Wealth Management

Caution! Bifurcated Stock Market

The U.S. stock market is bifurcated with tech stocks being the primary catalyst for the upward drive in equity prices. This chart (courtesy of Zacks) shows that there is a growing spread between the Nasdaq 100 and the S&P 500 (both market-cap weighted indices). When there is a lack of market breadth, that usually spells trouble.

The Nasdaq 100, as measured by the exchange-traded fund QQQ, is trading only a few percentage points below its all-time highs. Tech giants like Microsoft, Amazon, Facebook, Apple, Netflix, and Google are getting a kick upwards from this pandemic. However, the rest of the market is languishing; always a bad sign. History can certainly be the witness to that effect when the tech stocks precipitously declined in the dot-com crash of 2000.

Taxes and Your Retirement

Unfortunately, when you retire taxes typically do not just go away. It is important to plan properly to reduce the taxes you must pay so your money will last longer. You can think of taxes in retirement as coming from three different buckets, with each bucket representing a different tax rate. Below is a summary of different sources for income and how they are taxed.

Ordinary Income Tax Bucket

This is the most common tax bucket and the one where you pay the highest tax rates.  Your most common income sources like pensions, social security (up to 85%), and distributions from retirement accounts like IRAs or 401(k)s are all taxed as ordinary income. Unfortunately, many people build large values in this bucket and neglect the other two buckets. This can lead to paying high tax rates in retirement. Below is a chart that summarizes tax rates for 2020 using the two most common tax filing statuses.

Long-Term Capital Gains Tax Bucket

This bucket is for taxable investment accounts and applies to qualified dividends and long-term capital gains (LTCG), which occur if you sell an investment after holding it for 12 months. This bucket is tax-preferred and the tax rate depends on your tax rate for the ordinary income tax rate. See below to understand your tax rates for 2020 for this bucket:

Tax-Free Bucket

This is everyone’s favorite bucket for obvious reasons but is the hardest bucket to fill. The only options available are muni bonds, which usually only make sense if you are in a high tax bracket or Roth accounts like a Roth 401k or Roth IRA. An important part of planning in retirement often consists of Roth Conversions, which allows you to help fill the tax-free bucket. Roth conversions can be a powerful tool, but please contact us or your tax advisor to see if you can benefit from them.

The ideal scenario is to have diversification from a tax perspective with money in each of these buckets. This allows for greater flexibility in retirement for planning to reduce the taxes you will pay throughout retirement.  We are happy to talk about your individual situation and put together a plan for you.

Negative Interest Rates – The Fed Doesn’t Think So

Federal Reserve (Fed) Chairman Jerome Powell remarked during a 60 Minutes interview on Sunday, “There’re plenty of people who think negative interest rates are a good policy. But we don’t really think so at the Federal Reserve.”

The markets (Federal Fund Futures) started to finally believe the Fed today as the futures had been predicting negative rates from May 7th until Powell’s comments on Sunday (see the Bloomberg chart).

(Source: Bloomberg)

Based on his remarks and current market pricing, there appears to be very little upside potential for Treasury bonds.

In his memo “Mysterious”, Howard Marks of Oaktree, went through several examples of why negative rates would introduce distortions into the financial system and summed it up with perhaps the most reliable solution in a low to possibly negative interest rate world …lies in buying things with durable cash flows”.  Value investors look at the present day of the future free cash flows of a business and the durability of those cash flows. Could we be at an inflection point where value stocks outperform growth stocks going forward as market participants start to focus on those companies with durable cash flows?

Creative Planning

The Boston Consulting Group recently authored an article on how companies and leaders can adapt to our rapidly unfolding reality. Successful leadership with the head (to envision the future and the priorities required to succeed), the heart (to inspire and empower employees), and the hands(to ensure innovative and agile-execution capabilities) are the necessary elements to lead successful organizations.

At BFSG, we couldn’t agree more with this article.  Please check out this short video by clicking HERE to see how we empower our CERTIFIED FINANCIAL PLANNER Professionals to envision the future and draw upon both sides of the brain when completing comprehensive financial planning to achieve successful outcomes for our clients.

Consider Using an HSA

Using a Health Savings Account (HSA) is a prudent financial decision that many Americans overlook or simply do not understand.

One of their primary benefits is that contributed funds do not run out each year like the “use it or lose it” provisions with flexible spending accounts (FSA). Instead, unused funds roll over each year and can be used for future medical expenses. This feature creates a unique planning opportunity to help cover future medical expenses, which is important since it is well documented that medical expenses are the largest expense for many in retirement. A recent study by Employee Benefits Research Institute found that some retired couples would need as much as $370,000 to cover medical expenses in retirement—a forecast that is growing every year.1

HSAs have three inherent tax advantages:2 

  1. Contributions are 100% tax-deductible.
  2. Investment growth and interest are tax-exempt.
  3. Withdrawals for qualified health expenses are tax-free. 

Who qualifies for an HSA?

HSAs are available to those who are covered by high-deductible health plans

To be HSA-eligible, an individual cannot be:

  • Covered by another health plan, except as permitted by the IRS
  • Claimed as a dependent on another person’s tax return
  • Enrolled in Medicare (funds acquired through an HSA before using Medicare can be used)

If you have any questions, your best option is to simply inquire with your employer and see if you qualify for an HSA.

Are you contributing to your HSA? 

Contribution limits are set by the IRS ($3,550 if single or $7,100 for family). The catch-up provision for age 55 or older is $1,000. Contributions are 100% tax-deductible.

A person can do a partial rollover from an IRA into an HSA (within IRS limits) as well to help fund the HSA.

The amount you contribute is an important consideration and it is best to consult with your BFSG advisor to best understand how you can potentially benefit from an HSA and determine what amount is most beneficial for you to contribute.

Are you spending your HSA contributions? 

Funds can be used for current or future medical expenses and even Medicare premiums.3

Funds can be withdrawn from HSAs for any reason without penalty after age 65, though income taxes will be owed if the money is used for non-qualified expenses.4 

Health care burdens are likely going to be a lot higher in retirement and the triple-tax savings of HSAs favor investing HSA assets rather than using them right away.

Many HSAs feature investment account options, depending on the account administrator.

We can help go over your investment options available to you and help analyze the fees you are being charged.

  1. “Savings Medicare Beneficiaries Need for Health Expenses: Some Couples Could Need as Much as $370,000, Up From $350,000 in 2016,” EBRI Notes, Vol. 38, No. 10, Employee Benefit Research Institute, December 20, 2017.
  2. Publication 969, Health Savings Accounts and Other Tax-Favored Health Plans, U.S. Internal Revenue Service, 2017. Tax laws vary by state. For example, Alabama, California, and New Jersey do not allow state income tax deductions. Be sure to check your state’s tax laws or consult a certified public accountant.
  3. A retiree can use a health savings account even when on Medicare to cover medical expenses.
  4. Penalties (e.g. withdrawals for non-qualified health expenses) exist. Check IRS.gov.