Midyear 2023 Newsletter

August 14, 2023

BENEFICIARY IRA RMD REQUIREMENT PUSHED AGAIN

The SECURE Act of 2019 rewrote the rules for non-spouse beneficiaries who inherited IRAs in 2020 or later. While they used to be able to "stretch" their required minimum distributions (RMDs) from inherited IRAs over their lifetimes—thus stretching out the tax bills on their windfalls—the SECURE Act decreed that most non-spouse beneficiaries would need to empty the IRA within 10 calendar years of the original owner's death.

Lacking further guidance, many planned to withdraw the funds however they pleased: in varying installments at any point throughout the 10 years, or even by taking nothing for the first nine years and then a lump sum the final year. Basically, it was assumed that any withdrawal rate and strategy one could concoct would be A-OK as long as the account was empty in year 10.

The IRS disagreed, saying, in essence, "Take the money out in 10 years ... No, not like that."

In early 2022, they clarified that if the IRA owner had died on or after their required beginning date (RBD—the age at which IRA owners must begin taking RMDs) then the beneficiary would need to take annual RMDs from the inherited IRA. If the IRA owner had not yet reached their RBD when they passed, the beneficiary could withdraw the funds as they pleased so long as they were all out by year 10.

Because of the confusion, the IRS decided to do something nice: In 2022, they waived penalties—which at the time were a hefty 50% of the amount of the RMD (but have since been reduced to 25%)—until 2023 for those who had failed to take RMDs from IRAs inherited in 2020 or 2021. Hurray! In the meantime, RBD ages changed from 70.5 (for those who died in 2020 or 2021 and were born before July 1, 1949) to 72 (for those who died in 2022); the age is now 73. Enter more confusion.

In July, the IRS announced that they will once again delay RMD requirements until 2024 from IRAs inherited in 2020 or later and waive penalties for missed RMDs.

While in the short-term not having to take (and pay taxes on) RMDs sounds like a benefit, beneficiaries should consider the tax implications of having fewer years to withdraw the balance of their inherited IRAs. Larger withdrawals down the line equals more taxable income, which may push you into a higher tax bracket, increase your Medicare income-related monthly adjustment amount (IRMAA), and/or cause your Social Security to be taxed more.

Please reach out if you would like to discuss tax-efficient withdrawal strategies for your inherited IRA, as putting it off for as long as possible may not be wisest.

WELCOME, KATIE AND HUNTER!

Filling the shoes of Alice Roberts, who retired in 2023 after 20 years with Walsh & Associates in our DeKalb, Illinois office, is Administrative Assistant Katie Thompson. Katie brings more than 30 years of healthcare industry experience, primarily in customer service—a perfect fit for her easygoing but efficient manner. She made the career change in search of work-life balance without losing the day-to-day challenges that she enjoys.

Hunter Smith joined Walsh & Associates in May as a Client Relationship Manager in our Sarasota, Florida office after earning his B.A. in Psychology from the University of South Florida. While in school, he grew increasingly fascinated by the psychological pitfalls that limit a person's ability to build and preserve wealth. In addition to a full course load and his job at a clinical psychology practice, Hunter studied finance in his free time and earned his Financial Paraplanner Qualified Professional (FPQP™) designation. He looks forward to helping clients through their financial planning challenges by considering aspects of behavioral finance at play.

Please give both a warm welcome!

MARKET & ECONOMIC UPDATE | 2023 MIDYEAR

At the beginning of 2023, most economic and market analysts predicted that the economy and markets would continue their downward trend from 2022. However, as is often the case when "everyone" thinks something will happen, the opposite happened: GDP growth surprised prognosticators in both the first and second quarters, coming in at 2.0% and 2.4%, respectively. Consumer spending has remained strong even with higher inflation and higher interest rates. The latest inflation reports show inflation moving lower to 3%, closer to the Federal Reserve's (the Fed's) stated 2% target. This is down significantly from the record high 9.1% inflation we had in June 2022 according to the Consumer Price Index (CPI).

That said, we think there will be a struggle to reach the Federal Reserve's stated 2% target because core inflation reports that strip out volatile food and energy prices remain somewhat elevated and appear to be more "sticky" than anticipated, which is why the Fed has continued to raise rates in 2023. The Fed has raised rates a total of 11 times this cycle—four of those were in this year—but they decreased the size of their rate hikes from their peak 0.75% to just 0.25%, or 25 basis points, at the last meeting.

The reason the Fed has slowed the pace and size is because economic numbers have been positive but not too positive. Job growth continues to increase, but at a reasonable pace. The July jobs report showed that just 187,000 jobs were added during the month, missing economists' expectations of 200,000 and causing the previous two jobs reports to be revised lower. Even with slowing hiring, the unemployment rate fell to just 3.5%. This is about as close to full employment as an economy can get since there will always be people changing jobs. The participation rate has also been increasing and was at 62.6%, showing that rising wages are bringing people back into the labor force from the sidelines.

Not everything is in "all clear" mode, and we need to remain cautious. A too-healthy labor market could push wages even higher, which would be bad for inflation and cause the Fed to increase rates even more, potentially causing a recession in the future instead of the Goldilocks zone that we are currently in. Another risk is that the Fed could focus too much on the core inflation rate and perhaps go too far with their rate hikes. Unfortunately, in recent history, the Fed has often overreacted to market news either by being too aggressive or too lax on raising or lowering interest rates.

Like the economy, the markets have also pleasantly surprised us in 2023 to-date; as of July 31, most stock indices have had double-digit gains! The S&P 500 officially exited the bear market on June 8, meaning it gained 20% off its 2022 low. The market continually teaches us that it is difficult to time and that the best plan is to stick with your long-term plan and stay invested. Even as recently as March, when we saw a few small regional banks fail due to rising interest rates and poor management, it seemed like we were set up for another poor year. Yet stocks have significantly risen since that date.

Performance in 2023 has also been a reminder to stay diversified, as some of the worst performing asset classes and sectors of 2022 are now the top performers of 2023. It is important to maintain balance in portfolios and not become enamored with the best performing asset classes from a previous year.

Early in the year there was also concern that most of the performance in the market was attributable to a few very large technology/communication stocks. This was true until recently; other asset classes have started to perform better, and gains have broadened out over the last two months.

U.S. stocks performed better than their international counterparts due to inflation remaining higher in Europe, and China's post-COVID reopening has not gone as well as expected. International stocks still remain a diversifier and by most measures are less expensive than their U.S. counterparts. With such a quick move up, stocks are likely to be more volatile in the back half of the year. Earnings will need to continue to grow to justify these higher valuations, and that will be more difficult if the economy slows down. Companies have already reduced spending to protect their margins but may find it hard to increase prices in a weaker economy. We remain cautiously optimistic on the market.

BONDS

After their worst performance of all time in 2022, bonds were due for a rebound. It has not been a straight line up, but bond markets have mostly normalized so far this year. The Bloomberg Agg is up 2.02% as of July 31, and bonds are acting like bonds again. Although the Fed has raised rates slightly higher than expected, bond performance has been positive because there is more of a yield cushion to protect total return from rising interest rates. We think we are either at or very near the high point for interest rates this cycle, meaning that the risk from rising rates is mostly over with. Credit risk could pick up in the case of an economic slowdown, but we are not expecting that at this time. Overall, we are very positive on the bond market for the end of the year and into 2024.

DEBT DOWNGRADE

Fitch Ratings downgraded the long-term sovereign rating of the U.S. from AAA to AA+, citing an "expected fiscal deterioration over the next three years, a high and growing general government debt burden, and the erosion of governance relative to 'AA' and 'AAA' rated peers." Overall, the downgrade mainly reflects governance and medium-term fiscal challenges rather than new fiscal information.

One wonders what Fitch was looking at for the last 10 years, as the debt issue has been one most investors are aware of. The U.S. will have to reckon with its debt and deficit at some point in the future—an aging population, low historical tax rates, and demands for more government intervention (i.e., spending) are not ingredients that combine to reduce the deficit. When the reckoning does come, it is likely to come in the form of reduced government spending as well as higher tax rates in the long term.

As for the market reaction, a downgrade from AAA to AA+ by S&P in 2011 had a negative impact on sentiment but did not result in any apparent forced selling. The muted market reaction highlights an uncomfortable reality about the United States' long-term fiscal stability and potentially could prompt more politicians to take it seriously … but we doubt it.

NEW 'SAVE' REPAYMENT PLAN FOR FEDERAL STUDENT LOANS

The current outstanding U.S. federal student loan balance is $1.644 trillion dollars and represents 43.6 million borrowers, each carrying an average balance of more than $37,000 dollars. In the past fifteen years alone, the number of borrowers has increased by 57% percent, while the amount of debt has increased by 198%!* It should comes as no surprise that educational loans currently account for 9.5% of consumer debt in the U.S., second only to mortgages.**

To lighten the burden for student loan borrowers, Congress established an income-driven repayment plan in 1994 to cap repayment at no more than 20% of their discretionary income and to forgive loans after 25 years of payments.Since then, new repayment plans have been rolled out, allowing borrowers to pay a max 15% or even 10% of their discretionary income, with loan forgiveness at 25 years or 20 years. There are five active income-driven repayment plans for federal education loans, the last of which was created in 2015 and was called the Revised Pay As You Earn (REPAYE) plan.

The Biden administration is currently rolling out a new federal student loan repayment plan called Saving on a Valuable Education (SAVE) to replace REPAYE, and current REPAYE participants will automatically qualify and be enrolled in SAVE. SAVE will decrease the size of required payments by half, to 5% of monthly discretionary income. Any borrowers who earn less than 225% of the poverty line—or $32,800—will not owe monthly payments (but are encouraged to make payments). For those making their monthly payments, loan balances will not grow due to unpaid interest. Also, SAVE excludes spousal income if you are married but file taxes separately, removing the need for a spouse to cosign your repayment application.

Federal student loan borrowers on any plan other than REPAYE can apply for SAVE at studentaid.gov/idr.

*EducationData.org "Student Loan Debt Statistics"; data as of June 30, 2023

**EducationData.org "Student Loan Debt vs Other Debts;" data as of December 3, 2022

Securities offered through LPL Financial, member FINRA/SIPC.

Important Disclosures

This information is not intended to be a substitute for specific individualized tax or legal advice. We suggest that you discuss your specific situation with a qualified tax or legal advisor.

Content in this material is for general information only and not intended to provide specific advice or recommendations for any individual. All performance referenced is historical and is no guarantee of future results. All indices are unmanaged and may not be invested into directly. The economic forecasts set forth in this material may not develop as predicted and there can be no guarantee that strategies promoted will be successful.

Investing involves risk including possible loss of principal. No investment strategy or risk management technique can guarantee return or eliminate risk in all market environments.

U.S. Treasuries may be considered "safe haven" investments but do carry some degree of risk including interest rate, credit, and market risk. They are guaranteed by the U.S. government as to the timely payment of principal and interest and, if held to maturity, offer a fixed rate of return and fixed principal value.

Bonds are subject to market and interest rate risk if sold prior to maturity. Bond values will decline as interest rates rise and bonds are subject to availability and change in price.

International investing involves special risks such as currency fluctuation and political instability and may not be suitable for all investors. These risks are often heightened for investments in emerging markets.

The Bloomberg US Aggregate Bond Index is a broad-based benchmark that measures the investment-grade, U.S. dollar-denominated, fixed-rate taxable bond market, including Treasuries, government-related and corporate securities, mortgage-backed securities, asset-backed securities and collateralized mortgage-backed securities.

The Bloomberg US Corporate High Yield Index measures the USD-denominated, high yield, fixed-rate, corporate bond market. Securities are classified as high yield if the middle rating of Moody's, Fitch, and S&P is Ba1/BB+/BB+ or below, excluding emerging markets debt.

Gross domestic product (GDP) is the monetary value of all the finished goods and services produced within a country's borders in a specific time period, though GDP is usually calculated on an annual basis. It includes all of private and public consumption, government outlays, investments, and exports less imports that occur within a defined territory.

The MSCI EAFE Index is a capitalization-weighted index that tracks the total return of common stocks in 21 developed-market countries within Europe, Australasia, and the Far East.

The MSCI Emerging Markets Index captures large and mid cap representation across 26 Emerging Markets (EM) countries. With 1,404 constituents, the index covers approximately 85% of the free float-adjusted market capitalization in each country.

The Russell 2000 Index measures the performance of the small cap segment of the U.S. equity universe and is comprised of the smallest 2000 companies in the Russell 3000 Index, representing approximately 8% of the total market capitalization of that Index.

The Russell 1000 Index measures the performance of the 1000 largest companies in the Russell 3000 Index, which represents approximately 92% of the total market capitalization of the Russell 3000 Index.

The S&P 500 Index is a capitalization-weighted index of 500 stocks designed to measure performance of the broad domestic economy through changes in the aggregate market value of 500 stocks representing all major industries.

Asset allocation does not ensure a profit or protect against a loss.

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