How long can Consumers Keep Carrying the Economy?
Consumer spending accounts for about two-thirds of U.S. gross domestic product (GDP), so it plays an outsized role in driving economic growth or slowing it down.1 For the last 18 months, U.S. consumers have kept the economy strong despite high inflation and rising interest rates. There is much discussion as to whether consumer spending will continue into 2024.
The Federal Reserve recently did not adjust interest rates. Raising interest rates has the same impact as increasing consumer spending. Both the level of consumer spending and increased interest rates help combat inflation. The Fed’s actions regarding interest rates try to balance numerous factors including consumer spending and employment. A reversal of spending and interest rates could lead to a recession
Measuring spending and inflation
The standard measure of consumer spending is personal consumption expenditures (PCE), released each month by the Bureau of Economic Analysis (BEA). Economists look at the monthly change in PCE for the short-term trend and the year-over-year change for the longer-term trend.
September PCE increased 0.7% over August, a strong monthly growth rate and up from 0.4% in August over July. The September increase was 0.4% measured in “real” inflation-adjusted dollars, which indicates that consumers were spending more than the rate of inflation. The annual change in PCE was 5.9%, well above the 3.4% annual change in the PCE price index, which is the Fed’s preferred measure of inflation. (The Fed’s target for PCE inflation is 2%.)2–3
The pandemic effect
The current consumer spending story began with the pandemic recession, when a broad range of business activity stopped, and consumers received large government stimulus packages with little to spend it on. In April 2020, the personal saving rate — the percentage of personal income that remains after taxes and spending — spiked to a record 32%, almost double the previous high. It declined as businesses reopened but remained above pre-pandemic levels until late 2021, when stimulus had ended, and high inflation made spending more expensive. The September 2023 saving rate was just 3.4%, well below the 6.5% average before the pandemic.4 While a low saving rate could be cause for concern in the long term, it indicates that consumers are willing to spend their income despite higher prices.
Why are consumers spending instead of saving?
Multiple explanations have been offered for this high-spending/low-saving pattern. Some lower-income consumers may be spending a larger percentage of their income because they must — they are spending more for basic needs due to high inflation. People with more disposable income might still be responding to pent-up demand for goods and services that were not available during the pandemic. And, after the tragedies and disruptions of the pandemic, some consumers may prefer to spend now and worry less about the future. The expensive housing market could be adding to this trend by making a typical saving goal seem unattainable to younger consumers.5
On a macro level, however, consumers may be spending instead of saving because they still have substantial savings. Although it was thought that pandemic-era savings were nearly exhausted, revised government data suggests there may be $1 trillion to $1.8 trillion in so-called “excess savings” still available. About half of this is likely held by households in the top 10% income bracket, but that still leaves a large savings buffer that could continue to drive middle-class spending for some time.6
The recently released Federal Reserve Survey of Consumer Finances revealed a similar story. The average inflation-adjusted median net worth of American families jumped by a record 37% from 2019 to 2022 — more than double the previous highest increase in the Fed survey, which is released every three years. Every demographic group saw substantial increases, but the largest by far was for consumers under age 35, whose net worth increased 143%. Because this survey only went through 2022, it does not capture the effects of continuing inflation in 2023.7
Wages and inflation
While pandemic-era savings may support consumer spending well into 2024, only wages can maintain strong spending for the long term. The question is whether wages will keep up with inflation without rising so quickly that they drive inflation even higher. For the 12-month period ending September 2023, average hourly earnings increased 4.2%. This was above the 3.4% PCE inflation rate over the same period, but down from the 5.1% pace of wage increases a year earlier.8 The fact that wage growth is keeping up with inflation while also slowing down bodes well for the goal of taming inflation with continued consumer spending.
Holiday spending
The winter holiday season, officially defined as November and December, accounts for about 20% of retail spending for the year, and is even more important for some retailers. An annual survey by the National Retail Federation found that consumers plan to spend an average of $875 this year on gifts, decorations, holiday meals, and other seasonal items. This is up from $833 in 2022 and slightly above the five-year average.9 Two broader surveys have found declines in consumer confidence in recent months, but it remains to be seen whether this leads to a decline in spending.10-11 While the winter holidays are not a “make or break” situation for the U.S. economy, this year’s holiday spending may provide clues to consumer behavior in the new year.
1–2, 4) U.S. Bureau of Economic Analysis, 2023
3, 7) Federal Reserve, 2023
5) The Wall Street Journal, October 1, 2023
6) Bloomberg, October 10, 2023
8) U.S. Bureau of Labor Statistics, 2023
9) National Retail Federation, 2023
10) The Conference Board, September 26, 2023
11) University of Michigan, October 27, 2023
2023 Year-End Tax Tips to Consider
This is a good time to review your tax situation for 2023. Allow enough time to complete the changes before year-end. Check with your custodian for the deadlines for completing by December 31, 2023. Following are some actions to consider before the end of the year. Many of these items will depend on your expected tax bracket in 2023 compared to 2024.
1. Defer income to next year
Consider opportunities to defer income to 2024, particularly if you think you may be in a lower tax bracket then. For example, you may be able to defer a year-end bonus or delay the collection of business debts, rents, and payments for services. Doing so may enable you to postpone payment of tax on the income until next year.
2. Accelerate deductions
Consider opportunities to accelerate deductions into the current tax year. If you itemize deductions, making payments for deductible expenses such as qualifying interest, state taxes, and medical expenses before the end of the year rather early in 2024. Alternating, payments in 2014 may result in a benefit by exceeding the standard deduction.
3. Make deductible charitable contributions
If you itemize deductions on your federal income tax return, you can generally deduct charitable contributions, but the deduction is limited to 50% (currently increased to 60% for cash contributions to public charities), 30%, or 20% of your adjusted gross income (AGI), depending on the type of property you give and the type of organization to which you contribute. (Excess amounts can be carried over for up to five years.)
There may be an advantage if you contribute appreciated securities. The gain on the securities will not be taxed if you held the security for more than a year.
For those 701/2 or older it may be beneficial to use direct payments using your required minimum distributions (Qualified Charitable Distributions.) To qualify for this strategy, it is important to meet the IRS requirement.
4. Increase withholding to cover a tax shortfall
If you will owe federal income tax for the year, consider increasing your withholding on Form W-4 for the remainder of the year to cover the shortfall. Time may be limited for employees to request a Form W-4 change and for their employers to implement it in time for 2023. The biggest advantage in doing so is that withholding is considered as having been paid evenly throughout the year instead of when the dollars are taken from your paycheck. This strategy can be used to make up for low or missing quarterly estimated tax payments.
You can also have tax withheld from distributions from some financial accounts.
5. Save more for retirement
Deductible contributions to a traditional IRA and pre-tax contributions to an employer-sponsored retirement plan such as a 401(k) can reduce your 2023 taxable income. If you haven’t already contributed up to the maximum amount allowed, consider doing so. For 2023, you can contribute up to $22,500 to a 401(k) plan ($30,000 if you’re age 50 or older) and up to $6,500 to traditional and Roth IRAs combined ($7,500 if you’re age 50 or older).* The window to make 2023 contributions to an employer plan generally closes at the end of the year, while you have until April 15, 2024, to make 2023 IRA contributions.
*Roth contributions are not deductible, but Roth qualified distributions are not taxable.
6. Take required minimum distributions
If you are age 73 or older, you generally must take required minimum distributions (RMDs) from traditional IRAs and employer-sponsored retirement plans (special rules apply if you’re still working and participating in your employer’s retirement plan). You have to make the withdrawals by the date required — the end of the year for most individuals. The penalty for failing to do so is substantial: 25% of any amount that you failed to distribute as required (10% if corrected in a timely manner).
7. Weigh year-end investment moves
You should not let tax considerations drive your investment decisions. However, it’s worth considering the tax implications of any year-end investment moves that you make. For example, if you have realized net capital gains from selling securities at a profit, you might avoid being taxed on some or all of those gains by selling losing positions. Any losses over and above the amount of your gains can be used to offset up to $3,000 of ordinary income ($1,500 if your filing status is married filing separately) or carried forward to reduce your taxes in future years.
Rising Oil Prices Could Be a Threat to the Economy
Oil prices have increased more than 30% since late June, driving up transportation costs for consumers and businesses and putting financial markets on edge. West Texas Intermediate crude, the U.S. benchmark for oil prices, was $93 per barre September 27, the highest level since August 2022. Brent crude (the global oil benchmark) rose above $96.1
Gasoline prices have followed suit. On September 27, the national average price for a gallon of unleaded gas was $3.83, up from $3.75 a year earlier. The price in California, the most expensive state for gasoline, averaged $5.89 per gallon.2
Market dynamics have impacted fuel prices in recent months. This adds concerns about broader inflation and the nation’s economic prospects.
Tight oil supplies
Oil prices are sensitive to shifts in the delicate balance between supply and demand in the global market. Much of the third quarter’s increase has been attributed to a combination of record-high global demand and coordinated supply cuts.3 On September 5, Saudi Arabia and Russia announced the extension of voluntary production cuts (1.3 million barrels per day combined) through the end of 2023. These cuts, which began in June, are on top of cuts that were previously put in place through 2024 by the Organization of the Petroleum Exporting Countries (OPEC), along with Russia and other allied oil producers (dubbed OPEC+). In total, supply cuts are expected to reduce global crude inventories by 3.3 million barrels per day in Q4 2023.4
OPEC is a coalition of 13 member countries, led by Saudi Arabia, which regulate their output to support oil prices. OPEC joined forces with the 10 OPEC+ countries in 2016 so they would have more power to influence prices. The two groups produced about 59% of the world’s supply of crude in 2022.5
Even so, OPEC does not have the iron grip on the oil market that it once wielded. Due to advances in shale drilling methods, U.S. oil production has more than doubled since 2011. The United States has been the top oil-producing nation since 2018 and was responsible for 20% of the world’s total in 2022. Saudi Arabia and Russia followed behind with 12% and 11%, respectively.6
Pain at the pump
Crude accounted for 57% of the nationwide cost of a gallon of gas in 2022, with the remainder reflecting refining costs, marketing and distribution, and taxes. Moreover, market conditions and gas prices vary widely by state and region.7
Gas prices also respond to seasonal demand shifts. For example, they tend to climb in the summer, when more drivers hit the road for vacations, then decline in the fall. In addition to the rising cost of crude, extreme heat in 2023 forced refineries in the Southeast to operate below capacity for safety reasons, pushing up prices even more than would be typical in the summer.8
On the bright side, the national average gas price is still below the record of $5.02 set in June 2022, when global oil costs spiked in the months following Russia’s invasion of Ukraine. And most states switch to a cheaper winter blend by October, which could deliver some price relief.9
Will U.S. drilling fill the gap?
Gasoline and heating oil (both derived from crude) are essential expenses for many households, which may leave them with less money to spend on other goods and services. A broad pullback in consumer spending — which accounts for about two-thirds of U.S. gross domestic product (GDP) — could take a significant toll on growth.10
Extended periods of high oil prices have been blamed for bringing on recessions in the past, and low prices have sometimes provided an economic boost. But this relationship has become more complex as the United States has expanded its presence in the global oil market. The United States has been called a swing producer because production levels often fluctuate in response to market prices. High oil prices tend to benefit producers by pumping up company profits, and they incentivize more hiring and drilling. A surge in drilling could have a positive impact on GDP that offsets some of the negative forces.
But more U.S. production is not guaranteed. With oil prices sitting above $100 per barrel for much of 2022, companies were reluctant to invest in drilling.11 In recent weeks, U.S. producers have reportedly added drilling rigs in the shale oil patch at the fastest rate since November of 2022, but it’s still unknown whether U.S. production will increase enough to lower prices.12
Inflation and the Fed
When fuel costs are high, businesses must decide whether to absorb them — lowering profit margins — or pass them on to consumers, which could reignite inflation across the economy.
Measured by the consumer price index (CPI), inflation increased 0.6% in August and was up 3.7% over the previous year. A 10.6% surge in gasoline prices was responsible for more than half of that monthly increase.13
The Federal Reserve has been raising interest rates aggressively to control inflation by slowing economic activity. Despite the rate hikes, the economy has remained surprisingly strong, so higher fuel costs may help the Fed’s efforts to slow the pace. Even so, the inflationary effects associated with rising oil prices appear to be another risk to the economic outlook that Fed policymakers must consider as they decide the future path of interest rates.
1) The Wall Street Journal, September 27, 2023
2, 9) American Automobile Association, 2023
3, 12) The Wall Street Journal, September 19, 2023
4) Bloomberg, September 12, 2023
5–7) U.S. Energy Information Administration, 2023
8) Associated Press, August 2, 2023
10) U.S. Bureau of Economic Analysis, 2023
11) The Wall Street Journal, February 24, 2022
13) U.S. Bureau of Labor Statistics, 2023
What Happens if There is a Government Shutdown?
There are only a few days till the U.S. government may shutdown. It is possible that a last-minute agreement could avoid a shutdown. Following is an abbreviated summary of the federal funding process, the current situation in Congress, and the potential consequences of a failure to fund government operations.
Twelve appropriations bills
The federal fiscal year begins on October 1, and under normal procedures 12 appropriations bills for various government sectors should be passed by that date to fund activities ranging from defense and national park operations to food safety and salaries for federal employees.
These appropriations are considered discretionary spending, meaning that Congress has flexibility in setting the amounts. Although discretionary spending is an ongoing source of conflict, it accounted for only 27% of federal spending in FY 2023, and almost half of that was for defense, which is typically less of a point of conflict. Mandatory spending (including Social Security and Medicare), which is required by law, accounted for about 63%, and interest on the federal debt accounted for 10%.1
It is obvious that it would be helpful for federal agencies to know their operating budgets in advance of the fiscal year, but all 12 appropriations bills have not been passed before October 1 since FY 1997. In 11 of the last 13 years, lawmakers have not passed a single spending bill in time.2 That is the situation as of September 27 this year. (One bill, to fund military construction and the Department of Veterans Affairs, has been passed by the House but not the Senate.)3
Continuing resolutions and omnibus spending bills
To delay further budget negotiations, Congress typically passes a continuing resolution, which extends federal spending to a specific date, generally at or based on the same level as the previous year. These bills are essentially placeholders that keep the government open until full-year spending legislation is enacted. Since 1998, it has taken an average of almost four months after the beginning of the fiscal year for that year’s final spending bill to become law.4
Even with the extension provided by continuing resolutions, Congress seldom passes the 12 appropriations bills. Instead, they are often combined into massive omnibus spending bills that may include other provisions that do not affect funding. For example, the SECURE 2.0 Act, which fundamentally changed the retirement savings rules, was included in the omnibus spending bill for FY 2023, passed in late December 2023, almost three months into the fiscal year.
Current Congressional situation
The U.S. Constitution gives the House of Representatives sole power to initiate revenue bills, so the House typically passes funding legislation and sends it to the Senate. There are often conflicts between the two bodies, especially when they are controlled by different parties, as they are now. These conflicts are typically settled through negotiations after a continuing resolution extends the budget process.
The Senate acted first this year, releasing bipartisan legislation on September 26 that would maintain current funding through November 17 and provide additional funding for disaster relief and the war in Ukraine. Although this is likely to pass the Senate later in the week, it was unclear how the House would react to the legislation.5
Late on September 26, the House cleared four appropriation bills for debate (Agriculture, Defense, Homeland Security, and State Department). It is unknown whether these bills will pass the House, and if they do, it will be too late to negotiate the provisions with the Senate. A proposed continuing resolution that would extend government funding and include new provisions for border security had not been cleared for debate as of the afternoon of September 27.6
Effects of a shutdown
The effects of a government shutdown depend on its length, and fortunately, most are short. There have been 20 shutdowns since the current budget process began in the mid-1970s, with an average length of eight days. The longest by far was the most recent shutdown, which lasted 35 days in December 2018 and January 2019, and demonstrates some potential consequences of an extended closure.7 However, in 2018-19, five of the 12 spending bills had already passed before the shutdown — including large agencies like Defense, Education, and Health & Human Services — which helped limit the damage. The current impasse, with no appropriations passed, could lead to an even more painful situation.8
Some things will not be affected: The mail will be delivered. Social Security checks will be mailed. Interest on U.S. Treasury bonds will be paid.9 However, some programs will stop immediately, including the Supplemental Nutrition Program for Women, Infants, and Children, which helps to provide food for about 7 million low-income mothers and children.10
Federal workers will not be paid. Workers considered “essential” will be required to work without pay, while others will be furloughed. Lost wages will be reimbursed after funding is approved, but this does not help lower-paid employees who may be living paycheck to paycheck.11 In an extended shutdown, the greatest hardship would fall on lower-paid essential workers, which would include many military families. Furloughed workers would struggle as well, but they might look for other jobs, and in many states would be able to apply for unemployment benefits.12 (Members of Congress, who are paid out of a permanent appropriation that does need renewal, would continue to be paid.)13
Air travel could be affected. In 2019, absenteeism more than tripled among Transportation Security Administration (TSA) workers, resulting in long lines, delays, and gate closures at some airports. According to the TSA, many workers took time off for financial reasons.14 Air traffic controllers, who are better paid, remained on the job without pay and without normal support staff. However, on January 25, 2019, an increase in absences by controllers temporarily shut down New York’s La Guardia airport and led to substantial delays at airports in Newark, Philadelphia, and Atlanta. This may have been an impetus to reopen the government later that day.15
Unlike federal employees, workers for government contractors are not guaranteed to be paid, and contractors often work side-by-side with federal employees in government agencies. In 2019, it was estimated that 1.2 million contract employees faced lost or delayed revenue of more than $200 million per day.16 A more widespread shutdown would put even more workers at risk.
While essential workers will maintain some federal services, furloughed workers would leave significant gaps. At this time, it’s unknown exactly how each agency will respond to a shutdown. In 2019, some national parks used alternate funding to maintain limited access, which caused problems with trash and vandalism and was deemed illegal by the Government Accounting Office. This year, all parks might be closed during an extended shutdown.17 Many other federal services may be delayed or suspended, ranging from food inspections to small business loans and economic reports.18 Delays in economic statistics could make it more difficult for the Federal Reserve to judge appropriate policy.19
Although a shutdown would cause temporary hardship for workers and the citizens they serve, the long-term effect on the economy would be relatively benign, because lost payments are generally made up after spending is authorized. A shutdown might decrease gross domestic product (GDP) for the fourth quarter of 2023, but if the shutdown ends by the end of the year, GDP for the first quarter of 2024 would theoretically be increased. Even if delayed spending is recovered, however, lost productivity by furloughed workers will not be regained. And an extended shutdown could harm consumer and investor sentiment.20
Surprisingly, previous shutdowns generally have not hurt the broad stock market, other than short-term reactions. But the current market situation is delicate to begin with, and it is impossible to predict future market direction.21
For now, it’s wise to maintain a steady course in your own finances. In the event of a shutdown, be sure to check the status of federal agencies and services that may affect you directly.
All investments are subject to market fluctuation, risk, and loss of principal. When sold, investments may be worth more or less than their original cost. U.S. Treasury securities are guaranteed by the federal government as to the timely payment of principal and interest. The principal value of Treasury securities fluctuates with market conditions. If not held to maturity, they could be worth more or less than the original amount paid. Projections are based on current conditions, subject to change, and may not happen.
1) Congressional Budget Office, May 2023
2, 4, 8) Pew Research Center, September 13, 2023
3) Committee for a Responsible Federal Budget, September 27, 2023
5, 6, 9, 18, 19) The Wall Street Journal, September 26, 2023
7, 11) CNN, September 21, 2023
10) MarketWatch, September 26, 2023
12) afge.org, September 25, 2023 (American Federation of Government Employees)
13) CBS News, September 25, 2023
14) Associated Press, January 21, 2019
15) The Washington Post, January 25, 2019
16) Bloomberg, January 17, 2019
17) Bloomberg Government, September 12, 2023
20) Congressional Research Service, September 22, 2023
21) USA Today, September 26, 2023
RMD Relief and Guidance for 2023
Earlier IRS proposed regulations regarding required minimum distributions (RMDs) reflected changes made by the Setting Every Community Up for Retirement Enhancement (SECURE) Act of 2019. IRS delayed releasing final regulations to include changes to RMDs made by the SECURE 2.0 Act of 2022, which was passed in late 2022. IRS issued interim RMD relief and guidance for 2023. Final RMD regulations, when issued, will not apply before 2024.
Relief with respect to change in RMD age to 73
The RMD age is the age at which IRA owners and employees must generally start taking distributions from their IRAs and workplace retirement plans. There is an exception that may apply if an employee is still working for the employer sponsoring the plan. (For Roth IRAs, RMDs are not required during the lifetime of the IRA owner.)
The SECURE 2.0 Act of 2022 increased the general RMD age from 72 to 73 (for individuals reaching age 72 after 2022). Since then, some individuals reaching age 72 in 2023 have taken distributions for 2023 even though they do not need to take a distribution until they reach age 73 under the changes made by the legislation.
Distributions, other than RMDs which cannot be rolled over, from IRAs and other workplace retirement plans can generally be rolled over tax-free to another retirement account within 60 days of the distribution. The 60-day window for a rollover may already have passed for some individuals who took distributions that were not required in 2023.
To help those individuals, the IRS is extending the deadline for the 60-day rollover period for certain distributions until September 30, 2023. Specifically, the relief is available with respect to any distributions made between January 1, 2023, and July 31, 2023, to an IRA owner or employee (or the IRA owner’s surviving spouse) who was born in 1951 if the distributions would have been RMDs but for the change in the RMD age to 73.
Generally, only one rollover is permitted from a particular IRA within a 12-month period. The special rollover allowed under this relief is permitted even if the IRA owner or surviving spouse has rolled over a distribution in the last 12 months. However, making such a rollover will preclude the IRA owner or surviving spouse from rolling over a distribution in the next 12 months. However, an individual could still make direct trustee-to-trustee transfers since they do not count as rollovers under the one-rollover-per-year rule.
Inherited IRAs and retirement plans
Before the SECURE Act, RMDs for IRAs and retirement plans inherited before 2020 could generally be spread over the life expectancy of a designated beneficiary. The SECURE Act changed the RMD rules by requiring that in most cases the entire account must be distributed 10 years after the death of the IRA owner or employee if there is a designated beneficiary (and if death occurred after 2019). However, an exception allows an eligible designated beneficiary to take distributions over their life expectancy and the 10-year rule would not apply until after the death of the eligible designated beneficiary in that case.
Eligible designated beneficiaries include a spouse or minor child of the IRA owner or employee, a disabled or chronically ill individual, and an individual no more than 10 years younger than the IRA owner or employee. The entire account would also need to be distributed 10 years after a minor child reaches the age of majority (i.e., at age 31).
The proposed regulations issued in early 2022 surprised many when they suggested that annual distributions are also required during the first nine years of such 10-year periods in most cases. Comments on the proposed regulations sent to the IRS asked for some relief because RMDs had already been missed and a 25% penalty tax (50% prior to 2023) is assessed when an individual fails to take an RMD.
The IRS has announced that it will not assert the penalty tax in certain circumstances where individuals affected by the RMD changes failed to take annual distributions in 2023 during one of the 10-year periods. (Similar relief was previously provided for 2021 and 2022.) For example, relief may be available if the IRA owner or employee died in 2020, 2021, or 2022 and on or after their required beginning date (The required beginning date is usually April 1 of the year after the IRA owner or employee reaches RMD age. Roth IRA owners are always treated as dying before their required beginning date) and the designated beneficiary who is not an eligible designated beneficiary did not take annual distributions for 2021, 2022, or 2023 as required (during the 10-year period following the IRA owner’s or employee’s death). Relief might also be available if an eligible designated beneficiary died in 2020, 2021, or 2022 and annual distributions were not taken in 2021, 2022, or 2023 as required (during the 10-year period following the eligible designated beneficiary’s death).
Congress Tells Treasury to Expect SECURE 2.0 Technical Fixes
Congress sent a letter to U.S. Treasury Secretary Janet Yellen and IRS Commissioner Daniel Werfel late in May, that it will introduce legislation to correct several technical errors in the SECURE 2.0 Act. The letter, signed by Senators Ron Wyden (D-OR) and Mike Crapo (R-ID), chair and ranking member of the Senate Finance Committee, respectively, and Representatives Jason Smith (R-MO) and Richard Neal (D-MA), chair and ranking member of the House Ways and Means Committee, respectively, describes four provisions in SECURE 2.0 with problematic language.
- Startup tax credit for small employers adopting new retirement plans.
- Change in the required minimum distribution (RMD) age from 73 to 75.
- SIMPLE IRA and SEP plan Roth Accounts
- Requirement that catch-up contributions be made on a Roth basis for high earners.
Startup tax credits for small employers
Section 102 of SECURE 2.0 provides for two tax-credit enhancements for small businesses who adopt new retirement plans, beginning in 2023.
First, for employers with 50 employees or fewer, the pension plan startup tax credit increases from 50% of qualified startup costs to 100%, with a maximum allowable credit of $5,000 per year for the first three years the plan is in effect.
Second, the Act offers a new tax credit for employer contributions to employee accounts for the first five tax years of the plan’s existence. The amount of the credit is a maximum of $1,000 for each participant earning not more than $100,000 in income (adjusted for inflation). Each year, a specific percentage applies, decreasing from 100% to 25%. The credit is reduced for employers with 51 to 100 employees; no credit is available for those with more than 100 employees.
The letter notes, “The provision could be read to subject the additional credit for employer contributions to the dollar limit that otherwise applies to the startup credit. However, Congress intended the new credit for employer contributions to be in addition to the startup credit otherwise available to the employer.”
Change in RMD age.
Numerous comments noted that a technical correction is needed for Section 107 of the Act, which raised the RMD age from 72 to 73 beginning this year, and then again to 75 in 2033. The intention was to increase the age to 73 for those who reach age 72 after December 31, 2022, and to 75 for those who reach age 73 after December 31, 2032. However, the provision could be misinterpreted to mean the age-75 rule applies to those who reach age 74 after December 31, 2032.
SIMPLE IRA and SEP Roth accounts
Section 601 of the Act permits SIMPLE IRAs and Simplified Employee Pension plans to include a Roth IRA. The provision could have been interpreted that the provision was meant that SEP and SIMPLE IRA contributions must be included when determining annual Roth IRA contribution limits. As the letter explains, “Congress intended that no contributions to a SIMPLE IRA or SEP plan (including Roth contributions) be taken into account for purposes of the otherwise applicable Roth IRA contribution limit.”
Roth catch-up contributions for high earners
Addressing what the American Retirement Association called a “significant technical error” in Section 603, the letter clarified a rule surrounding catch-up contributions for high earners. Specifically, the rule’s intent was to require catch-up contributions for those earning more than $145,000 to be made on an after-tax, Roth basis beginning in 2024; however, language in a “conforming change” detailed in the provision could be interpreted to effectively eliminate the ability for all participants to make any catch-up contributions.
The congresspeople’s letter clarified that, “Congress did not intend to disallow catch-up contributions nor to modify how the catch-up contribution rules apply to employees who participate in plans of unrelated employers. Rather, Congress’s intent was to require catch-up contributions for participants whose wages from the employer sponsoring the plan exceeded $145,000 for the preceding year to be made on a Roth basis and to permit other participants to make catch-up contributions on either a pre-tax or Roth basis.”
No time frame given.
Although the letter provided no specific period for introducing the corrective legislation, it did indicate that such legislation may also include additional items. Stay tuned.
Have You Been Following the Debt Ceiling Debate?
President Joe Biden and House Speaker Kevin McCarthy met on May 22 to discuss raising the statutory limit on U.S. government debt, generally called the debt ceiling. There was not resolution although both termed the discussion “productive,”, and their respective negotiating teams continued discussions.1 Here are some answers to questions you may have about the issues behind the current impasse.
What is the debt ceiling? The debt ceiling is a statutory limit on cumulative U.S. government debt, which is the sum of annual deficits since 1835 — the only time the U.S. government had no debt — plus interest owed to investors who purchased Treasury securities issued to finance the debt.2 It limits the amount that the government can borrow to meet financial obligations already authorized by Congress. It does not authorize future spending. However, raising the debt ceiling has been used in recent years as leverage to negotiate on the federal budget.
Why do we have a debt ceiling? A debt ceiling was first introduced in 1917 to make it easier for the federal government to borrow during World War I. Before that time, all borrowing had to be authorized by Congress in extremely specific terms, which made it difficult to respond to changing needs. The modern debt ceiling, which aggregates almost all federal debt under one limit, was established in 1939 and has generally been used as a flexible structure to encourage fiscal responsibility.3 Since 1960, the ceiling has been raised, modified, or suspended 78 times, mostly with little fanfare until a political battle in 2011.4
How much is the debt ceiling? The current limit was set by Congress at about $31.4 trillion in December 2021.5 The debt was less than $6 trillion in 2001, when it began to rise due to tax cuts and increased military and national security spending in response to 9/11. It has tripled since 2008, driven by reduced tax revenues and stimulus spending during the Great Recession and the COVID-19 pandemic.6
When will we reach the debt ceiling? The government reached the $31.4 trillion limit on January 19, 2023. Since then, the Treasury has been using short-term accounting tactics (called “extraordinary measures”) to allow spending for a limited period without raising the ceiling.7 According to Treasury Secretary Janet Yellen, this extension is expected to expire on or shortly after June 1, 2023.8 The so-called “X-date” could vary because tax revenues are not fully predictable. It has come more quickly than anticipated, due to postponement of the tax-filing deadline for disaster-area taxpayers in certain states and lower capital gains tax receipts.9
What will happen if the ceiling is not increased? The U.S. government will not be able to pay all its financial obligations. This has never happened, so it is difficult to predict exactly how it would play out. The Treasury could still pay some of its obligations from incoming revenues, but there would have to be choices regarding what bills would not be paid. These are some of the possible results.
- The government could default on its bond payments. U.S. Treasury securities are generally considered among the safest investments in the world because they are backed by the full faith and credit of the U.S. government as to the timely payment of principal and interest. These securities are widely held by individual and institutional investors as well as local, state, and foreign governments. Even the possibility of defaulting on interest payments could disrupt global markets, and an extended default could have serious economic repercussions around the world. An estimate by Moody’s Analytics suggests that a one-week default could send the U.S. economy into a mild recession with the loss of 1.5 million jobs and real GDP contraction of 0.7 percentage point. A default through the end of July (which seems highly unlikely) could cause a deep recession with 7.8 million lost jobs and a real GDP decline of 4.6%. Any default, or even near-default, could result in downgrading the U.S. credit rating, as occurred in 2011. This would make borrowing more expensive, adding to the ongoing problem.10
- Government payments could be delayed. Social Security and Veterans benefit payments could be delayed, causing hardship to those who depend on them for immediate needs. The same is true for wages of U.S. government workers, and overdue payments to government contractors could mean they may not be able to pay their employees. Late reimbursements to Medicare providers could strain smaller hospitals and medical practices. Any past due payments would be made once the debt ceiling is raised, but the short-term consequences could be painful.
What are the issues in the negotiations? Public statements from negotiators indicate the key issues include caps on future spending, use of unspent COVID-relief funds, work requirements for certain social programs, and expediting rules for energy projects. Both sides have agreed to spending caps in general terms, but they differ on how caps should be structured. The 2011 debt ceiling impasse resulted in spending caps, which had mixed results over the long term.11 Any caps would only affect discretionary spending, accounts for just 28% of federal spending. Defense spending is almost half of that amount. The rest is mandatory spending, including Social Security and Medicare (which will account for nearly 35% of federal spending in 2023) and interest on the national debt.12
Will there be a resolution? It is impossible to know for sure, but both sides have clearly stated that they will not allow the U.S. government to default on its obligations. However, time is growing short, and any agreement must pass in both the House and the Senate, requiring at least some bipartisan support. Speaker McCarthy has said that an agreement must be reached early enough to give House lawmakers a required 72-hour period to review the legislation before the June 1 deadline.13 If an agreement is not reached by that time, a temporary measure could suspend or raise the ceiling for a limited period to provide more time for negotiations.
Should investors worry? Although a default could have serious market repercussions, the most likely scenario is that the ceiling will be suspended or raised close to the deadline. If so, any related market volatility is likely to be temporary.14 While the U.S. debt is a significant issue, your investment strategy should be based on your long-term goals and risk tolerance, and it’s generally wise to stay the course through political conflicts.
The principal value of Treasury securities fluctuates with market conditions. If not held to maturity, they could be worth more or less than the original amount paid. Forecasts are based on current conditions, are subject to change, and may not happen.
1, 11, 13) The New York Times, May 22, 2023
2, 4, 6, 8) U.S. Treasury, 2023
3) Bipartisan Policy Center, 2023
5, 7, 12) Congressional Budget Office, February 2023
9-10, 14) Moody’s Analytics, May 2023
Rescuing America’s Safety Net
A March 2023 survey found that more than 90% of Americans worry about the Social Security program, and about half of those said they worry a great deal.1 A separate survey the same month found that more than 80% of Americans worry Medicare will not be able to provide the same level of benefits in the future.2
These concerns are well-founded, because both programs — the cornerstones of “America’s Safety Net” — face serious fiscal challenges that require Congressional action. And the longer Congress waits to act, the more extreme the solutions will have to be. Even so, it’s important to keep in mind that neither of these programs is in danger of collapsing completely. The question is what type of changes will be required to rescue them.
Demographic Dilemma
The fundamental problem facing both programs is the aging of the American population. Today’s workers pay taxes to fund benefits received by today’s retirees, and with lower birth rates and longer life spans, there are fewer workers paying into the programs and more retirees receiving benefits for a longer period. In 1960, there were 5.1 workers for each Social Security beneficiary; in 2023 there are 2.7, dropping steadily to 2.2 by 2045.3
Dwindling Trust Funds
Payroll taxes from today’s workers, along with income taxes on Social Security benefits, go into interest-bearing trust funds. During times when payroll taxes and other income exceeded benefit payments, these funds built up reserve assets. But now the reserves are being depleted as they supplement payroll taxes and other income to meet scheduled benefit payments.
Each year, the Trustees of the Social Security and Medicare Trust Funds provide detailed reports to Congress that track the programs’ current financial condition and projected financial outlook. These reports have warned for years that the trust funds would be depleted in the not-too-distant future, and the most recent reports, both released on March 31, 2023, suggest that the future may arrive even sooner than expected.
Social Security Outlook
Social Security consists of two programs, each with its own trust fund. Retired workers and their families and survivors receive monthly benefits under the Old-Age and Survivors Insurance (OASI) program; disabled workers and their families receive monthly benefits under the Disability Insurance (DI) program.
The OASI Trust Fund reserves are projected to be depleted in 2033, one year earlier than in last year’s report, at which time incoming revenue would pay only 77% of scheduled benefits. Reserves in the much smaller DI Trust Fund, which is on stronger footing, are not projected to be depleted during the 75-year period ending 2097.4
Under current law, these two trust funds cannot be combined, but the Trustees also provide an estimate for the combined program, referred to as OASDI. This would extend full benefits another year, to 2034, at which time, incoming revenue would pay only 80% of scheduled benefits.5
Put simply, the current outlook suggests that Social Security beneficiaries might face a benefit cut of 23% in a decade unless Congress takes action.
Medicare Outlook
Medicare also has two trust funds. The Hospital Insurance (HI) Trust Fund pays for inpatient and hospital care under Medicare Part A. The Supplementary Medical Insurance (SMI) Trust Fund comprises two accounts: one for Medicare Part B physician and outpatient costs and the other for Medicare Part D prescription drug costs.
The HI trust fund reserves are projected to be depleted in 2031. This is three years later than in last year’s report, due to lower costs and higher payroll taxes, but still more imminent than the Social Security shortfall. At that time, revenue would pay only 89% of the program’s costs.6
The SMI Trust Fund accounts for Medicare Parts B and D are expected to have sufficient funding because they are automatically balanced through premiums and revenue from the federal government’s general fund, which provides about 75% of costs, a major outlay from the federal budget.7
Possible Fixes
The Trustees of both programs continue to urge Congress to address these financial shortfalls soon, so that solutions will be less drastic and may be implemented gradually.
Any permanent fix to Social Security would likely require a combination of changes, including some of these.8
- Raise the Social Security payroll tax rate (currently 12.4%, half paid by the employee and half by the employer). An immediate and permanent payroll tax increase to 15.84% would be necessary to address the long-range revenue shortfall (or to 16.55% if the increase started in 2034).9
- Raise the ceiling on wages subject to Social Security payroll taxes ($160,200 in 2023).
- Raise the full retirement age (currently 67 for anyone born in 1960 or later).
- Change the benefit calculation formula.
- Use a different index to calculate the annual cost-of-living adjustment.
- Tax a higher percentage of benefits for higher-income beneficiaries.
Options for reducing the Medicare shortfall include a combination of spending cuts and tax increases. These are some possibilities.10
- Improve the payment system for Medicare Advantage Plans (private plans that receive partial funding from Medicare).
- Modernize cost sharing between Medicare and Medigap (supplementary insurance).
- Increase the Medicare payroll tax rate (currently 2.9%, shared equally between employee and employer, with an additional 0.9% on income above $200,000 for single filers and $250,000 for joint filers).11
- Broaden the tax base subject to Medicare payroll taxes (there is no income ceiling for Medicare payroll taxes, but certain income is currently not subject to the tax).
Based on past changes to these programs, it’s likely that any future changes would primarily affect future beneficiaries and have a relatively small effect on those already receiving benefits. While neither Social Security nor Medicare is in danger of disappearing, it would be wise to maintain a strong retirement savings strategy to prepare for potential changes to America’s Safety Net.
All projections are based on current conditions, subject to change, and may not happen.
1) Gallup, April 6, 2023
2) Kaiser Family Foundation, March 2023
3–5, 9) 2023 Social Security Trustees Report
6–7, 11) 2023 Medicare Trustees Report
8) Social Security Administration, February 21, 2023
10) Committee for a Responsible Federal Budget, June 16, 2022
SECURE 2.0 Helps Small Employers Help Their Employees
Approximately 78% of people who work for companies with fewer than 10 employees and about 65% of those who work for companies with 10 to 24 employees do not have access to a retirement plan at work.1 That’s unfortunate, because workers with a retirement plan are far more likely to save for retirement than those without a plan. In 2022, 62% of those without a retirement plan had accumulated less than $1,000 for retirement, compared with 71% of those with a plan who had saved at least $50,000. More than four in 10 workers with access to a work-based plan had amassed a quarter million dollars or more.2
In December 2022, Congress aimed to address this issue (among others) by passing legislation that will help small employers more efficiently and cost-effectively offer retirement plans to their workforces, while providing incentives to help improve participation rates among lower-income workers. The SECURE 2.0 Act of 2022 — so named because it builds upon the original Setting Every Community Up for Retirement Enhancement (SECURE) Act passed in 2019 — is a sweeping set of provisions designed to improve the nation’s retirement-planning health. Here is a brief look at some of the tax perks, rule changes, and incentives included in the legislation.
Tax Perks for Employers in 2023
Perhaps most appealing to small business owners, the Act enhances the tax credits associated with adopting new retirement plans, beginning in 2023.
For employers with 50 employees or less, the pension plan start-up tax credit increases from 50% of qualified start-up costs to 100%. Employers with 51 to 100 employees will still be eligible for the 50% credit. In either case, the credit maximum is $5,000 per year (based on the number of employees) for the first three years the plan is in effect.
In addition, the Act offers a tax credit for employer contributions to employee accounts for the first five tax years of the plan’s existence. The amount of the credit is a maximum of $1,000 for each participant earning not more than $100,000 (adjusted for inflation) in income. Each year, a specific percentage applies. In years one and two, employers receive 100% of the credit; in year three, 75%; in year four, 50%; and in year five, 25%. The amount of credit is reduced for employers with 51 to 100 employees. No credit is allowed for employers with more than 100 workers.
Rule Changes and Relevant Years
In 2024, employers will be able to adopt a deferral-only starter 401(k) or safe-harbor 403(b) plan, which are designed to be lower cost and easier to administer than traditional plans. Both plan types have auto-enrollment features and accept employee contributions only. Employees are enrolled at minimum contribution rates of 3%, not to exceed 15%, and may opt out. The plans may accept up to $6,000 per participant annually ($7,000 for those 50 and older), indexed for inflation.
SIMPLE plans may benefit from two new contribution rules. First, employers may make nonelective contributions to employee accounts up to 10% of compensation or $5,000. Second, the annual contribution limits (standard and catch-up) for employers with no more than 25 employees will increase by 10%, rather than the limit that would otherwise apply. An employer with 26 to 100 employees would be permitted to allow higher contributions if the employer makes either a matching contribution on the first 4% of compensation or a 3% nonelective contribution to all participants, whether they contribute. These changes also take effect in 2024.
Beginning in 2025, 401(k) and 403(b) plans will generally be required to automatically enroll eligible employees and automatically increase their contribution rates every year, unless they opt out. Employees will be enrolled at a minimum contribution rate of 3% of income, and rates will increase each year by 1% until they reach at least 10% (but not more than 15%). Not all plans will be subject to this new provision. Exceptions include those in existence prior to December 29, 2022; those sponsored by organizations less than three years old or employing 10 or fewer workers; governmental and church plans; and SIMPLE 401(k) plans.
Incentives for Participation
SECURE 2.0 drafters were creative in finding ways to encourage workers, particularly those with lower incomes, to take advantage of their plans. For example, effective immediately, employers may choose to offer small-value financial incentives, such as gift cards, for joining a plan. Beginning in 2024, employers may provide a matching contribution on employee student loan payments, which should help encourage younger workers to plan for their future. Also in 2024, workers will be able to withdraw up to $1,000 a year to cover unforeseeable or immediate emergencies without having to pay a 10% early distribution penalty, which should help address the fear of locking up retirement-plan contributions for many years. Employees will have up to three years to repay the emergency distributions and will not be able to take a second emergency distribution during this three-year period unless the first has been reimbursed.
1) AARP, July 2022
2) Employee Benefit Research Institute, 2022
Jason Zweig view of Benjamin Graham’s approach to investing
Jason Zweig is a journalist at the Wall Street Journal. I have consistently found his column, “The Intelligent Investor” to be clear and insightful. His March 21 column, “The Risk That Come With Rescuing Banks” is followed by “Money Mailbag”. He was asked for a comparison of “The Intelligent Investor” and “Security Analysis” both written by Benjamin Graham.
Following are excerpts from his answer.
“ Benjamin Graham (1894-1976) was one of the greatest investors of the 20th century, as well as Warren Buffett’s boss and mentor.”
“He understood that markets are dynamic and that investors should be flexible.”
“The guidelines Graham laid down in the final edition …(1973) differ significantly from those he set in the previous, 1965 edition.”
“What Graham never changed is the emotional framework he built. Whether you are a professional or an individual investor…”
“If he were around today, he would have yet another set of rules.”
- “cultivate the seven investing virtues of curiosity, skepticism, discipline, independence, humility, patience and courage;
- regard a stock as a stake in an underlying business, not as a ticker symbol or a lottery ticket;
- recognize that the stock market is often insane;
- think not only about how much you will make if you are right, but how much you will lose if you are wrong;
- trade as seldom as possible.”
He provides much to think about, even if you do not agree with him.
