What a Wild Ride it Has Been

The first half of 2020 has not played out the way anyone predicted it would at the beginning of the year. The largest global pandemic in 100 years has overtaken our very connected world and had significant short-term economic implications. The shutdown of the economy has resulted in a nearly instantaneous recession, record jumps in unemployment, and the fastest, deepest collapse in stocks prices in decades, if not ever.

Rather than pass on the economic outlooks from economists who were clearly wrong about their predictions six months ago, I’d like to review recent events, the little can be known at this point, and our long-term strategy.

The equity market set its all-time high on February 19th and subsequently crashed into a bear market setting its low (to this point) on March 23rd. This drop was 34% in 33 days and ended the longest bull market since World War II, which began in March 2009. There is no historical precedent for this steep of a decline in this short of a time.*

Just as wildly, the market preceded to post its best 50 days in its history. The S&P 500 closed out the first half of 2020 at 3,100, just 8.4% off its all-time high and 4.0% lower than where it began the year. If the recent market low set on March 23rd remains the low, then we are already in a new bull market, which would make this bear market not only

the steepest but the shortest as well.

Although the economic data is improving and the worst of the recession seems to be behind us, it is impossible to know the shape of the recovery. This is true in all recessions, but especially true amid this pandemic, which may take turns that we don’t see coming. It certainly has to this point.

All of this begs the question, “what do we do now?” First, let’s acknowledge that it’s OK to be scared by the unknowns in front of us. We are human, after all. If we didn’t experience any emotions, good or bad, this life would lose its meaning. Dr. Spock would have made a great investor but wouldn’t be able to enjoy his investment gains on anything fulfilling. Our fears are more than just numbers on a monthly statement or flashing on a computer screen.

Our investment portfolio represents trips we didn’t take and clothes we didn’t buy so that we would be better prepared for the future. When we talk about markets, we’re really talking about our greatest hopes, goals, fears, and dreams, like sending our kids to college or not running out of money in retirement.

If we can press the rewind button in our minds, let’s revisit the reasons why we started investing in the first place. Good investing is always goal-focused and planning driven, so ideally, we started with specific goals. A common one is retiring at a certain age and with a certain income. The goals have probably evolved over time and may include

multiple generations, but they are still goals to invest for.

The design of your investment portfolio is based on taking the least amount of risk to achieve the stated goals. Our portfolios are designed with the weighty evidence of history to give us a sense of how markets behave over time. That history includes bear markets like this most recent one. I know that “this time is different,” which is certainly true given the nature the foe we are fighting. But so was the tech bubble, global terrorism, and the housing and financial crash. Every crisis is a little bit different and, in the end, quite similar in that we have always recovered.

If our goals haven’t changed and the investment process is solid and based on the markets’ long-term history, then our best course of action is to stay the course. That may sound like a cliché at a time when you want something more complicated, but that doesn’t mean that something else will work better.

Most of our goals are not in

the next 12 months. If they are, we shouldn’t be taking risks with those funds. The timeline for most of our goals are multi-decade and even multigenerational. As

of June 30th, the interest rate on the 10-year US Treasury bond was 0.66%, while inflation over the previous year was 1.24%.* Fleeing to bonds may feel like the only solution to the market turmoil, but it is no way to meet our goals.

Having advised clients through multiple recessions and even more market corrections, I have found that the equity market tends to reach its bottom at our greatest moment of fear. As economist Brian Wesbury wrote on June 8th of this year, “The US has gone through tremendous turmoil so far this year, with a response to COVID-19 that included

unprecedentedly widespread government-mandated economic shutdowns, followed by a combination of legitimate protests, riots, and looting. No one knows for sure what the second half will bring, much less 2021 and beyond. But we think that, like in the past, those who have faith in the future will be rewarded.”

Now is the time to trust the plan and have faith in the future.

*JP Morgan, Guide to the Markets June 30, 2020

Things We Can Control

This year has reinforced lessons that seem to apply on a whole new level during a global pandemic. For me, one of those lessons is to focus and work on the things we can control and not give much worry to the things we have absolutely no control over. This is easier said than done, but still a worthy goal. Here are some planning ideas that may apply to you during this time of uncertainty.

No RMDs in 2020

Just in case you missed it, the

Required Minimum Distribution

(RMD) rules have been suspended

for 2020 as part of the CARES

Act. This applies to all retirement

accounts that normally have an

RMD and inherited IRAs that

have an RMD starting with the

year after the death of the account

owner. This means that if you

don’t want or need to take

distributions from your IRA that

may push your income to a higher

tax bracket, you don’t have to.

Unwanted RMD distributions can be undone until August 31st

The suspension of the RMD rules occurred in March 2020 after some IRA owners had taken their RMDs. Standard IRA rules allow for a once per year 60-day rollover, which would allow the IRA owner to put the funds back in the IRA within 60-days of the distribution

and call the contribution a rollover which would void the distribution. However, the 60-day window had already closed on individuals who would have taken their RMD distributions in January.

On June 23rd, the IRS released IRS Notice 2020-51, which modified the rollover rules for IRA owners subject to RMDs. The new rules state that any IRA distributions taken this year that would have counted towards an RMD can be returned to the IRA by August 31st and marked as a rollover, effectively undoing the original distribution. This also applies to inherited IRAs, which are typically not allowed to make 60-day rollovers. The once per year rollover rule has also been suspended for RMD distributions that are returned.

In summary, if you have taken IRA distributions and would like to return them to your IRA to reduce your taxable income for 2020, we can help you with that until August 31st.

With RMDs suspended, Roth conversions are much easier

In years past, IRA owners over age 70 ½ were required to take their RMD first as a normal distribution to their bank or non-qualified brokerage account before moving funds from their Traditional IRA to their Roth IRA as a Roth conversion. In many cases, the RMD amount was already more than they would have chosen to withdrawal in the first place, and Roth conversions on top of the RMD would have occurred in a higher tax bracket. Now that the RMD requirement has been waived in 2020, IRA owners can make Roth conversions at whatever amount they want. Some retirees find themselves in the 10% or 12% tax brackets without their RMDs and should consider a partial Roth conversion to take advantage of these low tax rates.

Qualified Charitable Distributions (QCDs) are still available to IRA Owners over age 70 1/2

In December of 2019, Congress passed the Secure Act, which changed the RMD beginning date, or the year in which IRA owners are required to start taking minimum distributions to age 72. In an entirely unfair move, IRA owners who turned 70 ½ in 2019 and would not reach age 72 by the end of 2020 would still be required to take minimum distributions in 2020. Ironically, in response to the Coronavirus pandemic, the CARES Act passed in March 2020 and suspended the RMD for this year, which gave relief to the under 72 crowd. In any case, the Qualified Charitable Distribution rules were not updated to match the new age 72 beginning date. This means that any IRA owner who has reached the age of 70 ½ can gift money from their IRA directly to a charity, and these distributions will not be counted as taxable income. These distributions are limited to $100,000 per year per IRA owner.

Even though IRA owners are not required to take any funds from their IRAs this year, Qualified Charitable Distributions are still a great way to get money out of your IRA tax-free. Funds withdrawn from your IRA this year will help keep your RMD lower in 2021 because that calculation includes the value of your IRA at the end of this year. If giving to charity is already a part of your budget, this is likely the most tax-advantaged way to make those gifts.

Coronavirus-Related Retirement Account Distributions

For retirement account owners under age 59 ½, the CARES Act provided relief for those financially affected by the pandemic. Those who have been diagnosed with Covid-19 or have a spouse or dependent diagnosed or those who have had an adverse financial consequence of pandemic can take IRA distributions with much more relaxed rules.

Specifically, IRA owners who qualify will be exempt from the 10% penalty, have three years to pay back their IRAs and undo the distribution, and will be able to spread out the income over three tax years.

Tax planning generally points toward accelerating income

I often tell my clients that predicting the short-term movements of the financial markets is impossible and predicting legislation from Congress is even harder. With that said, several factors point to higher income tax rates in the future. The first is the simple fact that the multiple stimulus packages approved by Congress both in the recent past and the possible bills still to be passed will create an annual deficit in the $4 trillion range in 2020.

Currently, Mr. Biden enjoys a comfortable lead over President Trump in both national polls and in key battleground states. The likelihood of the Democrats gaining control of the Senate looks to be improving. The dialogue indicates that, if elected, the party would look to increase tax revenue. Even if current polling starts to turn towards Mr. Trump and the Republicans by November, there will be tough decisions to be made towards the middle and end of this decade.

To be clear, I am not trying to influence your vote. However, as your financial advisor, it is my duty to help my clients manage their taxes as best as possible. The view from here looks like the next few years may be an excellent opportunity to take advantage of historically low tax rates. The standard tax planning in this low tax rate environment

is to fill up the lower tax brackets by accelerating income through Roth conversions and long-term capital gains.