Month: October 2019

Earlier this year, the House of Representatives passed a new bill called the Setting Every Community Up for Retirement Enhancement Act, aka the SECURE Act.  (Acronyms are kind of a thing in Congress.)  As the name implies, the bill has important ramifications for people’s retirement savings.  In this article, we want to give you a preview of what the bill is designed to do.

Now, before we do that, it’s important to note that the SECURE Act must first be passed by the Senate and then signed by the president before it actually goes into effect. Many things in the bill could change before that happens, though, so it’s impossible to know exactly what the final law will look like. And of course, it’s always possible the Senate could choose not to pass the bill or make so many changes that the House decides to rework their version.

That said, the SECURE Act enjoys bipartisan support. In fact, only three members of the House voted against it, with 417 members voting for.¹ So it’s expected the Act will become law sometime soon. As financial advisors, it’s our job to get familiar with the bill now so we can help you prepare for the changes it will bring.

What is the SECURE Act?

The SECURE Act does many things, but at its core, it’s designed to help more Americans save for retirement. Many of the bill’s provisions are designed specifically for businesses, which we won’t get into in this article. But there are also provisions that impact regular individuals, including pre-retirees, the recently retired, and even their children. None of these changes are particularly dramatic, but they are important nonetheless.

Changes to IRAs and 401(k)s²

One of the changes the bill makes is lengthening the time people can contribute to their IRAs. Currently, retirees can only contribute to an IRA up to age 70½.  Once they hit this milestone, they are required to begin making withdrawals, called required minimum distributions. Under the SECURE Act, that age would increase to 72. That means retirees have an additional 18 months to benefit from the tax advantages that come with IRAs. 

Another change the bill makes is for new parents.  Under current law, you must be 59½ years old to make withdrawals from a traditional IRA or 401k. If you withdraw money earlier than that, you would have to pay a penalty of 10% on the amount you took out. There are a few exceptions, such as if you need the money to pay large medical bills, buy a home, or manage a disability. But, generally speaking, the government wants the money you contribute to your retirement accounts to be saved for retirement. 

Under the SECURE Act, new parents will also be able to withdraw funds penalty-free. This is to help cover birth and adoption expenses, and it’s especially helpful for younger parents who have high deductible insurance plans. There is a $5,000 cap on withdrawals, though, and they would need to be made within one year of the birth or adoption.

Changes to inherited IRAs²

Another important change – especially from an estate planning perspective – regards inherited IRAs.

For years, one of the more popular estate planning strategies has involved the use of Stretch IRAs.  When a parent or grandparent dies, they can leave their IRA to their children, grandchildren, or other heirs.  Under current law, the beneficiary can take distributions from their inherited IRA based on their official life expectancy.  This allows them to “stretch out” the value of the IRA – and the tax advantages that come with it – for a longer period of time.  For example, if a 50-year old with a life expenctacy of 85 inherited her mother’s IRA, she could stretch out her distributions over the next 35 years.  

If the SECURE Act goes into law, this will no longer be possible.  Instead, the beneficiary must take out 100% of the IRA’s assets within 10 years of the original owner’s death.  As distributions are taxable income, this could have a major impact on the beneficiary’s tax situation.  

Planning ahead

As you’ve probably guessed, we are sending this article to all of our clients and friends.  Some are older, some younger; some nearing retirement, some far away; and some already there.  That’s because, while no single provision will affect everyone, almost everyone will be affected in some way.    

As we mentioned, the SECURE Act has not yet become law, and it’s uncertain when the Senate will vote on it.  That said, it’s important that we start planning ahead.  If you have any questions about the SECURE Act, please let us know.     

If any of the changes you just read about don’t affect you, but could affect someone you know, please share this article with them.  Or, please let us know so we can reach out to them if and when the bill becomes law.  As financial advisors, we want to ensure our clients are prepared for any changes coming down the pike – and we want to ensure your family is prepared, too.

In the meantime, our team will keep a close eye on Washington as this bill makes its way through Congress.  As soon as the situation is clearer, we will let you know.  As always, please let me know if there is ever anything we can do for you.          

¹ “Congressional Leaders Want SECURE Act Passage in 2019,” Plan Sponsor, October 7, 2019.  https://www.plansponsor.com/congressional-leaders-want-secure-act-passage-2019/

² “Text of H.R. 1994,” Congress.gov, 6/3/2019.  https://www.congress.gov/bill/116th-congress/house-bill/1994/text

 “Markets are flashing deep red as investors worry about the health of the economy”
– CNN Business

“S&P and Dow Slide as Evidence of Global Slowdown Mounts”
– The New York Times

“Stocks Drop on Worries About Growth”
– The Wall Street Journal

The markets hit turbulence last week, with the Dow dropping almost 500 points on Wednesday, October 2.¹  Since recent reports have stoked new fears of a coming recession, we decided to write down our thoughts about what’s happening and why.  

For over a year now, economists have fretted about the possibility of a recession.  The amount of evidence for one has waxed and waned, as good news and bad have jockeyed for attention.  But recently, the signs in favor of a coming recession have started to light up in neon.  

Before we get into that, though, it’s useful to remember what a recession actually is – and what it isn’t.  Since the media tends to report every bit of news with breathless urgency, it’s easy to let the word “recession” transform into a scary, supernatural boogie man come to gobble up our economy.  But what is a recession, really?

Economists define a recession in different ways, but here’s the simplest way to look at it: 

A recession is a significant decline in economic activity over an extended period of time.²

Let’s break that down with a little Recession 101.  

When economists refer to economic activity, they usually mean a country’s gross domestic product, or GDP.  This is a measure of the value of all goods and services a country produces every year.  When a nation produces less, or when the value of what it produces drops, so too does the GDP.  With that drop often comes a drop in employment, wages, corporate profits – and stock prices.  As a result, consumers tend to spend less, which means less business is being done, which means less economic activity is happening.  In other words, everything tends to slow down.  Spending, lending, selling, making, building, investing.  If this goes on for too long – usually at least two consecutive quarters – we’re in a recession.  Make sense?    

The tricky thing about recessions is that it’s almost impossible to know when they’ll occur until we’re already in one.  After all, GDP is a measure of what has been produced, not what will be produced.  That’s why we tend to get a lot of false alarms when it looks like a recession may happen – and little warning when one does happen.  

So.  That’s what a recession is.  But why are experts worried about one now?  

First, it has been a long time since the last recession.  In fact, it’s been over a decade!  Since then, we’ve enjoyed one of the longest bull markets in history.  Since the economy tends to move in cycles – a period of growth, followed by a period of stagnation, followed by a decline, rinse and repeat – many analysts have felt we’re long overdue for the next one.  

More important is the preponderance of data that suggests the economy is already slowing down.  For example, on Tuesday, October 1, a new report showed that American manufacturing had slowed down for the second month in a row, dropping to its lowest level since 2009.¹  Other reports suggest the economy is adding far fewer jobs than in previous years.  Combined with volatility in bonds, trade war uncertainty, and slower growth across the globe, and you can see why the horizon looks stormy.  

That said, we’ve heard these tunes before.  While parts of the economy are slowing, that doesn’t guarantee a recession is coming next month, next quarter, or even next year.  Consumer spending – perhaps the single biggest driver of the economy – has remained strong all year, and the unemployment rate remains very low.  

When it comes to fears of a recession, none of these signs are catastrophic on their own.  All these smaller issues just seem to be piling up on top of each other, enough to make everyone sit up and take notice.  Here’s how we look at it.  Imagine you’ve had a very nice, reliable car for a long time.  It’s been strong, steady, and always gets you where you want to go.  

Recently, though, you’ve noticed that the miles on your car are starting to show a bit.  Your odometer is now over 100,000, a reminder that you’ve had your car for a long time.  Furthermore, little problems are starting to pop up.  That check engine light keeps coming on, even though you’ve had a mechanic look at it.  The engine makes a funny noise whenever you turn the ignition, and is it just you, or are your brakes less responsive than usual?  

None of these problems, on their own, would make you think your car is anything less than reliable.  But put them all together…

That’s where we’re at with the economy.  We may yet be able to wring a few more family trips out of it – but it’s also time to start preparing for when it inevitably breaks down.  

The effects of a recession

For the sake of discussion, though, let’s say a recession is going to happen soon.  What does that mean?  How long do recessions last?  And how bad do they get?  

Every recession is different, but it’s important to remember that we’re not talking about another Great Depression here, or even another 2008-2009.  If a recession happens, it doesn’t mean everything will collapse.  And if it happens, it certainly won’t catch anyone unawares.  Remember, experts have been stressing about this for a while.  

Most recessions also tend to be mild in the grand scheme of things.  Since 1940, the average recession has lasted just under eleven months, with the shortest being six months and the longest, eighteen.³  On the other hand, make no mistake: Recessions can cause real economic pain for people.  A slower economy means less spending, which means less profits, which means lower stock prices, which means lower wages, and worst of all, lower employment.  And sometimes, even when a recession is technically over and the markets recover, it can take much longer for employment to get back to normal.   

So, if a recession is coming, what should we do to prepare?  

Great question!  We love the word “prepare.”  You know what the definition is, right?  

Prepare
verb
To make someone ready or able to do or deal with something.⁴

So, how do we make ourselves ready to deal with a possible recession?  

First, even the wealthiest of people should always have enough in emergency savings to cover at least six months’ worth of expenses.  This is also a good time to prioritize paying off short-term, high interest debts and evaluating your career security.  If you need help with any of these things, please let us know.  

Second, we need to remember that even though a recession will have an impact on the markets in the short term, we must always treat your portfolio for what it is: a long-term investment in your long-term future.  That means we must not start making panicked decisions because we’re afraid of short-term losses.  

That said, if you are nearing the horizon on some of your long-term goals – like retirement, starting a business, building a house, whatever – then it may be prudent to start thinking more conservatively with your investments.  After all, no one wants to get knocked off track right before the finish line.  With 2019 winding down, it’s time for us to have a complete review of your portfolio and your goals so we can update your financial plan as appropriate.  

In other words, if a storm is coming, let’s determine whether you can weather it, or whether it’s time to “batten down the hatches.”  

Here’s what we want you to do.  If you have any questions or concerns about the markets, the economy, or a possible recession, please let us know!  We want to address them, so that you’ll continue to feel confident about working towards your goals.    

It’s impossible to know whether a recession is coming or not.  There are signs for, and there are signs against.  But regardless of when the next recession hits, let’s remember that it’s not a scary boogie man.  It’s a slowdown in the economy – and it’s not uncommon.  Most importantly, let’s remember that when it comes to the future, prediction is futile…but planning is not.  

Have a great October!    

¹ “U.S. Stocks Drop on Worries About Growth,” The Wall Street Journal, October 2, 2019.  https://www.wsj.com/articles/global-stocks-fall-amid-rising-fears-of-economic-slowdown-11570004904

² “Recession,” Investopedia.com, May 6, 2019.  https://www.investopedia.com/terms/r/recession.asp

³ “List of recessions in the United States,” Wikipedia.org, https://en.wikipedia.org/wiki/List_of_recessions_in_the_United_States#Great_Depression_onward

⁴ “Definition of prepare,” Lexico, https://www.lexico.com/en/definition/prepare