Following a turbulent end to 2018, financial markets are off to a fast start in 2019.  The U.S. stock market has recouped its December losses with both large and small company stocks making sizeable gains. Foreign stocks rose over 10% in the first quarter but are still clawing their way back from a lackluster 2018.  Quietly, bonds had a stellar quarter (considering the low interest rate environment of the last decade), notching their highest quarterly return since early 2016.  

It is a difficult task to identify and quantify the specific causes of any market move, but there are a few possible drivers of the market’s strong returns and quick reversal over the last several months:

  • The Federal Reserve’s about-face:  After hiking the Fed Funds rate in December, the Fed turned “dovish” and dialed back expectations for further interest rate increases this year;

  • Hopes for a U.S./China trade deal and the possibility of a trade war resolution;

  • Expectations of a softer landing for the Chinese economy as more stimulus measures are put into place;

  • Increased optimism for a bipartisan resolution and positive outcome for Brexit; and   

  • Continued low unemployment, low inflation, and relatively strong earnings from U.S. corporations.

Asset class returns for the quarter were as follows:

      

Index

 

Asset Class

First

Quarter 2019

Barclays U.S. Govt./Credit—Int.

Fixed Income

2.3%

S&P 500

Large U.S. Stock

13.7%

Russell 2000

Small U.S. Stock

14.6%

MSCI ACWI ex-USA

Foreign Stock

10.3%

S&P Global REIT

Real Estate Securities

14.1%

 

 

 

 

 

 

It has been over a year since the 2018 tax reform was implemented. During that time, we have been collaborating with our clients’ advisory teams to understand and benefit from the new tax laws. One planning concept that has become more nuanced is Roth IRA conversions (converting part or all of a pretax IRA to a tax-free Roth IRA by paying taxes in the current year).  Roth conversions may be beneficial for investors who are currently in a lower tax bracket and expect to be in a higher (or similar) tax bracket in the future. For example, those who have retired but have not started drawing Social Security benefits or begun taking required minimum distributions (RMDs) from IRAs may be candidates for Roth conversions. For these clients, their 50s and 60s could actually be lower taxable income years than their 70s and beyond. This may present an opportunity for such clients to “fill up” their current marginal tax bracket with Roth conversion money.  It is especially advantageous if they see themselves or their beneficiaries being subject to higher taxes in the future.

Below, we provide a hypothetical example of a retired married couple, ages 68 and 67, who are planning to delay Social Security benefits until age 70 and would like to convert a portion of their IRA balances to Roth IRAs. In this example, the couple can stay within their current marginal federal tax bracket of 12% and complete $200,000 of Roth conversions over three years before their marginal tax bracket nearly doubles to 22% (when they begin taking RMDs and Social Security benefits).

Roth Conversion Strategy

This material is presented for informational purposes only and should not be construed as individual legal, tax or financial advice. When considering tax planning strategies, you should always consult with tax and/or legal advisors.

Unlike traditional IRAs, Roth IRAs do not require withdrawals during the owner’s lifetime and inherited Roth IRA distributions are tax free as well (but do have RMDs). This could be a significant tax savings tool for beneficiaries who inherit a parent’s Roth account in their high-income years. Having less taxable income from RMDs in your retirement years may also mean less in “stealth taxes” (i.e., on Social Security income and Medicare premiums) and a lower bar for other deductions. Roth conversions can be a useful tool anytime you or your kids have a temporary or prolonged break in employment or spans of time with lower income. For a young person just starting a career, converting traditional IRA money into Roth money with decades of compounding (tax free) future growth ahead can be an incredibly impactful financial tool.

For those possibly subject to estate taxation (i.e., above the current estate tax exemption amount of $22.8 million for a married couple; $11.4 million for an individual), the inclusion of a significant traditional IRA in your estate may be tax-inefficient for heirs. The IRA balance may be included in the taxable estate and the final RMD and subsequent withdrawals may create unexpected taxable income to the beneficiaries. 

With a Roth conversion, it is always important to consider how income taxes on the conversion are going to be paid. We typically suggest paying the taxes with funds outside of the IRA, so that the full Roth conversion amount can grow tax free. As with most financial planning strategies, the Roth conversion is best discussed with your advisory team to make sure it fits your unique set of personal financial circumstances and goals. There are many situations where Roth conversions may not be beneficial, and they are certainly not for everyone. However, when done correctly and strategically, Roth conversions can be a valuable long-term planning tool for a certain segment of investors.

We thank our clients and fellow business professionals for their continued trust and support. We hope your year is off to a great start and invite you to contact our team with any questions or concerns regarding your finances.

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