Good and Bad News about Social Security
With approximately 94% of American workers covered by Social Security and 65 million people currently receiving benefits, keeping Social Security healthy is a major concern.1 Social Security is financed primarily through payroll taxes. Unless Congress act benefits may eventually be reduced. Trustees of the Social Security Trust Funds release a detailed report to Congress in June. The good news was that the effects of the pandemic were not as significant as projected a year ago.
Mixed news for Social Security
Social Security program consists of two programs, the Old-Age and Survivors Insurance (OASI) program and Disability Insurance (OASDI). Each program has its own financial account (Trust Fund). Payroll taxes collected are deposited in the applicable Trust Fund. OASI provide benefits to retired workers, their families, and survivors of workers. D provides benefits to disabled workers and their families. Funding is also provided by other income (reimbursements from the General Fund of the U.S. Treasury and income tax revenue from benefit taxation).
Social security is required to invest funds collected in special government-guaranteed Treasury bonds that earn interest. These funds are now being used to pay benefits more than the payroll tax collected. Payroll taxes are not sufficient to pay current benefits. Changes in our demographics are a significant reason for the deficiency.
A recent report by the Trustees estimate that the funds will not be able to fund full retirement and survivor benefits. Benefit would then be reduced to 77% of scheduled OASI benefits, declining to 72% through 2096, the end of the 75-year, long-range projection period.
The Trustees report, estimate the combined reserves (OASDI) will be able to pay scheduled benefits until 2035. Benefit would then be reduced to 80% of scheduled benefits, declining to 74% by 2096. OASI and DI Trust Funds are separate, and generally one program’s taxes and reserves cannot be used to fund the other program. However, this could be changed by Congress, and combining these trust funds in the report is a way to illustrate the financial outlook for Social Security as a whole.
The above is based on current conditions and likely future demographic, economic, and program-specific conditions. Future events including the impact of the pandemic may results in changes not reflected in the Trustee’s estimates.
Some changes can be made to improve the situation
The Trustees continue to urge Congress to address the financial challenges. The sooner Congress acts the less harsh the changes will be. Some of the options that have been suggested including the following:
- Raising the current Social Security payroll tax rate. Increasing the payroll tax to 15.64% from 12.4% would correct the situation
- Raising or eliminating the ceiling on wages subject to Social Security payroll taxes ($147,000 in 2022).
- Raising the full retirement age from 67 (for anyone born in 1960 or later).
- Raising the early retirement age from 62.
- Reducing future benefits by about 20.3% for all current and future beneficiaries, or by about 24.1% if reductions were applied only to those who initially become eligible in 2022 or later.
- Changing the benefit formula that is used to calculate benefits.
- Calculating the annual cost-of-living adjustment (COLA) for benefits.
A comprehensive list of potential solutions can be found at https://www.ssa.gov/OACT/solvency/provisions/.
1) Social Security Administration, 2022
Turmoil and the Bear Market
Where we go from here is unknown. There have been many times the stock market and the economy have recovered from worse. The following is intended to be a general discussion. How to proceed will depend on each person’s circumstances (it depends). There are numerous technical issues not included in this discussion.
During the intensely volatile first 100 trading days of 2022, the Stocks of companies in the S&P 500 index delivered their worst performance since 1970 .1 The S&P 500 continued to tumble, and the benchmark index descended into a bear market — typically defined as a sustained drop in stock prices of at least 20% — on June 13, 2022. When the market closed, the S&P 500 had dropped 21.8% from its January 3 peak, and the tech-heavy NASDAQ, already in bear territory, had plunged 32.7% from its November 19, 2021 peak.2
Some investors who are nervous about the future and their portfolios seem to have taken a defensive stance by selling riskier assets, including investments in growth-oriented technology stocks.
What’s causing market volatility?
Throughout 2021, U.S. businesses dealt with unpredictable demand shifts and supply shocks related to the pandemic, but near-zero interest rates and trillions of dollars in pandemic relief supported consumer spending, boosted economic growth, and drove record corporate profits. Companies in the S&P 500 posted profits in 2021 that were 70% higher than in 2020 and 33% higher than in 2019, which helped fuel a stock market total return of nearly 29%.3-4
But in the first months of 2022, investors began to worry that the anticipated tightening of monetary policies by the Federal Reserve — intended to cool off stubbornly high inflation — would stifle economic growth and cause a recession. Prices began rising in the spring of 2021 due to high demand, supply-chain issues, and a labor shortage that pushed up wages. Inflation picked up speed in the first quarter of 2022 when China’s COVID-19 lockdowns impacted the supply of goods, and Russia’s invasion of Ukraine sent already high global food and fuel prices through the roof. In May 2022, the Consumer Price Index rose at an annual rate of 8.6%, a 40-year high.5
The relentless acceleration of price increases puts pressure on the Federal Open Market Committee (FOMC), which meets on June 15 and 16, to act aggressively to tame inflation. At the beginning of May, the FOMC raised the benchmark federal funds rate by 0.5% (to a range of 0.75%–1.00%). This was the first half-percent increase since May 2000, and Fed projections suggest there will be more to come.6
Rising interest rates push bond yields upward, and the opportunity for higher returns from lower-risk bond investments makes higher-risk stock investments less attractive. Moreover, stock investors are buying a portion of a company’s future cash flows, which become less valuable in an inflationary environment. Higher borrowing costs can also crimp consumers’ spending power and cut into the profits of companies that rely on debt.
The problem with one sector dominating the market
Stocks tracked by the S&P Information Technology Sector Index, which fell 29.2% from a January 3 high, have been hit harder than the S&P 500. Plus, like many benchmark indexes, the S&P 500 is weighted by market capitalization (the value of a company’s outstanding shares). This gives the largest companies, most of which are in the tech sector, an outsized role in index performance. As of May 31, the information technology sector still accounted for 27.1% of the market cap of the S&P 500, compared with weightings of 14.4% for health care and 11.2% for financials, the next-largest sectors. Apple, Microsoft, Alphabet, and Amazon, respectively, are the four most-valuable companies in the index; Nvidia is ranked ninth and Meta has fallen to number 11.7
For the past several years, tech stock gains drove the market to new heights, but when their share values began to plunge, they dragged the broader stock indexes down with them. A Wall Street Journal analysis of market data through May 17 found that just eight of the largest U.S. companies — the six previously mentioned, plus Netflix and Tesla (in the consumer discretionary sector) — were responsible for an astounding 46% of the S&P 500’s 2022 losses (on a total return basis).8
These well-known technology companies have grown into massive multinational businesses that have a major influence on everyday life. Some dominate their respective business spaces — social media, smartphones, online search and advertising, e-commerce, and cloud computing — enough to spark antitrust investigations and calls for stricter regulations in the United States and abroad. They also have plenty of cash on hand, which means they may be in better shape to withstand an economic slowdown than their smaller competitors.9
Takeaways
Spreading investments among the 11 sectors of the S&P 500 is a common way to diversify stock holdings. But over time, a stock portfolio that was once diversified can become overconcentrated in a sector that has outperformed the broader market. Tech-sector stocks notched huge total returns of about 50% in 2019, 44% in 2020, and 35% in 2021, so you may want to look closely at the composition of your portfolio and consider rebalancing if you find yourself overexposed to this highly volatile sector. (Rebalancing involves selling some investments to buy others. Keep in mind that selling investments in a taxable account could result in a tax liability.) 10
If you feel shell-shocked after more than five months of market turbulence, try to regain some perspective. Some market analysts view recent price declines as a painful but long overdue repricing of stocks with valuations that had grown excessive, as well as a reality check brought on by waning growth expectations. The forward price-to-earnings (P/E) ratio of companies in the S&P 500 has fallen from 23.3 at the end of 2021 to 17.8 in May 2022, much closer to the 10-year average of 16.9.11-12
It could be a while before investors can better assess how the economy and corporate profits will ultimately fare against fast-rising inflation and higher borrowing costs — and the stock market is no fan of uncertainty. Disappointing economic data and company earnings reports could continue to spark volatility in the coming months.
It may not be easy to take troubling headlines in stride, but if you have a sufficiently diversified, all-weather investment strategy, sticking to it is often the wisest course of action. If you panic and flee the market during a downturn, you won’t be able to benefit from upward swings on its better days. And if you continue investing regularly for a long-term goal such as retirement, a down market may be an opportunity to buy more shares at lower prices.
The return and principal value of stocks fluctuate with changes in market conditions. Shares, when sold, may be worth more or less than their original cost. Investments seeking a higher return tend to involve greater risk. Diversification is a method used to help manage risk. It does not guarantee a profit or protect against investment loss. The S&P 500 is an unmanaged group of securities that is considered representative of the U.S. stock market in general. The performance of an unmanaged index is not indicative of the performance of any specific investment. Individuals cannot invest directly in an index. Past performance is not a guarantee of future results. Actual results will vary. Dollar-cost averaging does not ensure a profit or prevent a loss. Such plans involve continuous investments in securities regardless of fluctuating prices. You should consider your financial ability to continue making purchases during periods of low and high price levels. However, this can be an effective way for investors to accumulate shares to help meet long-term goals.
1) SIFMA, 2022
2) Yahoo! Finance, 2022
3) The New York Times, May 31, 2022
4, 7, 10-11) S&P Dow Jones Indices, 2022
5) U.S. Bureau of Labor Statistics, 2022
6) Federal Reserve, 2022
8) The Wall Street Journal, May 19, 2022
9) The New York Times, May 20, 2022
12) FactSet, 2022
For the past several years, tech stock gains drove the market to new heights, but when their share values began to plunge, they dragged the broader stock indexes
IRS Releases 2023 Key Numbers for Health Savings Accounts
The IRS has released the 2023 contribution limits for health savings accounts (HSAs), as well as the 2023 minimum deductible and maximum out-of-pocket amounts for high-deductible health plans (HDHPs). An HSA is a tax-advantaged account that’s paired with an HDHP. An HSA offers several valuable tax benefits:
You may be able to make pre-tax contributions via payroll deduction through your employer, reducing your current income tax.
If you make contributions on your own using after-tax dollars, they’re deductible from your federal income tax (and perhaps from your state income tax) whether you itemize or not.
Contributions to your HSA, and any interest or earnings, grow tax deferred.
Contributions and any earnings you withdraw will be tax-free if used to pay qualified medical expenses.
Key tax numbers for 2022 and 2023.
Health Savings Accounts
Annual contribution limit 2022 2023
Self-only coverage $3,650 $3,850
Family coverage $7,300 $7,750
High-deductible health plan: self-only coverage 2022 2023
Annual deductible: minimum $1,400 $1,500
Annual out-of-pocket expenses required to be paid
(other than for premiums) can’t exceed $7,050 $7,500
High-deductible health plan: family coverage 2022 2023
Annual deductible: minimum $2,800 $3,000
Annual out-of-pocket expenses required to be paid (other than for premiums) can’t exceed
$14,100 $15,000
Catch-up contributions
Annual catch-up contribution limit for individuals age 55 or older $1,000 2022 and 2023
The IRS has released the 2023 key tax numbers for health savings accounts (HSAs) and high-deductible health plans (HDHPs).
Rising Rates Add to Housing Dilemmas
Home buyers braving the hot U.S. housing market have run headlong into a striking transition. The average interest rate for a 30-year fixed mortgage jumped from around 3.2% at the beginning of 2022 to 5.3% in mid-May, the highest level since 2009. This rise was sparked by the Federal Reserve’s commitment to raise the federal funds rate — a key benchmark for short-term interest rates — to help control the highest inflation in decades.1
Although mortgage rates are not directly tied to the federal funds rate, all borrowing costs are influenced by the Fed’s monetary policies. Mortgage rates tend to track changes in the 10-year Treasury yield, which is sensitive to changes in the funds rate and fluctuates based on the bond market’s longer-term expectations for economic growth and inflation.
Housing Costs Are Soaring
For nearly two years now, buyers have faced an intensely competitive housing market characterized by historically low inventory, bidding wars, and escalating prices. The national median price of existing homes rose 14.8% over the year ending April 2022 to reach $391,200. Home prices are rising in every region, and 70% of the nation’s 185 metro areas experienced double-digit annual increases in the first quarter. In a notable shift, price gains in affordable small- and mid-size cities outpaced gains in more expensive urban markets, as many home buyers seized the opportunity to work remotely.2
Home prices and market conditions can vary widely by region and even by neighborhood. April median prices in the 10 most expensive cities ranged from $662,000 in Denver to $1,875,000 in San Jose. Half of the nation’s 10 priciest markets are in California, a state with a particularly severe and longstanding housing shortage.3
Rents have also been rising. In April 2022, the median rent for 0- to 2-bedroom properties in the 50 largest U.S. metro areas reached $1,827, a year-over-year increase of 16.7%. Spikes were more dramatic in Sun Belt cities such as Miami (51.6%), San Diego (25.6%), and Austin (24.7%).4
In this environment, prospective home buyers, renters who must renew a lease, or anyone looking for a different place to live could find themselves in a challenging situation.
Affordability Is Waning
The combination of rising mortgage rates and home prices has taken a serious toll on affordability. A borrower with a $300,000 mortgage would pay $1,666 per month at a 5.3% rate versus $1,297 at a 3.2% rate, the prevailing rate earlier this year. Affordability is an even bigger issue in high-cost areas and for first-time buyers who haven’t benefited from gains in home equity.
Borrowers who started a home search and were pre-qualified by a lender before rates spiked may not be approved for the mortgages they initially sought. Consequently, demand for adjustable-rate mortgages (ARMs) that offer lower rates has surged in recent months.5 A lower monthly payment makes it possible to qualify for a larger mortgage, so borrowers who expect to move at some point may be comfortable with an ARM that has a fixed rate for the first three, five, seven, or 10 years of the 30-year term before it adjusts to prevailing rates.
Some buyers will change their expectations and settle for a less-expensive home. But others may give up the search if they are not satisfied with the homes they can afford, especially if they are priced out of their favorite neighborhoods. Many entry-level buyers could be forced out of the market entirely, at least for the time being.
Buyers of new homes may be subject to substantial interest-rate risk because purchase contracts are often signed many months before their homes will be completed. With their deposits at stake, buyers might consider paying the extra cost to extend rate locks for six, nine, or even 12 months.
Higher borrowing costs are likely to reduce demand for homes enough to slow price growth, and prices might retreat in some overheated markets. Even so, most economists don’t expect home prices to collapse because market fundamentals are otherwise relatively strong. Inventory levels are still extremely low, and lenders have generally been conservative, so most homeowners who bought in recent years can afford their mortgages.6 Interest rates don’t impact cash buyers, such as downsizing retirees and investors, who account for about 26% of transactions.7 And assuming the economy and employment hold up, there should be plenty of demand from millennials in their peak home buying years.8
Tips for Bewildered First-Time Buyers
Paying rent indefinitely may do little to improve your financial future, but if you are ready to commit to a mortgage, buying a home could stabilize your housing costs for as long as the payment is fixed. You can also build equity in the property as your loan balance is paid off over time — more so if the value appreciates.
No one knows for sure where mortgage rates are headed or what will happen next in the housing market. So how can you decide whether it makes financial sense to purchase a home? As always, the answer depends on where you want to live, your lifestyle preferences, and your finances.
Here are three ways to start preparing for the home buying process.
Become a better borrower. Before you apply for a mortgage, order a copy of your credit report to check for errors and clean up any inaccuracies. Having a higher credit score could earn you a lower interest rate.
Save up for a down payment. Buyers must typically invest 20% of the purchase price for conventional mortgages, but some loan programs allow smaller down payments of 5% to 10%. If parents or other family members offer to “gift” cash for a down payment, lenders may ask for a letter to document the source of funds. There may also be local programs that provide down-payment assistance for buyers who meet income requirements and take classes on home ownership.
Find out how much you can afford to spend. Start with online calculators that take your income, debt, and expenses into account. A mortgage provider can help determine how much you may qualify to borrow. It can take three to five years to recoup real estate transaction costs, so be sure to consider the stability of your employment situation and your income.
1) Bloomberg, May 12, and May 19, 2022
2-3, 7) National Association of Realtors, 2022
4) Realtor.com, 2022
5) The Wall Street Journal, May 5, 2022
6) NPR, May 12, 2022
8) The Wall Street Journal, December 14, 2021
The Question is How Long High Inflation Will Last?
at an annual rate of 8.5% in March 2022. That is the highest level since December 1981.1 A Gallup poll at the end of March found that one out of six Americans considers inflation to be the most important problem facing the United States.2 The Consumer Price Index for All Urban Consumers (CPI-U), the most common measure of inflation, rose
Many economists, including policymakers at the Federal Reserve, believed the increase would be transitory and subside over a period of months when inflation began rising in the spring of 2021. Inflation has proven to be more stubborn than expected. There are many reasons for the rising prices. The Fed has a plan to deal with the situation.
Russia and China contributed to the situation.
Among the cause of rising inflation are the growing pains of a rapidly opening economy, pent-up consumer demand, supply-chain slowdowns, and not enough workers to fill open jobs. Significant government stimulus and the Federal Reserve monetary policies helped prevent a deeper recession but contributed to an increase in inflation.
Russian invasion of Ukraine increased the already high global fuel and food prices.3 China’s response to the reappearance of COVID’s was strict lockdowns, which closed factories and increased already struggling supply chains for Chinese goods. The volume of cargo handled by the port of Shanghai, the world’s busiest port, dropped by an estimated 40% in early April.4
Behind the Headlines
8.5% year-over-year “headline” inflation in March was high. However, monthly numbers provide a clearer picture of the current trend. The month-over-month increase of 1.2% was extremely high, but more than half of it was due to gasoline prices, which rose 18.3% in March alone.5 Despite the Russia-Ukraine conflict and increased seasonal demand, U.S. gas prices dropped in April, but the trend was moving upward by the end of the month.6 The federal government’s decision to release one million barrels of oil per day from the Strategic Petroleum Reserve for the next six months and allow summer sales of higher-ethanol gasoline may help moderate prices.7
Core inflation, which strips out volatile food and energy prices, rose 6.5% year-over-year in March, the highest rate since 1982. However, the month-over-month increase from February to March was just 0.3%, the slowest pace in six months. Another positive sign was the price of used cars and trucks, which rose more than 35% over the last 12 months (a prime driver of general inflation) but dropped 3.8% in March.8
Wages and Consumer Demand
For the 12 months ended in March, average hourly earnings increased 5.6%. This was not enough to keep up with inflation, although it was enough to dulled some of the effects. Lower-paid service workers received higher increases, with wages jumping by almost 15% for nonmanagement employees in the leisure and hospitality industry. Although inflation has cut deeply into wage gains over the last year, wages have increased at about the same rate as inflation over the two-year period of the pandemic.9
One of the big questions going forward is whether rising wages will enable consumers to continue to pay higher prices, which can lead to an inflationary spiral of ever-increasing wages and prices. Recent signals are mixed. The official measure of consumer spending increased 1.1% in March, but an early April poll found that two out of three Americans had cut back on spending due to inflation.10-11
Soft or Hard Landing?
The Federal Open Market Committee (FOMC) of the Federal Reserve has laid out a plan to fight inflation by raising interest rates and tightening the money supply. After dropping the benchmark federal funds rate to near zero in order to stimulate the economy at the onset of the pandemic, the FOMC raised the rate by 0.25% at its March 2022 meeting and projected the equivalent of six more quarter-percent increases by the end of the year and three or four more in 2024.12 This would bring the rate to around 2.75%, just above what the FOMC considers a “neutral rate” that will neither stimulate nor restrain the economy.13
These moves were projected to bring the Fed’s preferred measure of inflation, the Personal Consumption Expenditures (PCE) Price Index, down to 4.3% by the end of 2022, 2.7% by the end of 2023, and 2.3% by the end of 2024.14 PCE inflation was 6.6% in March. this tends to run below CPI, so even if the Fed achieves these goals, CPI inflation will likely remain somewhat higher.15
Fed policymakers have signaled a willingness to be more aggressive, if necessary, and the FOMC raised the funds rate by 0.5% at its May meeting, as opposed to the more common 0.25% increase. This was the first half-percent increase since May 2000, and there may be more to come. The FOMC also began reducing the Fed’s bond holdings to tighten the money supply. New projections to be released in June will provide an updated picture of the Fed’s intentions for the federal funds rate.16
The question facing the FOMC is how fast it can raise interest rates and tighten the money supply while maintaining optimal employment and economic growth. The ideal is a “soft landing,” like what occurred in the 1990s, when inflation was tamed without damaging the economy. At the other extreme is the “hard landing” of the early 1980s, when the Fed raised the funds rate to almost 20% to control runaway double-digit inflation, throwing the economy into a recession.18
Fed Chair Jerome Powell acknowledges that a soft landing will be difficult to achieve, but he believes the strong job market may help the economy withstand aggressive monetary policies. Supply chains are expected to improve over time, and workers who have not yet returned to the labor force might fill open jobs without increasing wage and price pressures.19
The next few months will be a key period to reveal the future direction of inflation and monetary policy. The hope is that March represented the peak and inflation will begin to trend downward. But even if that proves to be true, it could be a painfully slow descent.
Projections are based on current conditions, are subject to change, and may not happen.
1, 5, 8-9) U.S. Bureau of Labor Statistics, 2022
2) Gallup, March 29, 2022
3, 7) The New York Times, April 12, 2022
4) CNBC, April 7, 2022
6) AAA, April 25 & 29, 2022
10, 15) U.S. Bureau of Economic Analysis, 2022
11) CBS News, April 11, 2022
12, 14, 16) Federal Reserve, 2022
13, 17) The Wall Street Journal, April 18, 2022
18) The New York Times, March 21, 2022
Required Distributions from Inherited Retirement Accounts Change after 2019
Changes were made to the Required Minimum Distributions (RMD) for inherited Retirement Accounts by The Setting Every Community Up for Retirement Enhancement (SECURE) Act of 2019. The ability of beneficiaries to “stretch-out” the distribution of the account balance of an inherited defined contribution plan or an IRA were changed. After 2019 beneficiaries must distribute the full amount in the account within 10 years of the original owner’s death, with some exceptions. Where an exception applies, the entire account must generally be emptied within 10 years of the beneficiary’s death, or within 10 years after a minor child beneficiary reaches age 21.
IRS issued proposed regulations (generally applicable starting in 2022) that interpret the revised required minimum distribution (RMD) rules in February 2022. The new rules are complex and create uncertainty. Hopefully, the IRS will simplify and answer the questions. Account owners and their beneficiaries would benefit by familiarize themselves with these new interpretations and how they might be affected by them.
RMD BasicsOwners of traditional IRAs and participants of retirement plan like a 401(k) must start taking RMDs in the year they reach age 72 (age 70½ if you were born before July 1, 1949). An owner of the account may be able to wait until the year after retiring to start RMDs from that account at age 72 or older and still working for the employer that maintains the retirement plan. No RMDs are required from a Roth IRA during lifetime (beneficiaries are subject to inherited retirement account rules). Generally, a 50% penalty applies to the extent that RMDs are not timely distributed.
Changes were made to the Required Minimum Distributions (RMD) for inherited Retirement Accounts by The Setting Every Community Up for Retirement Enhancement (SECURE) Act of 2019. The ability of beneficiaries to “stretch-out” the distribution of the account balance of an inherited defined contribution plan or an IRA were changed. After 2019 beneficiaries must distribute the full amount in the account within 10 years of the original owner’s death, with some exceptions. Where an exception applies, the entire account must generally be emptied within 10 years of the beneficiary’s death, or within 10 years after a minor child beneficiary reaches age 21.
IRS issued proposed regulations (generally applicable starting in 2022) that interpret the revised required minimum distribution (RMD) rules in February 2022. The new rules are complex and create uncertainty. Hopefully, the IRS will simplify and answer the questions. Account owners and their beneficiaries would benefit by familiarize themselves with these new interpretations and how they might be affected by them.
RMD Basics
Owners of traditional IRAs and participants of retirement plan like a 401(k) must start taking RMDs in the year they reach age 72 (age 70½ if you were born before July 1, 1949). An owner of the account may be able to wait until the year after retiring to start RMDs from that account at age 72 or older and still working for the employer that maintains the retirement plan. No RMDs are required from a Roth IRA during lifetime (beneficiaries are subject to inherited retirement account rules). Generally, a 50% penalty applies to the extent that RMDs are not timely distributed.
The required beginning date (RBD) for the first year must be taken by April 1 of the next year. After the first distribution, annual distributions must be taken by the end of each year. Note, if the first distribution is delayed until April 1 two distributions will be required for that year, one by April 1 and the other by December 31.
The RMD rules govern how quickly retirement plans and/or IRAs must be distributed by the beneficiaries of the accounts. The rules are largely based on two factors: (1) the individuals named as beneficiaries of the retirement plan, and (2) whether the owner dies before or on or after your RBD. Because no lifetime RMDs are required from a Roth IRA, Roth IRA owners are always treated as dying before their RBD.
Who Is Subject to the 10-Year Rule?
Eligible designated beneficiaries (EDBs) are permitted to stretch out distributions to a limited extent. EDB’s include your surviving spouse, your minor children, any individuals not more than 10 years younger than you, and certain disabled or chronically ill individuals. Generally, EDBs can take annual required distributions based on remaining life expectancy. However, once an EDB dies, or once a minor child EDB reaches age 21, any remaining funds must be distributed within 10 years.
Note that the SECURE Act requires that if a designated beneficiary is not an EDB, the entire account must be fully distributed within 10 years after your death.
What If the Designated Beneficiary Is Not an EDB?
If you die before your required beginning date, no distributions are required during the first nine years after your death, but the entire account must be distributed in the tenth year.
If you die on or after your required beginning date, annual distributions based on the designated beneficiary’s remaining life expectancy are required in the first nine years after the year of your death, then the remainder of the account must be distributed in the tenth year.
What If the Beneficiary Is a Nonspouse EDB?
Annual distributions will be required based on your remaining life expectancy. If death occurs before the required beginning date, required annual distributions will be based on the EDB’s remaining life expectancy. If the owner of the account dies on or after their required beginning date, annual distributions after the owner’s death will be based on the greater of (a) what would have been the owners remaining life expectancy or (b) the beneficiary’s remaining life expectancy. Also, if distributions are calculated each year based on what would have been the remaining life expectancy, the entire account must be distributed by the end of the calendar year in which the beneficiary’s remaining life expectancy would have been reduced to one or less (if the beneficiary’s remaining life expectancy had been used).
After the death of the beneficiary or if the beneficiary is a minor child turns age 21, annual distributions based on remaining life expectancy must continue during the first nine years after the year of such an event. The entire account must be fully distributed in the tenth year.
What If a Designated Beneficiary A Spouse?
There are many special rules if a spouse is a designated beneficiary. The 10-year rule generally has no effect until after the death of the surviving spouse, or possibly until after the death of the spouse’s designated beneficiary.
What Life Expectancy Is Used to Determine RMDs After Death?
Annual required distributions based on life expectancy are generally calculated each year by dividing the account balance as of December 31 of the previous year by the applicable denominator for the current year (but the RMD will never exceed the entire account balance on the date of the distribution).
When life expectancy is used, the applicable denominator is the life expectancy in the calendar year of death, reduced by one for each subsequent year. When the nonspouse beneficiary’s life expectancy is used, the applicable denominator is that beneficiary’s life expectancy in the year following the calendar year of your death, reduced by one for each subsequent year. (Note that if the applicable denominator is reduced to zero in any year using this “subtract one” method, the entire account would need to be distributed.) And at the end of the appropriate 10-year period, any remaining balance must be distributed.
The rules relating to required minimum distributions are complicated, and the consequences of making a mistake can be severe. Talk to a tax professional to understand how the rules, and the new proposed regulations, apply to your individual situation.
Federal Student Loan Repayments Are Postponed Again
The U.S. Department of Education announced the sixth extension for federal student loan repayment, interest, and collections, through August 31, 2022.1 The prior postponement, the fifth, was to end April 30, 2022. The original extension was in March 2020 at the start of the pandemic.
Education Secretary Miguel Cardona stated: “This additional extension will allow borrowers to gain more financial security as the economy continues to improve and as the nation continues to recover from the COVID-19 pandemic.2
A “fresh start”
The Department of Education noted that it will give all federal student loan borrowers a “fresh start” by allowing them to enter repayment in good standing, even those individuals whose loans have been delinquent or in default. More information about loan rehabilitation will be coming from the Department in the weeks ahead.
The Department’s press release stated: “During the extension, the Department will continue to assess the financial impacts of the pandemic on student loan borrowers and to prepare to transition borrowers smoothly back into repayment. This includes allowing all borrowers with paused loans to receive a ‘fresh start’ on repayment by eliminating the impact of delinquency and default and allowing them to reenter repayment in good standing.”3
What should borrowers do between now and September?
Approximately 41 million Americans have federal student loans.4 There are a number of things borrowers can do between now and September 2022.
• Seek to build up financial reserves during the next few months to be ready to start repayment in September.
• Continue making student loan payments during the pause (the full amount of the payment will be applied to principal). Interest doesn’t accrue during the pause. Borrowers who continue making payments during this time may be able to save money in the long term, because when the pause ends, interest will be accruing on a smaller principal balance.
• Apply for the federal Public Service Loan Forgiveness (PSLF) program if they are working in public service and have not yet applied.
• Visit the federal student aid website, studentaid.gov, to learn more about PSLF and loan repayment options, including income-based options.
• Pay attention to the news. There has been increased political pressure on the current administration to enact some type of student loan cancellation, ranging from $10,000 per borrower to full cancellation. There are no guarantees, however. So, it wouldn’t be a good idea for borrowers to put all their eggs in this basket.
1-3) U.S. Department of Education, 2022
4) The Washington Post, April 6, 2022
Is the Global Economy endangered by Ukraine war?
Globalization of trade was expected to promote peace. Russia’s invasion of Ukraine is taxing that theory. The vulnerabilities of global supply chains are being highlighted. This has compounded the strains caused by the pandemic.
The United States, European Union (EU), United Kingdom (UK), and their allies are using financial sanctions to inflict severe damage on Russia’s economy and pressure its leaders to end the war. This has come a momentous cost to the global economy.
Punishing Russia
The joint effort of these countries to isolate Russia is unparalleled. Some of Russia’s largest banks have been expelled from SWIFT, an international payments system. Assets that Russia’s central bank held in North America and Europe have been frozen, restricting its ability to prop up the value of its currency, the ruble.1
Germany stopped the opening of a new gas pipeline that was intended access natural gas from Russia at the same time the United States and the United Kingdom announced bans on Russian oil imports.2 Hundreds of Western companies have suspended operations or pulled out of Russia, the world’s 11th largest economy, either to comply with sanctions or because of public outrage over the war. Some wealthy oligarchs believed to be close to the Kremlin have also had their assets frozen or seized.3
The effects of sanctions have clearly been felt in Russia, where the central bank raised its key interest rate to 20%, and it’s estimated that the Russian economy could contract up to 10%.4-5 Until recently, Russia was a full participant in the global economy, so being cut off from Western supply chains and technologies could be painful for Russian businesses and consumers. It remains to be seen whether China will step in to fill the void left behind by the West.
Supply Shocks
Russia is a major producer and exporter of food, energy, metals, and other raw materials that often fluctuate in price based on the balance between supply and demand across global markets.6 Therefore, supply shocks stemming from the war and sanctions have caused price spikes for some high-demand goods.
Russia is a top energy exporter, so crude oil and natural gas prices have surged since the conflict began, largely due to concerns about supply constraints. The EU relies heavily on energy imported from Russia (about 40% of its gas supply and almost 25% of its oil). Thus, reductions in energy deliveries from Russia would be difficult to replace and could worsen shortages in the global market.7
Russia is also a major producer of metals such as palladium (needed for catalytic converters), platinum, aluminum, copper, and nickel (needed for batteries).8In addition, about half of the world’s supply of the neon gas used to make semiconductors came from Ukrainian companies that have been forced to close their operations. Until neon production is ramped up elsewhere, shortages could exacerbate the chip shortage that has been slowing the production of new cars, computers, electronic devices, and other products.9
Russia and Ukraine account for nearly 30% of global wheat exports, 17% of corn, 32% of barley, and 75% of sunflower seed oil. Financial sanctions have largely blocked Russia from exporting food, while the conflict has prevented Ukraine from transporting food out of the country. Russia is the world’s top producer of fertilizer, providing about 15% of the global supply. Thus, crop yields throughout the world could be hindered by a shortage of fertilizer, which has risen to record prices alongside the natural gas from which it is often made.10
Consumers everywhere may soon face even higher grocery bills. The United Nations projects that global food costs, which are already at an all-time high, could soar another 22% due to the war. Egypt and other developing nations in North Africa, the Middle East, and Asia are especially dependent on grains from Russia and Ukraine. Disrupted food supplies and elevated prices are expected to cause a notable increase in world hunger.11
Ripple Effects
Russia and Ukraine account for only about 2% of global gross domestic product, but high energy prices and supply shocks caused by the war could have a far-reaching impact on a global economy that has not fully recovered from the pandemic. The Organization for Economic Cooperation and Development (OECD) estimates that global economic growth in the first year after the war began will be 1.1% lower, and inflation will be about 2.5% higher, than they would have been without the invasion. The impact will be greatest for countries with closer trade and financial ties to Russia and Ukraine. Throughout the world, people with lower incomes will likely suffer more because food and energy account for a larger share of spending.12
According to the same OECD report, inflation could rise an additional 2% in the euro area and 1.4% higher in the United States than it would have without the war. The OECD expects 2022 economic growth to be reduced by about 1.4% in the euro area and 0.9% in the United States.13
Russian aggression has caused a humanitarian disaster and an economic catastrophe in Ukraine that are nearly impossible to measure. More than 4 million people have already fled Ukraine, and many more could follow. Without outside help, accommodating the flood of refugees is likely to strain the finances of host governments such as Hungary, Moldova, Poland, Romania, and Slovakia.14
Europe has more exposure to the Russia-Ukraine conflict than the United States, but in both economies, inflation had already climbed to levels that haven’t been seen for decades.15 In the coming months, the world’s key central banks will face the tricky task of raising interest rates enough to control inflation without causing a recession. There could also be longer-term repercussions, such as the reorganization of global supply chains and less integrated financial markets.
Estimates and projections are based on current conditions, are subject to change, and may not happen.
1) The Wall Street Journal, March 18, 2022
2) The Wall Street Journal, March 23, 2022
3) The New York Times, March 22, 2022
4, 15) The Wall Street Journal, March 7, 2022
5) The Wall Street Journal, March 16, 2022
6-8, 12-13) OECD, March 2022
9) Reuters, February 25, 2022
10) The New York Times, March 20, 2022
11) Bloomberg, March 13, 2022
14) Associated Press, March 30, 2022
Managing Bond Risks When Interest Rates Rise
After dropping the benchmark federal funds rate to a rock-bottom range of 0%–0.25% early in the pandemic, the Federal Open Market Committee has begun raising the rate toward more typical historical levels in response to high inflation. At its March 2022 meeting, the Committee raised the funds rate to 0.25%–0.50% and projected the equivalent of six more quarter-percentage-point increases in 2022 and three or four more in 2023.1
Raising the federal funds rate places upward pressure on a wide range of interest rates, including the cost of borrowing through bond issues. Regardless of the rate environment, however, bonds are a mainstay for investors who want to generate income or dampen the effects of stock market volatility on their portfolios. You may have questions about how higher rates could affect your fixed-income investments and what you can do to help mitigate the effect in your portfolio.
Rate sensitivity
When interest rates rise, the value of existing bonds typically falls, because investors would prefer to buy new bonds with higher yields. In a rising rate environment, investors may be hesitant to tie up funds for a lengthy period, so bonds with longer maturity dates are generally more sensitive to rate changes than shorter-dated bonds. Thus, one way to address interest-rate sensitivity in your portfolio is to hold short- and medium-term bonds. However, keep in mind that although these bonds may be less sensitive to rate changes, they will generally offer a lower yield than longer-term bonds.
A more specific measure of interest-rate sensitivity is called duration. A bond’s duration is derived from a complex calculation that includes the maturity date, the present value of principal and interest to be received in the future, and other factors. To estimate the impact of a rate change on a bond investment, multiply the duration by the expected percentage change in interest rates. For example, if interest rates rise by 1%, a bond or bond fund with a three-year duration might be expected to lose roughly 3% in value; one with a seven-year duration might fall by about 7%. Your investment professional or brokerage firm can provide information about the duration of your bond investments.
If two bonds have the same maturity, the bond with the higher yield will typically have a shorter duration. For this reason, U.S. Treasuries tend to be more rate sensitive than corporate bonds of similar maturities. Treasury securities, which are backed by the federal government as to the timely payment of principal and interest, are considered lower risk and thus can pay lower rates of interest than corporate bonds. A five-year Treasury bond has a duration of less than five years, reflecting income payments received prior to maturity. However, a five-year corporate bond with a higher yield has an even shorter duration.
When a bond is held to maturity, the bond owner would receive the face value and interest, unless the issuer defaults. However, bonds redeemed prior to maturity may be worth more or less than their original value. Thus, rising interest rates should not affect the return on a bond you hold to maturity, but may affect the price of a bond you want to sell on the secondary market before it reaches maturity.
Bond ladders
Owning a diversified mix of bond types and maturities can help reduce the level of risk in the fixed-income portion of your portfolio. One structured way to take this risk management approach is to construct a bond ladder, a portfolio of bonds with maturities that are spaced at regular intervals over a certain number of years. For example, a five-year ladder might have 20% of the bonds mature each year.
Bond ladders may vary in size and structure, and could include several types of bonds depending on an investor’s time horizon, risk tolerance, and goals. As bonds in the lowest rung of the ladder mature, the funds are often reinvested at the long end of the ladder. By doing so, investors may be able to increase their cash flow by capturing higher yields on new issues. A ladder might also be part of a withdrawal strategy in which the returned principal from maturing bonds provides retirement income.
In the current situation, with rates projected to rise over a two- to three-year period, it might make sense to create a short bond ladder now and a longer ladder when rates appear to have stabilized. Keep in mind that the anticipated path of the federal funds rate is only a projection, based on current conditions, and may not happen. The actual direction of interest rates might change.
Laddering ETFs and UITs
Building a ladder with individual bonds provides certainty if the bonds are held to maturity, but it can be expensive. Individual bonds typically require a minimum purchase of at least $5,000 in face value, so creating a diversified bond ladder might require a sizable investment. Diversification is a method used to help manage investment risk; it does not guarantee a profit or protect against investment loss.
A similar approach involves laddering bond exchange-traded funds (ETFs) that have defined maturity dates. These funds, typically called target-maturity funds, generally hold many bonds that mature in the same year the ETF will liquidate and return assets to shareholders. Target maturity ETFs may enhance diversification and provide liquidity, but unlike individual bonds, the income payments and final distribution rate are not fully predictable.
Another option is to purchase unit investment trusts (UITs) with staggered termination dates. Bond-based UITs typically hold a varied portfolio of bonds with maturity dates that coincide with the trust termination date, at which point you could reinvest the proceeds as you wish. The UIT sponsor may offer investors the opportunity to roll over the proceeds to a new UIT, which typically incurs an additional sales charge.
Bond funds
Bond funds — mutual funds and ETFs composed mostly of bonds and other debt instruments — are subject to the same inflation, interest rate, and credit risks associated with their underlying bonds. Thus, falling bond prices due to rising rates can adversely affect a bond fund’s performance. Because longer-term bonds are generally more sensitive to rising rates, funds that hold short- or medium-term bonds may be more stable as rates increase.
Bond funds do not have set maturity dates (except for the target maturity ETFs discussed above), because they typically hold bonds with varying maturities, and they can buy and sell bonds before they mature. So, you might consider the fund’s duration, which considers the durations of the underlying bonds. The longer the duration, the more sensitive a fund is to changes in interest rates. You can usually find duration with other information about a bond fund. Although helpful as a general guideline, duration is best used when comparing funds with similar types of underlying bonds.
A fund’s sensitivity to interest rates is only one aspect of its value — fund performance can be driven by a variety of dynamics in the market and the broader economy. Moreover, as underlying bonds mature and are replaced by higher-yielding bonds in a rising interest rate environment, the fund’s yield and/or share value could potentially increase over the long term. Even in the short term, interest paid by the fund could help moderate any losses in share value.
It’s also important to remember that fund managers might respond differently if falling bond prices adversely affect a fund’s performance. Some might try to preserve the fund’s asset value at the expense of its yield by reducing interest payments. Others might emphasize preserving a fund’s yield at the expense of its asset value by investing in bonds of longer duration or lower credit quality that pay higher interest but carry greater risk. Information on a fund’s management, objectives, and flexibility in meeting those objectives is spelled out in the prospectus and may be available with other fund information online.
The return and principal value of individual bonds, UIT units, and mutual fund and ETF shares fluctuate with changes in market conditions. Fund shares and UIT units, when sold, and bonds redeemed prior to maturity may be worth more or less than their original cost. ETFs typically have lower expense ratios than mutual funds, but you may pay a brokerage commission whenever you buy or sell ETFs, so your overall costs could be higher, especially if you trade frequently. Supply and demand for ETF shares may cause them to trade at a premium or a discount relative to the value of the underlying shares. UITs may carry additional risks, including the potential for a downturn in the financial condition of the issuers of the underlying securities. There may be tax consequences associated with the termination of the UIT and rolling over an investment into a successive UIT. There is no assurance that collaborating with a financial professional will improve investment results.
1) Federal Reserve, March 16, 2022
2021 Federal Income Tax Returns are Due April 18, 2022 For Most Individuals
If you live in Maine or Massachusetts the due date is April 19, 2022.
You can extend the filing date.
You can file for an extension by filing IRS Form 4868, Application for Automatic Extension of Time to File U.S. Individual Income Tax Return by the April due date. The extension gives you an additional six months (until October 17, 2022) to file your federal income tax return. You can also file for an automatic six-month extension electronically (details on how to do so can be found in the Form 4868 instructions). There may be penalties for failing to file or for filing late.
Note: Special rules apply if you’re living outside the country, or serving in the military outside the country, on the regular due date of your federal income tax return.
Include a payment if possible.
File the return, and pay as much as you can afford if you absolutely cannot pay what you owe. You’ll owe interest and possibly penalties on the unpaid tax. You will limit the penalties assessed by filing your return on time, and you may be able to work with the IRS to pay the unpaid balance (options available may include the ability to enter into an installment agreement).
It’s important to understand that filing for an automatic extension to file your return does not provide any additional time to pay your tax. When you file for an extension, you must estimate the amount of tax you will owe. Paying the full amount by the April filing due date will reduce interest and penalties based on the amount not paid. IRS may void the extension if your estimate of taxes was not reasonable.
Tax refunds
The IRS encourages taxpayers seeking tax refunds to file their tax returns as soon as possible. The IRS anticipates most tax refunds being issued within 21 days of the IRS receiving a tax return if the return is filed electronically, the tax refund is delivered through direct deposit, and there are no issues with the tax return. To avoid delays in processing, the IRS encourages people to avoid paper tax returns whenever possible.
IRA contributions
Contributions to an individual retirement account (IRA) for 2021 can be made up to the April due date (without regard to extensions) for filing the 2021 federal income tax return.
