Last week we took a break from our list of year-end considerations to review the third quarter. Now let’s get back into it by looking at generating cash from your portfolio and how to think about gains and losses as we approach year-end.

As with other topics we’ve covered, taking income from your portfolio and realizing gains and losses are specific to the calendar year. This is something you can leverage if you know how. Here’s an example of what I’m referring to.

Let’s say you have three types of accounts: a brokerage account, a Traditional IRA, and a Roth IRA. You have an upcoming expense or maybe you need regular cash infusions to help cover expenses during retirement. Just to pick a number, let’s assume your cash need is $20,000.

Which account should you take that money from? To me, the correct answer is mostly about taxes and that creates a basic order of distribution.

Generally, you want to draw from your brokerage account first (assuming you’ve spent your cash savings down beyond acceptable levels). Even though earning dividends and interest and selling investments is taxable in this account type each year, you have cost basis and preferential tax treatment. We’ll discuss this further in a moment.

The second account you’d pull from is your Traditional IRA (or workplace plan) because every dollar you withdraw is taxed as ordinary income and might have a penalty if you withdraw too early. This could mean paying at least several percentage points of extra income tax on every dollar withdrawn versus taking the same dollar from your brokerage account. You’re forced to start withdrawing at age 73, as we’ve discussed recently, but otherwise you’ll want to plan carefully.

Next on the list is pulling from cash value life insurance or perhaps a non-qualified annuity. Doing so has additional complications and considerations but it’s possible.

The last account type you’d pull from is usually going to be your Roth IRA. The reason is that personal Roth accounts (versus inherited Roths) don’t have RMDs and, at least in theory, can be left to grow tax free for your lifetime. That’s something to leverage as much as possible.

So there’s our basic order of distribution. Here are some considerations when looking to generate your $20,000:

When do you need to spend this money? Look ahead a year or so and set aside cash for known expenses. Maybe it’s a new roof, car, extended vacation, or tuition payments outside of 529 plans. You should use this opportunity to rebalance your portfolio a bit and use money market funds or bank CDs as placeholders. In other words, get this money out of risky long-term investments and into something safe because you know you’re going to spend it.

What do capital gains and losses look like in your brokerage account? This year has been good for stocks and bonds have held up okay. This means you may not have unrealized losses (“paper” losses that don’t matter for tax purposes until you sell) when you look at your gain and loss information on your statement or on your custodian’s website. Still, you should check because I try to sell losses first in most situations. Let’s say you have $10,000 of market value in a bond fund that’s about even in terms of its unrealized gain. If so, that’s probably the first investment to sell to generate cash.

Okay, so where to get the next $10,000? Look at your stocks and sell from your best performer. That might be a broad market fund or maybe a sector fund investing in tech stocks, for example. I’m usually thinking about that when I review gain and loss information because trimming your best performers is a simple way to rebalance a bit. Maybe your tech fund has a market value of $10,000 but your cost basis is $3,000 for an unrealized gain of $7,000. If you sold the whole position this year the $7,000 of gain would be added to your 2024 tax return as a capital gain.

Have you realized gains or losses this year? Look at your history and double check. Gains stack on top of each other while losses offset gains and you’ll pay tax based on how this nets out.

Do you have losses that are carrying forward from a prior year? This is shown on Schedule D within your prior year’s tax return. If so, those losses could help offset the gain you’re generating this year.

Realizing capital gains in a brokerage account is taxable but at a preferential rate. Most taxpayers pay a federal capital gains tax rate of 15%. (California taxes this as ordinary income.) That’s lower than the middle brackets of 22% and 24%, for example. Additionally, people in the 10% and 12% tax brackets often don’t have to pay capital gains taxes.

A few quick words about cost basis in an IRA; simply put, it doesn’t matter for tax purposes in most cases.

Consider withdrawing from multiple account types based on your tax situation. This gets more important as your cash need grows. For example, maybe you need to withdraw $50,000 and the $20,000 above is all you have in your brokerage account. You’d then look to your Traditional IRA for the other $30,000. Since that’s all taxable as income, have your tax advisor or humble financial planner run a projection to determine how the capital gain and extra ordinary income would impact your tax situation. It might be advisable to take some of the cash from your Roth. Or you could take some from your Traditional IRA this tax year and the rest in January, straddling tax years.

In short, you have options for generating cash when you have multiple account types, so try to use them!

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Just like that it’s October and we’re done with the third quarter. It was raucous at times but ended well for most investors. I’ll send out my Quarterly Update letter next Tuesday instead of today so we can stay on track with our theme of financial decisions that have a year-end deadline.

This week let’s discuss Roth conversions. You can do as many of these as you like within the year but they must be completed by December 31^st to count for 2024.

Conversions happen when you have money in a tax-deferred retirement account like a Traditional IRA or 401(k) and move a portion or the whole thing to a Roth IRA. Why would you want to consider doing this? You’re already saving for retirement, so that’s good. Beyond that, it’s all about taxes and when you pay them.

Your typical retirement account is tax-deferred, meaning the government gives you a tax deduction when you contribute and they’ll wait until you withdraw money before taxing you. That could be a while, maybe decades. In a sense, the government is making an investment because by forgoing income taxes on your initial $1,000 contribution, they could ultimately get to tax an account valued at maybe ten times that.

You can get around this future tax issue in two fundamental ways. One is to skip contributing to a Traditional IRA in the first place and contribute to a Roth instead. You’ll give up the near-term tax benefit in exchange for growth that would be tax free in retirement. This method works great the younger you are. Unless you’re in a higher federal tax bracket, say 24% or more, you should strongly consider only contributing to a Roth IRA and Roth 401(k), assuming your workplace offers the latter. Take the pain now and enjoy the benefits later.

The second way is to force money into a Roth via conversion. Here are some considerations.

• Is this a low taxable income year? Maybe you’ve had tax losses or started a business, had large deductible medical expenses, or anything that artificially lowers your taxable income. Maybe you retired early and aren’t taking Social Security yet. A yes to any of this (and other reasons – these are just some of the big ones) means you are a candidate for a Roth conversion.
• Conversions aren’t contributions so income limitations don’t apply.
• Roth conversions add to your taxable income in the year you do them so making educated guesses about your place in the federal tax brackets is critical.
• There is no minimum amount for a conversion, so try to stay within the relevant tax brackets.
• You can Google the brackets but the 22% bracket for Married Filing Jointly goes from about $94,000 to $201,000. Try to stay within that bracket or lower for Roth conversions. Paying proportionally more tax than that makes it harder to break even.
• Breaking even on the conversion deals with the size of the tax bill and how long you have to grow money in the Roth.
• Plan to pay the tax from cash in the bank since paying from your IRA also makes it harder to break even.
• Once your money is in your Roth you can grow it until age 59 ½ when you’re allowed to withdraw penalty-free. But you can grow for longer, maybe your whole life.
• You’ve already paid tax on your conversion so those specific dollars won’t be taxable again. Any gains in your account wouldn’t be taxed either unless you break the rules. One rule is that each conversion has to remain in the account for five years to be tax free. It might make sense to open individual accounts for each year’s conversion to help with bookkeeping if you think you might need to break into the conversion early.
• Investment options are the same whether money is in a Traditional IRA or a Roth.
• The conversion shouldn’t cost anything. You can move existing investments or cash from your IRA to a Roth. Moving investments is less precise because your custodian might take a few days to process the conversion so you won’t know the exact dollar amount until after the conversion happens. This is why I favor moving cash. I suggest you do so assuming you don’t have transaction costs to sell and repurchase investments. Ask your custodian about this.
• While conversions typically take a few days to process, custodians get backed up as year-end approaches. Procrastinators should try to make December 15^th their deadline.
• Under current tax rules you won’t be required to take RMDs from your Roth. This is huge for people who start converting to Roth early because it buys down future RMDs when your tax rates are (hopefully) lower. Still, weigh your options because future RMDs may not be a big enough issue to warrant paying taxes on Roth conversions.
• Roth conversions can be like prepaying taxes for beneficiaries. Sometimes that’s reason enough to convert to Roth. Again, weigh your options.

So those are some situational questions and considerations dealing with converting some or all of your traditional retirement money into a Roth. This sounds great, and I suppose it is, but it’s not necessarily for everyone. Do your homework and get good advice so you can hopefully avoid stepping on any retirement savings landmines.

Have questions? Ask us. We can help.

I don’t know about you but it sure seems like the post-summer pace is increasing. We’re almost in October and the start of the fourth quarter, so it’s a good time to consider lingering financial considerations and deadlines.

But first, the highly anticipated Fed meeting is upon us this week. As I type the CME FedWatch tool indicates an almost 65% chance the Fed will lower rates by half a point when it meets tomorrow and a 35% chance of a quarter point decrease. A case could be made for either outcome. That the Fed will lower rates seems like a forgone conclusion because they’ve so clearly telegraphed it in recent weeks. Still, lots of people will be paying attention to the announcement and subsequent press conference.

While this isn’t the most exciting stuff in the world, I suggest watching the recording of the presser if you can’t watch live at 11:30am PST. These press conferences happen after each regular meeting of the Federal Open Market Committee and are a great way to keep tabs on how the macro economy is doing. Here’s the site: https://www.federalreserve.gov/

Okay, on to our main topic this morning. As you’re likely aware, the deadline for a lot of financial actions each year is December 31^st. We’re about 3 ½ months out but calendar inertia builds into year-end so don’t wait too long on these items. We’ll spread these topics out over the next several weeks, but here’s a short list of financial stuff to consider based on age and other factors, and that have year-end deadlines.

If you’re 73 or older, have you taken this year’s Required Minimum Distribution (RMD) from your retirement accounts?

If you’ve inherited an IRA, have you taken your RMDs? This is less about age and depends on when you inherited the account.

Does a Roth conversion make sense this year?

Will you have a need for cash from your investment portfolio soon?

Have you reviewed your (non-retirement) investment portfolio for losses to offset realized gains?

There are other considerations, but these are several of the big ones. Each can be complicated and I’ll risk glossing over some of the minutiae in an effort to keep things simple. As always, consult your humble financial planner or tax professional for specific advice.

Let’s look at taking RMDs from your own retirement accounts –

The beginning age for RMDs is now 73. This means that if you turned (or will turn) 73 anytime this calendar year you’ll need to start taking minimum distributions from your retirement accounts by December 31^st. In practice this means you’ll need to do so at least a few business days before the deadline to account for processing time. Beyond that, the government doesn’t really care when and how often you take distributions. What matters is that you at least take the minimum out so you’ll owe tax on it.

Your RMD is based on your account value at the end of the prior year. That balance gets applied to a table that is widely available via a Google search. I like this one: https://www.bankrate.com/retirement/ira-rmd-table/

The table shows how the portion you’re required to withdraw grows as you age. For example, at age 73 you’re RMD is worth about 3.8% of your IRA balance. At age 83 it’s about 5.5%. By 93 it’s almost 10%. By age 103 it’s nearly 20%.

The amount is calculated for each separate IRA by the account’s custodian, so finding it shouldn’t be a problem. Some custodians put the RMD amount on your monthly statement but all of them will have it available when you log onto their website. I also have the RMD for accounts I’m responsible for managing.

Once you know the RMD for each account, you can add up the various amounts (assuming you have multiple accounts) and take the total from one account or from each account, it’s up to you. You can withhold taxes at the time of distribution or elect to not withhold. But be careful here. Every dollar you take from a Regular, Contributory, Traditional, or Rollover IRA (different names for essentially the same thing) is taxed as ordinary income and adds to your tax burden. Will you have ample cash to pay the extra taxes when you file your return? If not, withholding from your RMD is a better option.

What to do with your distributions? If you don’t need to spend the money you can move your RMD into your non-retirement account to keep it invested. One thing you can’t do is move your RMD into a Roth IRA. You can do Roth Conversions, which are also taxable and beyond the scope of this post, but this is a separate transaction involving non-RMD dollars.

If you forget your RMD you’ll be charged a large penalty plus the tax on the amount you didn’t take. Our benevolent government will give you a pass on forgetting your first RMD by letting your due date slide until April 1^st of the following year. However, you’ll have to take two RMDs that year and pay tax on the whole amount. That could make sense from a tax strategy standpoint but be careful.

If you’re wondering, the only way around paying taxes on your RMDs is to give the money to charity. You can donate some or all of your RMD up to $105,000 per year. This is known as a Qualified Charitable Distribution and would be handled through your custodian. Some custodians make checkbooks available for this purpose, which is nice because there are specific rules for processing QCDs. These dollars wouldn’t be taxable in the year donated so it’s a great option if you’re at least 70 ½ (or older on the date of the gift – a holdover from prior RMD rules) and would otherwise be making donations anyway.

To sum this up, RMDs can be complicated but are required, hence the name. The good news is that if we’re managing your investments we’re also managing your RMDs. We’ll be in touch soon if you still have some to take. Otherwise, feel free to ask questions as you enjoy autumn.

Have questions? Ask us. We can help.

From the perspective of stock and bond markets, the third quarter (Q3) of 2024 felt tied to the hip of Fed policy. The “Will they or won’t they” question about the Fed finally lowering interest rates seemed to pervade just about everything and even caused a short but nasty bout of volatility mid-quarter. Also due in large part to interest rates, sizeable shifts took place across styles and sectors in the stock market. However, the major indices still performed well during the quarter amid all the commotion, even the bond market!

Here’s a roundup of how major market indices performed during Q3 and so far this year through 9/30, respectively:

• US Large Cap Stocks: up 5.8%, up 21.7%
• US Small Cap Stocks: up 9.3%, up 10.2%
• US Core Bonds: up 5.2%, up 3.6%
• Developed Foreign Markets: up 6.8%, up 11.5%
• Emerging Markets: up 9.7%, up 17.2%

In the stock market, the top performing sectors during Q3 were rate-sensitive sectors like Utilities and Real Estate. Utilities have gained nearly 31% year-to-date, but 20% of that came during Q3. And Real Estate dug itself out of a hole by rising about 14% during the quarter to end the first half of the year with an 11% return. At the opposite end of the spectrum, high flying sectors like Technology and Communication Services lagged. The former lost a bit during Q3 but still gained 17% this year while the latter grew about 6% and is up 25% year-to-date as Q3 ended.

Our bull market remains intact, but there’s movement beneath the surface. For much of the last couple of years AI-related stocks, led by the so-called Magnificent Seven, drove the performance of major market indices. That’s been shifting and this kicked into higher gear during Q3. According to my research partners at Bespoke Investment Group, nearly all of the gains in the S&P 500 index so far this year have come from other companies. That’s heathier for investors longer-term but creates short-term pain for other investors. You were mostly insulated from this sector and style rotation if the stock portion of your portfolio was broadly diversified.

In international markets, China broke out of a long slump to return 39% but nearly all of those gains came in Q3 (and seem due to recent direct market intervention by the Chinese government). This pushed emerging market indices higher since most have a large amount of exposure to China.

In the bond market, core bonds finally broke out of their quagmire to return about 3.6% so far this year. Depending on the index and type of bonds you’re looking at, returns this year range from about flat for longer-term bonds to around 4% for inflation-protected bonds. The benchmark 10yr Treasury yield fell to about 3.6% as prices rose during the quarter, before flipping back to about 4% as Q3 ended.

Much of the movement in the stock market, and substantially all of the movement in bonds, was due to a sea change in Fed interest rate policy in Q3. After quickly raising interest rates to fight inflation following pandemic-related spending and other economic issues, the Fed left rates high for what many thought was too long. Inflation eventually came back to manageable levels perhaps well before Q3 and numerous voices, including from within the Fed, said that higher interest rates had become restrictive for the economy.

Months of waiting for the Fed to lower rates came to a head in September when the Fed’s Open Market Committee voted to reduce it’s short-term rate benchmark by half a percentage point. This had been expected by markets but the actual event was pivotal for returns during the quarter and for the rate outlook. Lower rates are a net-positive for the economy and the path seems clear for lower rates in the near-term, although that path isn’t predetermined. However, Q3 ended with markets pricing in a roughly 80% chance that the Fed lowers rates again at its November and December meetings. More reductions are expected into the new year, perhaps cumulatively shaving off 2% or more from the cost of borrowing money in the economy.

This resetting of Fed policy may also help the Fed achieve a so-called soft landing, where higher interest rates are used to slow an overheated economy and then reduced without causing a recession. This is very tricky to pull off given that changes in monetary policy work with a “long and variable lag” of months, even quarters. Traditional recession indicators, such as an inverted yield curve, have largely failed as predictive tools in recent years. However, analysts see a stable job market, solid consumption and strong personal balance sheets for many consumers. These and other indicators suggest our economy is in good shape, at least for the time being. Maybe this is what a soft landing looks like, but only time will tell.

Now we’re in the final quarter of the year. This is typically a volatile time, especially during October, but the quarter has historically been the best of the year in terms of market performance. So plan for more volatility in the weeks and months ahead – there’s always ample reason for it. But plan for good outcomes as well. If I’m responsible for managing your portfolio, know that I’m watching markets constantly and checking your allocation against your model frequently, and tweaking things as needed. Let me know of questions and any year-end concerns or considerations.

Have questions? Ask us. We can help.

As you’ve no doubt heard, the Fed finally lowered its short-term benchmark interest rate last week. That’s a sea change in the financial world and should, hopefully, provide a bit of a tailwind for the economy and markets in the near-term. The Fed opted for a 50 basis point (half a percent) reduction.

Fed Chair Jerome Powell indicated further reductions in the coming months without guaranteeing anything. However, markets are pricing in about a 50/50 chance the Fed drops another half percent but by at least a quarter point when they meet again in November. Markets are also expecting reductions totaling around 2% from here, so all this will continue to be top-of-mind for some time to come.

Okay, on to our main topic this morning and continuing our theme from last week.

The deadline for a lot of financial actions each year is December 31^st. We covered “standard” Required Minimum Distributions last week. Now let’s look deeper into the weeds and review considerations when taking RMDs from IRAs you’ve inherited.

RMDs can seem exponentially more complicated when you’ve inherited an IRA. As with last week, I’ll gloss over some of the minutiae to provide a straightforward approach to this topic. As always, consult your humble financial planner or tax professional for specific advice.

The starting age for taking RMDs from your own account is 73 but with inherited IRAs it’s all about how old the decedent was when they passed and how old you are and what your status is when you inherit the account.

Here’s how this process usually begins. The account owner died with you listed as their beneficiary. The custodian of the decedent’s account will want a death certificate and some paperwork completed. You won’t be able to get specific information about the account until the custodian completes their initial processing, but this doesn’t take too long, maybe a couple of weeks if you’re a person versus an entity like a trust or charity.

The custodian will ask if you’d like to open a new account with them or have them send the inherited money elsewhere. Unless you need to spend all of the money now, non-spouse beneficiaries will want to move the money into an Inherited IRA. Assuming so, the custodian will usually take the decedent’s RMD for that year if required and it hasn’t been done already (often splitting this among beneficiaries if there are multiple). Then they’ll transfer the remaining balance into your new account that will be titled something like, “Jane Doe Inherited IRA, Beneficiary of Sally Johnson”. You can often elect to receive the investments already in the account, or you can have everything sold and receive cash into your new account – either way the transfer itself isn’t taxable.

This sets your new account apart from your other IRAs, Roth IRAs, 401(k) plans, etc, and is where the complexity begins.

If you’re the surviving spouse, it’s generally best to skip the Inherited IRA and put this money into your own IRA, assuming you have one. This let’s you treat the inherited money as your own for RMD purposes and generally makes the process simpler.

Pretty much everyone else will need to contend with a variety of issues.

If the decedent died this calendar year, the government lets you wait until next year to start taking money out. You can withdraw immediately, but you won’t be required to start taking your own RMDs until the following year. The deadline is December 31^st each year.

Distributions from a Traditional, Rollover, or Contributory IRA (different names for essentially the same account) are taxed as ordinary income, so yours will be too. Distributions from a Roth IRA likely won’t be taxed but still follow the same general RMD rules. There are penalties for missing an RMD, so you’ll want to understand how they work and not forget about them.

Look up the “Single Life Table” via a Google Search, or you can use this one: https://www.fidelity.com/building-savings/learn-about-iras/irs-single-life-expectancy-table

Find your age during the year the account owner died and divide the balance (a specific number provided by the custodian) by that year’s life expectancy factor. That’s your RMD. In subsequent years you’ll subtract 1 from the starting-year factor and redo the math with the then-prior year’s ending balance.

However, the government mandates that most non-spouse beneficiaries completely drain the account by the end of ten years starting the year after death. That used to be a five-year window and you had the ability to “stretch” an IRA over a beneficiary’s lifetime. No longer in most situations.

So does that mean you should skip the Single Life Table and divide the balance by ten? Or should you just take the minimum each year and draw the remainder in year ten? Or some other variation?

For some the answer is simple. They’ll take all the money quickly because they’re going to spend it. But others might prefer to let the money grow.

Essentially, it’s all about taxes and when you pay them.

There are specific rules depending on if the decedent was taking RMDs, but I suggest for most non-spouse beneficiaries its simplest to divide by ten to smooth out the tax burden over the full distribution period. But you can opt to take the minimum each year while opportunistically taking more in other years as your tax situation allows. Careful planning is critical to manage taxes but also to ensure the account is emptied on time.

As I mentioned above, this is meant to be helpful summary and shouldn’t be considered specific advice. Part of this is due to the rules being different for:

A spouse more than ten years different in age from the decedent.

Beneficiaries who are minors when they inherit.

Beneficiaries who are chronically ill when they inherit.

Beneficiaries who inherit from other beneficiaries.

Certain types of trusts that inherit a retirement account.

Or inheriting an account from an employer plan versus an IRA or Roth IRA.

Of course we’ll help you with this stuff if you’re a client, but here’s a more detailed article for the DIY types out there. This content is meant for planners so it’s a little dense and long. However, there are some good flow charts to help determine what options are available to different types of beneficiaries.

https://www.kitces.com/blog/secure-act-2-0-irs-regulations-rmd

Isn’t our tax code wonderful!

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Last week wasn’t a good one for stocks but, as I mentioned in a recent post, September is usually a volatile month so some bumpiness is to be expected. Major market indexes were down from about 3% to nearly 6% for the week with the largest losses impacting small companies and big tech names most. These were also areas of the market with the highest returns lately. The more broadly-based S&P 500 was down a little over 4%. Bonds were up a percent or so and that helped soften the blow for investors with portfolios containing bonds.

It can be helpful to put short-term market volatility into broader context. The S&P 500 is up better than 14% year-to-date, better than the Dow’s 9% and the NASDAQ’s 12%. Core bonds are finally posting positive returns this year, up around 4% or so depending on the index. And foreign stocks are up in the mid-single digit range. So it’s been a good year but market seasonality is amping things up a bit as usual. Add the election calendar and Fed policy expectations to the mix and, again, volatility should be expected.

For some historical context, my research partners at Bespoke Investment Group looked at S&P 500 performance since markets started trading five days a week in 1953. Last week was the worst start to September on record. There have only been four other times when the broad market benchmark declined by more than 2.5% in the first week of September. Why does that matter other than to demonstrate it doesn’t happen very often? One week doesn’t make a trend but it’s interesting market trivia anyway.

Going further, Bespoke looked at the same 1953 start year but from the second week of September to see how markets have fared during that month and through the fourth quarter. They found that the S&P 500 was up 76% of the time with average cumulative gains of over 4%. Notable losses occurred during this historical timeframe such as Black Monday in October 1987, when the Dow index lost 23% in a day. The onset of market meltdowns in September 2008 related to the Great Recession also marred the timeframe. Otherwise, September has tended to be weak and volatile but the final three months of the year often make up for it.

That said, I don’t want to overstate this. I recall plenty of times when the last few months of the year felt nasty related to trade wars, Fed policy, and various other causes of market anxiety. And I’ll never forget the “coming unglued” nature of late-2008. However, those market events were juiced up by excessive leverage and complex/risky trading strategies, global trade issues, a US and/or global economy on the rocks, and rising interest rates. Depending on one’s opinion our current environment has excesses, such as lofty valuations in some parts of the market, but we’re in a much better place than back in 1987 and 2008.

Market volatility can be disconcerting, especially when it seems to come from nowhere. We should always prepare our portfolios and minds for all eventualities but remember that volatility goes both ways. Major market indexes were up yesterday and again as I write this morning, without a major positive catalyst other than prices being down last week. We’ll see how this week pans out but we have to think beyond just the next few days, of course.

I’ve mentioned this numerous times before but it bears repeating: As long-term investors we need to deal with seeing our statement values bounce around, sometimes quite a bit, as we grow our wealth. Growth will happen but you have to give it time.

Have questions? Ask us. We can help.