Inherited IRAs – IRS Issues Final Regulations

Prior to 2019, most beneficiaries of Inherited IRAs could stretch out Required Minimum Distributions (RMDs) over their lifetime. However, the first SECURE Act eliminated this benefit and required that most non-spouse beneficiaries empty inherited accounts within 10 years. This change led to considerable confusion, most notably, whether annual RMDs were necessary during this 10-year period. As a result of the confusion, the IRS waived RMDs from Inherited IRAs for the past three years.  However, earlier this month the IRS issued final regulations for anyone that inherited an IRA in 2020 and thereafter.

IRS Final Regulations, required for any non-spousal IRA inherited in 2020 and later:

  1. If Deceased IRA Owner Had Started RMDs:
    • Most beneficiaries must withdraw funds within 10 years beginning the year after death.
    • Annual RMDs for each of the 10 years beginning the year after death.
    • Caution: Small annual withdrawals could lead to a large, taxable distribution in the final year to draw down the balance to $0.
  1. If Deceased IRA Owner Had Not Started RMDs:
    • No annual RMDs, but the account must be empty by the end of year 10.
    • Most beneficiaries can withdraw any amount, or $0, a year over 10 years.
    • Caution: Waiting until the 10th year could lead to a large, taxable distribution in the final year to draw down the balance to $0.

For inherited IRAs requiring distributions since 2020, the 10-year clock has already started, however the IRS waived all penalties for failure to take RMDs through 2024 due to previous regulatory uncertainty.

For beneficiaries that inherited multiple IRAs:

  • Different rules may apply to different inherited accounts.
  • Careful management of each account is important.

For beneficiaries that inherited an IRA prior to 2020:

  • These accounts remain subject to the old “stretch” IRA rules, allowing withdrawals over the beneficiary’s lifetime.

Important Takeaways:

  • Tax Planning: Work closely with your tax preparer and Rockbridge Financial Advisor to develop a withdrawal strategy that minimizes your tax burden. Taking only the minimum distribution each year could result in a significant tax hit in the final (10th) year. In certain situations, it may make sense to delay significant withdrawals; for example, if you are nearing retirement and income will decrease significantly in the future.
  • Account Inventory: If you’ve inherited multiple IRAs, carefully review the rules applicable to each account. Different inheritance dates may mean different withdrawal requirements.
  • Spousal Exemption: These new regulations generally do not affect spouses who inherit IRAs, as they have special rules allowing them to treat the inherited IRA as their own.

Whether you’ve recently inherited an IRA or inherited an IRA prior to 2020, it’s important to understand your obligations and strategize accordingly.

Note that a separate set of rules applies to beneficiaries of Inherited IRAs who are a surviving spouse, minor child, person not less than 10 years younger than the decedent, or persons that are disabled or chronically ill.

Given the potential tax implications and the complexity of these rules, consulting with your Rockbridge Financial Advisor and tax professionals is highly recommended to minimize your tax burden and ensure compliance with IRS regulations to avoid penalties up to 25%.

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Navigating The Fed’s Interest Rate Strategy

With today’s interest rate environment, investors have been able to capitalize off high-yielding money market funds and/or savings accounts. We do not anticipate this kind of yield forever, since the Federal Reserve indicates plans to decrease interest rates gradually. Based on the Fed’s plan, investors should expect to earn a similar yield on their cash for at least the next couple of years. However, historical trends suggest that these decreases often turn out to be more dramatic than initially expected. Although we cannot predict the future, historical observation can help us best position your cash savings in anticipation of these interest rate changes.

The Fed’s Historical Pattern

While the Fed often aims for gradual adjustments, historical precedents show that these cuts can be sharp and swift. This discrepancy often arises due to unforeseen economic challenges that require prompt action. For instance:

  • Late 1990s: Rates peaked around 6-7% before a sharp drop during the early 2000s recession due to the “dot-com” bubble.
  • 2008 Financial Crisis: Rates plummeted from over 5% to near zero in a matter of months as the Fed took drastic measures to stabilize the economy.
  • COVID-19 Pandemic: The projected gradual rate cuts were replaced by swift actions to mitigate the sudden economic shutdown.

Navigating The Fed’s Interest Rate Strategy

Preparing for Interest Rate Drops

To navigate the potential for both gradual and dramatic rate decreases, a strategic approach with your cash balance is necessary. Here’s how you can prepare:

  1. Establish your emergency fund: The first item we recommend when producing a financial plan is creating an emergency fund. As a general rule of thumb, we recommend holding 3 to 6 months of living expenses held in cash in a high yield savings account or a cash equivalent such as a money market fund. For our clients, we recommend Schwab’s Money Market Fund (SWVXX) parked in a brokerage account. This is currently earning 5.17% and the funds can be liquid in 3 days. Other options for high yield saving accounts include Betterment at 5.5%, Robinhood at 5%, and SoFi at 4.6%.
  2. Carve out cash for short-term goals: After establishing your emergency fund, evaluate your goals for the next few years. Whether it’s saving for a vacation, a home renovation, or a new car, having this money readily available will prevent you from needing to liquidate investments at an inopportune time. To keep your emergency fund separate from your short-term goal funds, we’d recommend utilizing a CD or Treasury with the maturity date aligned with when you’ll need the cash flow. For example, if you plan to fund your child’s wedding in 6 months, we recommend investing in a 6-month CD or Treasury security. 6-month treasuries are currently yielding 5.335%. 1-year treasuries are current yielding 5.147%.
  3. Invest in the market: Once your emergency fund and short-term savings are established, consider investing any additional cash into the market. With interest rates potentially dropping, the returns on money market funds and high-yield savings accounts may diminish. By investing in a diversified portfolio of stock and bonds, you can potentially achieve higher returns. Despite what rate you can get on your cash, it is always a good idea to invest your money in the market if it has a long-term focus.

Conclusion

By staying informed about the Fed’s actions and understanding their potential impact, you can make proactive decisions that enhance your financial security and growth. Securing liquidity for emergencies and short-term goals can help protect you from immediate financial risks. Simultaneously, investing the remaining cash allows you to grow your wealth, outpace inflation, and meet your long-term financial goals. If you have any questions or need tailored advice, don’t hesitate to reach out to a Rockbridge advisor.

 

 

 

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Rockbridge Institutional – June 2024 Market Review

Market Review

Stocks

Returns of stock market indices over the last quarter were mixed. The S&P 500 Index was up above 4%.  Stocks traded in Emerging Markets also turned in a good quarter, MSCI Index was up 5%. Domestic small cap stocks (Russell 2000 Index), on the other hand, were up over 3%. Stocks traded in developed international markets (EAFE Index) were about flat.

The past 12 months have been good for stocks. The S&P 500 was up 26% while other stock market indices were up between 10% and 13%.

The S&P 500 returns of 15% and 26% over the year-to-date and trailing twelve months, respectively, are well above those of other stocks and largely explained by stocks of just a half-dozen companies that are expected to benefit from the continued development of

Artificial Intelligence (AI) technology – Amazon, Apple, Google, Meta (Facebook), Microsoft, and of course, Nivida. Recent results for these companies are shown in the accompanying table: Note not only the levels, but also the differences among the recent results of these companies. Nvidia, the so-called bellwether for AI, stands out.

Bonds

Bond yields did not move much over the quarter. With little impact from changing yields, returns are up about one percent across all maturities. Year-to-date yields have increased about 0.5% resulting in negative returns, especially at longer maturities where increasing interest rates have a larger inverse effect. The pattern of bond yields for various maturities continues to be downward-sloping, signaling falling interest rates ahead, which is consistent with the Fed’s announcement of one reduction in the Federal Funds rate this year.

The Fed is committed not to let inflation get out of hand. The spread between longer-term (5-year) nominal interest rates and inflation-adjusted rates is still a reasonable 2.2%, signaling modest inflation expectations. In any event, the path of future interest rates remains uncertain resulting in continued market volatility going forward.

Diversification

The “Bull” market we have been enjoying is explained by the six stocks listed in the above table.  Obviously, to have enjoyed recent results it is crucial to have been invested in these stocks, which reflect expectations of the impact of Artificial Intelligence (AI). While expected to be profound, the future of AI is unpredictable. The short-term impact on various markets is sure to be volatile, producing significant risk in seeking to identify the future impact of AI on individual stocks.

The principle of diversification is that by holding several asset classes that move independently from one another, risk is reduced without reducing expected return. However, this strategy is difficult to implement when extraordinary returns are concentrated in just a few stocks. Yet, it is the only safe way to take advantage of the recent extraordinary rise in the few Tech stocks with appropriate risk.

The market prices of these stocks reflect where those excited about the future benefits of AI technology (buyers) trade with those concerned that we are ahead of ourselves (sellers). The economic impact of AI cannot be predicted – it is best to rely on what the market tells us, remain diversified, and hang on for the ride.

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