Some Thoughts on I Bonds

Originally when planning to write this week’s post it was going to be a longer piece about all the minutia of I Bonds, those investments made popular by excess inflation. But then I figured there’s so much out there online about these bonds already that I’d instead offer some thoughts on the purchase decision. Hopefully this will address your questions but I’m happy to discuss these and other details as needed.

Should you buy an I Bond?

The short answer is yes, but that’s mostly because I can’t think of a reason not to. Let me explain.

I Bonds are bought direct from the government via www.TreasuryDirect.gov. You’d hold them in electronic form and access all relevant information on that site. Yes, you can buy paper bonds but just with your tax refund. I don’t know why you’d opt for paper bonds these days anyway.

So, the first consideration is the hassle factor of yet another account on yet another website, and this time the site is pretty antiquated. Still, the process for setting up an online account, linking to your bank for funding, and actually buying an I Bond (or other types of savings bonds – you can do it all through this website) is clunky and prone to time-consuming mistakes. For example, my wife got locked out of her account and was told the only fix was to call Treasury Direct. We called and we’re told that too many people were calling and to call back some other time. We did so another day and had the same result. Frustrating.

That said, once you get the hang of the website’s quirks (and don’t get locked out) it’s pretty smooth. You can buy now, the money comes out of your bank account the next day and presto, you own an I Bond.

If we can get beyond the hassle factor, the reason to buy is that I Bonds pay an interest rate based on inflation measured by the Consumer Price Index. More on that below. And when CPI is high, as it is now, I Bonds aim to keep pace with it. Last year when inflation was ripping I Bonds were paying 9.62%. This sounded awesome since typical core bonds in your investment accounts may have been down by that much or more. The CPI has moderated in recent months so new I Bonds pay 6.89%.

Even at the reduced rate I Bond interest is still higher than the yield on the 10yr Treasury note, a key market benchmark, at about 3.5%, so what gives? Wouldn’t you just put all of your money into I Bonds at 6.89% and sail off happy into the future?

The answer is unfortunately no. The fundamental problem, if we can call it that, is that each person can only buy $10,000 worth of I Bonds per year. Maybe up to $5,000 more if you do so via your tax refund, but hopefully you’re managing your taxes better than letting the government hold thousands of your hard-earned dollars for a year at no interest, but I digress… You also can’t buy I Bonds in retirement accounts. I Bonds can only be held in your name, jointly with another person, your trust’s name, or with a beneficiary listed. “Entity” accounts are also possible but are beyond the scope of this post.

Is it worth the hassle factor to invest a relatively small amount of your nest egg? After thinking about this at length last year and again this year I think the short answer is yes. Why yes if I’ve been complaining about the hassle of dealing with an antiquated website? Mostly because I can’t think of a good other reason not to.

Some additional I Bond details –

There’s no secondary market for these bonds, so you won’t see their value fluctuate every day. The value of your I Bond sits there unchanged until interest gets applied every six months. That’s a psychological difference but may help a little at maintaining your sanity in volatile markets.

The money has to sit for at least 12 months but can be accessed prior to five years with a penalty of three months interest. Maybe I Bonds are good for extra medium-term savings that you’d prefer not to commit to the stock and bond markets? Otherwise, you could let the money accrue interest for up to 30 years.

The interest accrues tax-deferred until withdrawn unless you choose to report it each year. Then it gets taxed by the Feds and not the state.

And maybe no tax if you use the proceeds for higher education expenses and your modified adjusted gross income is lower than about $159,000 on your joint tax return. Those are current numbers, so this benefit may not materialize at the time if your income is too high, but at least in theory the interest could be tax free. If you know you’ll have higher income than this, I wouldn’t bother putting any money into I Bonds that would otherwise go into your kid’s 529 plan, for example.

The other issue for I Bonds is your average return over a longer period of time is likely to be less, perhaps substantially less, than current rates. The reason is that I Bond interest is a blend of a tiny, fixed rate and a rate that adjusts every six months based on the CPI. Assuming inflation gets back to the Fed’s goal of around 2%, I Bonds could end up averaging something much closer to that, perhaps less than the 10yr Treasury.

But again, worse case is you put some of your excess cash savings into something that ends up looking like a medium-term Treasury bond. What financial planner could find fault with that?

Have questions? Ask us. We can help.

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SECURE Act 2.0

Last week I laid out a schedule of sorts for my posts over the next few weeks. This morning I’m flipping that around a bit to talk about the SECURE Act 2.0 that was passed by Congress and signed into law during the wee hours of last year. I’ve been spending time in recent days going through the details, so it’s all very top of mind right now.

The original SECURE (Setting Every Community Up for Retirement Enhancement) Act was signed into law near year-end back in 2019 and disrupted the field of retirement planning. For example, the original Act included about ten major provisions like taking away the ability for non-spouse IRA beneficiaries to “stretch” required minimum distributions (RMDs) over their own lifetimes. These stretch provisions had been the go-to for years. Instead, the time limit became ten years and a whole bunch of complexity was added. The Act also bumped the starting age for RMDs to 72 from 70.5.

SECURE Act 2.0 had been talked about ever since and almost became law at least once before being watered down a bit in some ways for final passage. With this legislation we’re seeing a broadening of the retirement landscape amid maybe 100 provisions and more complexity. Interestingly, many of the changes will roll out over the next several years and some aren’t available in the marketplace yet because the financial industry needs time to respond. And as often happens anyway, Congress will weigh back in to fix mistakes that are inevitable within about 400 pages of text. So, the Act’s planning implications will unfold over time.

There’s a ton of detail so I’m going to list the points and some notes that I think are most relevant instead of bludgeoning you with all the small stuff.

RMDs -

Required Minimum Distributions now begin at age 73 instead of 72. So if you’re turning 72 during 2023, you can wait until next year to start your RMDs. Here are the age ranges:

If you were born before 1951, there’s no change – you’re still required to take your RMD.

If you were born during 1951 – 1959, your starting age is 73.

And if you were born in 1960 or later, you’ll start taking RMDs at 75.

Penalties for missing your RMD will drop from 50% to 25% of the amount you were supposed to take. And most people will pay only a 10% penalty assuming they correct their mistake quickly.

If you’re charitably inclined you’ll still be able to make Qualified Charitable Distributions from your IRA once you’ve hit age 70.5 (the actual age and not a day earlier). QCDs are generally a more tax efficient way to gift, especially if you’re taking RMDs.

Waiting to take your RMD can and usually does make good sense in the near-term from a tax perspective, but it also delays and potentially compounds the tax problem down the road, especially for those who can wait until 75, by compressing a higher balance IRA into a shorter life expectancy and larger RMDs. QCDs help because the money is obviously no longer in your IRA and subject to RMDs because it’s been gifted away. Roth conversions help too by moving the money from your regular IRA to a Roth, from which RMDs aren’t required. The details around Roth conversions are beyond the scope of this post, but we should definitely discuss conversions if you’re now waiting until 73, or even 75, to start your RMDs.

Starting next year surviving spouses will be allowed to treat their late-spouse’s IRA as their own (the current rule) or they could play the role of the decedent, so to speak. This could work in different ways but, for example, an older person loses their younger spouse, inherits their IRA, and then takes smaller RMDs based on their late-spouse’s life expectancy. Doing so would save some taxes versus merging the inherited account with their own and taking RMDs on everything based on their own life expectancy.

401(k) Updates –

First, let me say that there are multiple types of retirement plans, but for brevity I’m focusing primarily on the 401(k) since it’s more prevalent.

If you’re still working past RMD age and have a Roth 401(k) at work, you won’t be required to take a minimum distribution from it. The benefit here should be obvious, but this provision starts next year.

Employers can make matching and profit-sharing contributions to a Roth, whereas previously it was only to the employee’s Traditional 401(k) balance. The catch for the employer is these dollars can’t have a vesting schedule attached, but the details of how this will actually work still have to be ironed out.

And for employees over 50 with at least $145K of wages, starting next year catch-up contributions will have to go into a Roth. In other words, the extra money an older employee gets to save wouldn’t be saved pretax. These details need to be clarified too.

Also regarding catch-up contributions, in 2025 those who turn 60, 61, 62, or 63 can add an extra catch-up amount. Maybe $12,000 versus $10,000 currently.

The Act also created a Roth SIMPLE and a Roth SEP. The industry has to respond because these account types don’t exist in the real world yet. Maybe this opens up soon or later this year, I’m not sure. But this is a big benefit since SIMPLE and SEP plans have for years been the oddball by not containing Roth provisions like a 401(k) does.

529 Plans –

If you’re not yet getting the sense that Roth accounts are favored, get this: A portion of unused 529 Plan balances can be rolled into a Roth IRA tax free. There are lots of details here, such as a limit on how much can be moved each year and a there’s lifetime max of $35,000. The 529 Plan also has to have existed for at least 15 years and contributions from the last five years aren’t eligible. The Roth IRA also has to be in the name of the 529 Plan beneficiary, which can be changed prior to moving the money.

Other interesting updates –

There are a host of provisions allowing different groups to withdraw money early from their workplace plans without penalty. Other provisions are for those suffering from domestic violence, a natural disaster, or who simply need cash in an emergency. If so, this “emergency” category will allow folks to take a relatively small distribution of up to $1,000 per year penalty-free that could be paid back to avoid taxes.

The thrust behind this last point created a new type of savings account for workplace plans that will, I suppose, sit beside a 401(k), only be invested conservatively, and would allow for pretax contributions and matching contributions from the employer. This seems an interesting attempt at keeping people from treating their long-term savings like an ATM.

For those with disabled adult children, starting next year ABLE accounts can be opened until age 46 versus the current limit of age 26.

Again, all this and more is brand new. The practical details will take time to emerge as Congress fixes errors, the IRS weighs in, and as industry responds. I’ll try to keep you posted along the way, but please let us know of questions.

Have questions? Ask me. I can help.

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Quarterly Update

If the third quarter’s update wasn’t much fun to write, neither was this summary of the worst year for markets since 2008. But let’s push on and review major themes from Q4 and 2022, and the outlook as we roll into the new year.

Here’s a roundup of how major markets performed during Q4 and year-to-date, respectively:

  • US Large Cap Stocks: up 7.6%, down 18.2%
  • US Small Cap Stocks: up 6.2%, down 20.5%
  • US Core Bonds: up 1.6%, down 14%
  • Developed Foreign Markets: up 17.7%, down 14.4%
  • Emerging Markets: up 10.3%, down 20.6%

Stock and bond markets staged a bit of a comeback during October and November before running out of steam as we closed out the year. Looking at all twelve months, the US stock market as measured by the S&P 500, had two other positive runs, one in March and again in July, but otherwise the mood was decidedly negative and that kept prices volatile all year. According to Bespoke Investment Group, 2022 had a near record number of days when the stock market was down at least 1%. Markets at home and abroad would often open in positive territory only to fall into the close – a tough grind.

Across sectors and looking at the whole year, Communication Services, Consumer Discretionary, and Technology led the way lower, falling by 38%, 36%, and 28%, respectively. Corporate names you know, such as Netflix, Disney, Meta (aka Facebook), Google, Amazon, and Tesla, all pandemic market darlings, turned sour during 2022. And Apple was down a relatively benign 26%, but it’s over $2 trillion size helped pull index performance down. All of the 11 sectors lost ground on the year except for Energy, which was up 62%. Interestingly, most of the worst performing sectors still beat Energy over a three-plus year timeframe, but that’s not much consolation for most investors given the sector makes up only 5% of the S&P 500. As market themes go, “value” finally beat “growth” after many years of being trounced by Big Tech and other growth-oriented stocks. There were few places to hide from volatility throughout the year but being diversified between these two themes helped soften the blow a little.

In a way, the most dramatic developments last year happened in the bond market. While core bonds clawed back some return during Q4, the main bond benchmarks were down from 4% to 40% (that’s not a typo) for the year, with the wide return disparity being due to bond duration, a measure of a bond’s price sensitivity to rising interest rates. Typical bonds in your portfolio are of medium duration and were down about 13% last year. So it helped that we kept our maturities and duration shorter, often below the market average, but there weren’t many places to hide in bonds either. These kinds of returns haven’t been seen in decades and happened quickly, primarily due to news about inflation and the Federal Reserve’s response to it.

After revving up in mid-2021 following a variety of pandemic-related issues, 2022 began with inflation averaging about 7%. By June it had risen to a little over 9% before tapering off to where we started the year, at least through November, according to the Bureau of Labor Statistics. That was a lot of inflation quickly and, arguably, declines from the peak were due to Fed policy decisions from about Spring on. Specifically, the Fed raised its short-term benchmark rate seven times last year, from a level of about 0.25% in March to about 4.5% at year’s end. Each increase was meant to incrementally slow the economy and takes time to do so. The Fed was caught off guard by how fast prices were rising and ramped up its increases and rhetoric. While still historically low in absolute terms, rarely has the Fed raised rates so much so fast. The Fed was and is trying to walk a fine line by slowing the economy enough to bring inflation down while not triggering a recession. So far the inflation part seems to be working but, again according to Bespoke, economic indicators are slowing rapidly. Only time will tell if a so-called soft landing is possible.

These interest rate increases also helped the yield curve, another recession indicator, to invert for much of the year. Inversions occur when investors accept lower returns on longer-term bonds than shorter-term bonds because they feel the short-term is more uncertain. Historically this means a recession is a year or so out, but the record is mixed. As we enter 2023, most analysts expect that we’re either in a recession now or we’ll see one soon with the only questions being how bad it will be, and which sectors of the economy get hit hardest.

Other issues from last year linger and continue to jump between foreground to background. Russia’s ongoing war in Ukraine from last February still roils commodities markets and nobody knows how long it will continue. Pandemic-era supply chain issues helped spur inflation and are largely resolved for some industries while the back-and-forth of China’s zero-Covid policy continues to add uncertainty. Consumers here and abroad are still buying but how long that can last at the current rate is an open question. And Inflation is expected to keep slowing into 2023 as the Fed continues to raise rates, another 0.75% is the current best guess based on its own projections.

But it’s not all doom and gloom. While it’s prudent to expect more volatility in the near-term, stock and bond prices will eventually recover as all this and more gets sorted out – they always have. In the meantime, look to your plans, ask questions, and remind yourself that you’re in it for the long haul. We’re here to help.

Have questions? Ask me. I can help. 

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From Me to We

When I started this firm eight or so years ago I really wasn’t sure what my goal was other than being able to work with clients in the best way possible. For me this meant charging out on my own, leaving the brokerage world and its sales culture behind, and building from the ground up. It was rocky along the way, both in the struggles of business and, at times, the markets, but I never considered turning back.

As my business grew I brought Brayden on to assist. That was over four years ago and now he’s a Certified Financial Planner and ready to take on additional responsibilities within the firm. And like I mentioned a couple of weeks ago, we’ll soon be onboarding a team of highly skilled virtual assistants to take some of the administrative stuff off both of our plates. I’ll share more about them as we get closer to their start date. So, we’re growing and taking steps to account for that.

This week’s post will cover updates to some of the services we provide, how we’ll provide them, and what we’ll be asking of you.

Retirement Plan Updates –

This is a big part of what we do every day in addition to managing investments for most of our clients. I’ve been doing this work myself with Brayden’s help, and now he’ll take on a more active role. The buck, as they say, still stops with me but hopefully you’ll realize benefits from two CFPs working on your behalf.

We’ll reach out to our ongoing clients (those who we manage investments for) twice per year to ask a couple fundamental questions like:

  • Are there any changes to your financial life that we should be aware of? Such as…
    1. Income changes?
    2. Planning to retire or perhaps going back to work?
    3. Births of children or grandchildren, marriages, deaths, or other family status changes?
    4. Any need for larger amounts of cash in the near-term?
  • What questions do you have and how else can we help?

As always, we know you’re busy and you can feel free to add our emails to the delete pile until they’re relevant. If anything is truly time sensitive, we know where to find you.

But if your answer to any of these questions is Yes, then let us know and we’ll take it from there. Brayden will often take the lead on this but, importantly, please know that we work as a team. You can talk with either or both of us and that will never change. We’ll put our heads together and get back to you with questions, relevant documents requests, and next steps.

Tax Planning –

This is something we’ve been approaching slowly along with the evolution of software. Now we’ll be doubling down on offering this service to you as the software is exceptional and we have more experience with it. Our ongoing clients receive this service at no additional cost whereas our hourly clients will pay accordingly based on complexity.

Here’s how this works...

We need your last year’s tax return in a digital format. Paper can work but it’s not as clean as a PDF. Ask your tax preparer for a digital copy of your return. They all use software so this should be a simple thing to get. And if you can make a mental note to get us a copy every year at tax time, that would be great.

You can upload your return securely on our website www.ridgeviewfp.com. No login is required – here’s the link, but it’s easy to find in the Clients dropdown and by clicking on “Secure File Upload”. We can also email you a link at your request. Our system encrypts your file and adds it to the encrypted folder we already have for you – securing your data is critically important and we take that seriously.

https://ridgeviewfp.sharefile.com/share/getinfo/r715b255e9dd4afaa

Once we have your return we’ll need the answers to a few questions before getting started.

  • Since we’re looking at last year’s taxes, how will your income change this year?
  • Have you bought a home, started a business, or have other changes to deductions?
  • Any sizeable capital gains or losses?
  • What are your big tax questions?

We’ll run an initial analysis and look for planning opportunities. Worse case there aren’t any and you’ve spent a few minutes uploading a document and confirming you’re in good shape. Best case is we’re able to present you with some options to potentially save money now, in the future, or ideally both. Tax law changes frequently and the SECURE Act 2.0 has added more complexity, but also more opportunity. We’ll delve into retirement accounts and savings rates, Roth conversions, assessing the impact of extra income and timing of distributions, RMDs, capital gains and losses, and more. We’re also willing to interact with your tax person to ensure they’re onboard with anything you might end up doing. Brayden will often do the initial analysis here too, and then we’ll confer before communicating our findings to you.

The tax world is going through demographic issues just like everywhere else, so there’s a shortage of tax professionals to help with stuff like this. We’re not CPAs and don’t want to be, but we can help fill the gap that often exists between the filing of a return and longer-term planning.

Again, this is potentially a big benefit and all we need is your tax return.

For clarity, and just in case you’re wondering, I have no intentions of retiring or otherwise getting out of this business anytime soon. I see my time horizon as lasting decades. Instead, we’re evolving to serve you as best we can for the duration.

Have questions? Ask us. We can help.

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From Me to We and Other News

Good morning out there. We’re only into the second week of 2023 and already it seems like this will be another busy and eventful year. There’s lots of information that I’d like to share all at once. But in the spirit of brevity this morning’s post is a summary of more detailed content that I’ll be sending out over the next few weeks or so.

From Me to We –

My first inclination is to do things by myself. As you likely know, I left the brokerage world over eight years ago to start this firm on my own. I enjoy running long distances, often alone, and tend toward solo sports. It’s not “me against the world” or an ego problem (at least I hope not) that finds me preferring to work alone. I’m just wired for independence.

But of course that only gets you so far, and the complexities of business and life require more sets of hands.

My assistant-turned-paraplanner, Brayden, and I have been working together since 2018 and it’s been great helping him grow in his career. I’m happy to report that Brayden has just completed his relevant work experience requirement to become a Certified Financial Planner after previously passing the national board exam. Brayden will now be taking on more responsibility within the firm as a financial planner and in his place we’re bringing on a team of highly skilled virtual assistants. More to come on that and other operational details next week.

Secure Act 2.0 –

Just when you thought the Congress couldn’t tie its own Velcro… they passed the so-called Secure Act 2.0 and expanded the retirement savings landscape. This had been percolating for a while but snuck under the radar as part of an appropriations package that wasn’t signed into law until the final days of last year. I’ll be working on a better summary for a post a couple of weeks from now, but here’s some of the bigger news:

Required Minimum Distributions now begin at age 73 instead of 72. So if you’re turning 72 this year and were planning to start taking RMDs from your retirement accounts, you can wait until next year.

The main reason to wait is that it reduces your taxable income. Of course this only helps if you have other money to cover your spending needs. This isn’t the case for most people, but there are quite a few who are being forced into paying taxes unnecessarily due to the RMD rules.

These changes don’t impact folks who are already taking RMDs.

Another big change: if you were born in 1960 or later, your starting age is now 75.

Penalties for missing your RMD have been reduced from 50% to 25%, and perhaps to as low as 10% if you fix the problem quickly. In many ways the Act presents a kinder and gentler set of rules. More to come on this soon.

An update on I Bonds –

I Bonds were all the rage last year for good reason, at least superficially. The bonds pay an interest rate that gets reset as the Consumer Price Index (the generally accepted measure of inflation within the economy) changes. So it makes sense that as inflation was spiking, so would the rates on I Bonds, reaching as high as 9.6% last year.

But nothing is that simple for long. As inflation wanes so has the rate that I Bonds pay, currently about 6.9%. This sounds higher than the rates available on short- and medium-term Treasurys for example, of around 4.25% and 3.5%, respectively. (If those rates seem backwards, that’s an inverted yield curve for you.) Higher yes, but if CPI keeps trending lower I Bond rates will follow. They’re variable and are meant to be held longer-term, so we end up looking at an average rate over, say, five or more years that could be about the same as Treasurys.

So are I Bonds still a viable option for some of your hard-earned savings? The short answer is that it’s complicated. We’ll discuss that soon. In the meantime, the Treasury Direct website has a couple updated explainer pages that are pretty good.

https://treasurydirect.gov/savings-bonds/i-bonds/

https://treasurydirect.gov/savings-bonds/i-bonds/i-bonds-interest-rates/

Otherwise, I hope you and your family have been okay during the recent storms, flooding, power outages, and so forth. That’s a lot of water in a short time, so hopefully it goes a decent way to relieving drought conditions.

Have questions? Ask me. I can help.

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Happy Holidays!

Good morning,

I hope you and your family are doing well as we approach the end of another year. In many ways this year has been a great one. We’ve experienced laughter and love, the joy and satisfaction of accomplishments, and the optimism of new beginnings even amid loss.

But from a market perspective let’s hurry up and get the year over with, shall we?

As I’ve done in the past I’m taking the next couple of weeks off from writing this blog to spend a little more time with family over the holidays. I’m still hard at work for your benefit, of course, so let me know of anything last minute. Otherwise, I’ll be back to you on the first Tuesday in January.

Until then I wish you and yours Happy Holidays, and good fortune mixed with a little luck in 2023.

Have questions? Ask me. I can help.

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