non-company stock funds can be rolled over, tax-free, to an IRA, while the company stocks go into a taxable account. Tax (ordinary income) is only paid on the cost of the stock. The appreciation is not taxed until the stock is sold. When it is sold, the NUA is taxed at a lower, long-term capital gain rate—regardless of how long the stock was held.

Here’s a free extra tip: while you are checking these items off your list, check your client’s beneficiary forms. Make sure they exist and are updated with your client’s latest wishes. Beneficiary form errors are rampant, costly, and far too frequent. Do your client a favor and show your added value. When you go the “extra mile”, your clients will notice that you truly have their back and will reciprocate with their loyalty and trust. They will also know that you have their back and are helping them to live their lives with purpose.

Start the Conversation

The post Retirement Planning Strategies: 7 Year-End Mistakes to Avoid appeared first on AWM.