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My Take On The SECURE Act

48% of U.S. households led by someone 55 or older have no money saved for their retirement, according to a report released by the Government Accountability Office.

To make matters worse, 29% of those households don’t have access to a pension or other defined benefit plan that would help provide some source of income during retirement, leaving these families to live solely off of Social Security benefits.

It’s a very complex problem, driven in part by a shift away from traditional pensions toward a do-it-yourself savings system.

So what can be done to change people’s savings behavior and prevent them from facing their own retirement crisis?

Research has shown one of the most effective ways to get people to save is through a workplace retirement plan such as 401(k)s, 403(b)s, etc. — also known as defined-contribution plans.

However, millions of people do not have access to these plans either, especially at small businesses where the cost and complexity preclude the employers from establishing one.

There is currently a bill that aims to help workers save more for retirement by incentivizing small businesses to offer defined-contribution plans and making it easier for workers to save within those plans (along with some other stuff).

So, What is the bill?

The Setting Every Community Up for Retirement Enhancement Act, known as the SECURE Act, includes 30 provisions that seeks to reform the retirement savings landscape.

I’ll run through a few of the current provisions of the SECURE Act that I find particularly interesting and provide my opinions on if it really helps accomplish what they’re setting out to do — which is to help the average American save more for retirement.

It is important to note that the SECURE Act is not yet law, but it was attached to the year-end spending bill that it is likely to be signed by the President and go into effect January 1, 2020.

Section 102 & 105

Section 102 and 105 of the bill almost go hand-in-hand. Section 102 would allow an employer to automatically deduct money from an employee’s wages toward retirement — up to 15% of their salary — unless the employee opts out or to contribute a different amount. Basically, your employer determines how much you save to your Plan unless you tell them otherwise.

I actually really like this provision for defined-contribution plans and think it could go along way in helping individuals build wealth. Unfortunately, automatic enrollment already exists (with the current cap at 10% of an employee’s salary) and most employers don’t use it.

To help incentive businesses to include auto-enrollment in their Plan, Section 105 would create a $500 per year tax credit that would be available for three years to help offset the cost of including the provision in the Plan.

I really don’t think this credit will make a difference in the adoption rate of the auto-enrollment provision. Instead, I think employers should be given more tools to ensure that their participants are saving at sufficiently high levels to enjoy a secure retirement.

Section 107

Current IRS rules say that if you are older than 70 1/2, you can’t contribute to a traditional IRA (but you can still contribute to a Roth IRA). This piece of legislation would repeal that and doesn’t put an age limit on contributions.

The reasoning behind the change is that Americans are living longer, and an increasing number of people continue to work beyond traditional retirement age.

The current age cap for IRA contributions doesn’t make much sense so I am in favor of repealing it. But aside from some tax planning opportunities, this doesn’t do much to help those struggling to build substantial retirement assets do so.

This provision also includes language that coordinates deductible contributions to IRAs after age 70 1/2 with qualified charitable distributions (QCDs).

Here is what the provision says,

“The amount of distributions not includible in gross income by reason of the preceding sentence for a taxable year (determined without regard to this sentence) shall be reduced (but not below zero) by an amount equal to the excess of – (1) the aggregate amount of deductions allowed to the taxpayer under section 219 for all taxable years ending on or after the date the taxpayer attains age 70 1/2, over (2) the aggregate amount of reductions under this sentence for all taxable years preceding the current taxable year.”

Talk about confusing! What this is essentially saying is that QCDs must be reduced by the cumulative amount of deductible IRA contributions you made after age 70 1/2, that have not already reduced an earlier QCD amount.

Here is an example:

You made deductible IRA contributions at age 71, 72, and 73 for a total of $21,000 ($7,000 per year). At age 74, you make a qualified charitable distribution of $30,000 from your IRA. Only $9,000 of this amount will be treated as a QCD. The first $21,000 doesn’t count because you already took a deduction for it.

This makes sense otherwise you’d be getting a tax break on the money going in and an equivalent amount going out.

section 112

Under current law, employers generally may exclude part-time employees (employees who work less than 1,000 hours per year) when providing a defined contribution plan to their employees.

These rules can be especially detrimental to women since they are more likely to work part-time than men.

Section 112 would make it harder for employers to exclude part-time employees from Plans by expanding the eligibility requirements to include anyone who has worked three consecutive years of service with at least 500 hours of service.

I like this provision a lot and think it goes a long way to help the average working American save for retirement.

section 114

Current law requires individuals to begin required minimum distributions (RMDs) from their retirement accounts once they reach age 70 1/2. The SECURE Act would delay this to age 72.

Something to keep in mind is this only applies to those who are not age 70 1/2 by the end of 2019. If you’re already age 70 1/2, you’ll have to continue taking your RMDs as you would have. There is no grandfather clause.

Honestly, this does nothing but add a few more years for tax planning opportunities (like Roth conversions) for those who already have substantial traditional retirement assets.

section 204

Section 204 is my least favorite provision of this bill. It essentially makes it easier for employers to offer annuities in their 401(k) lineup.

While I’m not against using annuities for lifetime income planning, I am against wrapping them into retirement accounts so insurance companies can charge egregious fees. If you want proof, look at the current 403(b) market!

I recommend reading Tony Isola’s article on why he is against this provision as he’s an expert in the 403(b) space and has researched this thoroughly.

section 302

The Section would allow 529s to be used for student loan payments.

I wrote an article about how this change opens the door for some unique tax planning opportunities, but this doesn’t help the average person prepare for retirement.

section 401

This Section would make substantial changes to inherited retirement plans like 401(k)s and IRAs.

Currently, non-spouse beneficiaries must begin distributions from an inherited retirement account one of two ways:

spreading distributions over their lifetime, or
distribute the balance of the account within 5 years of the original account holder passing away

The bill would take away the first option completely and instead requires most beneficiaries to distribute the account over a 10-year period.

Inherited accounts aren’t meant to be retirement accounts so I can why the government would want to implement this provision — it accelerates the taxes the government is owed.

From a planning perspective, it makes proper estate planning and tax planning far more important for families with significant wealth. Does it help the average person with accumulating retirement assets? I think not.

Final thoughts

While the SECURE Act makes a few positive changes, it doesn’t do anything to help accelerate the retirement security of those who most need it.

Not surprisingly, many of the changes appear to be a clear result of the insurance companies having great lobbyists.

Needless to say, it will take further work by financial planners to help change the way people save for retirement, one family at a time. We can only hope that, in time, this also influences the way the government makes rules surrounding this topic for the better.

Lobster Today, Shrimp Tomorrow

On Tuesday, August 27, the yield on the 10-year Treasury note fell below the 2-year Treasury rate, resulting in an inverted yield curve.

This is a big deal because the bond market is a key indicator of economic health.

When returns on long-term bonds (10-year Treasuries) fall below short-term bonds (2-year Treasuries), it generally signals that investors are concerned about a slowing economy and are increasingly focused on near-term economic conditions.

And while parts of the curve have inverted in recent weeks, the 2- and 10-year spread — spread is the yield difference between the two — has not inverted in 14 years.

Yield curves

First, some perspective on how a yield curve is typically shaped.

A “normal” yield curve slopes upward, with short-term rates lower than longer-term rates.

This is because investors generally demand a premium to hold debt for longer periods of time — they are taking on more risk after-all.

An inverted yield curve seems counterintuitive then. Why would long-term investors settle for lower rewards than short-term investors, who are assuming less risk?

The answer: long-term investors believe that this is their last chance to lock in current rates before they fall even lower.

To quote a colleague of mine, would you rather eat lobster today or save for 10 years and eat shrimp instead?

The image below is a real-world example of what yield curves can look like. The yield curve on 8/22/2018 was normal, with long-term rates higher than short-term. More recently, the yield curves are increasingly inverting.

Source: FactSet Research Systems, August 23, 2019

Risk of an inverted curve

As you might expect, since lower interest rates generally mean slower economic growth, an inverted yield curve is often taken as a sign that the economy may soon stagnate.

While the past is not a predictor of the future, the reason an inverted yield curve unnerves many investors is that it has historically been a predictor of a recession.

In fact, an inverted Treasury yield curve has preceded all nine US recessions since 1955, according to a study conducted by the Federal Reserve Bank of San Francisco.¹

should you be worried?

Regardless, predicting a recession from past events isn’t foolproof and a yield curve inversion does not necessarily mean imminent doom for the stock market.

Even the New York Fed has noted that by even the most aggressive predictions, a recession is at least 12 months out.² And, after the inversion of the 2- and 10-year spread in December 2005, the S&P 500 rallied for nearly two more years, peaking in October 2007.

But what can you do to protect yourself in the event of an economic downturn?

There are two things that you should be doing now to hedge against a recession and they both revolve around your cash flow: 1) make yourself indispensable to your employer and 2) have enough cash on hand in case you do lose a job.

As far as investments go, tune out the noise and remain focused on your long-term financial goals. Market volatility is no reason to abandon your investment strategy.

In fact, when markets are down, it’s a great time to increase contributions and take advantage of purchasing assets while they’re cheap!

1. Federal Reserve Bank of San Francisco, “Economic Forecasts with the Yield Curve,” March 5, 2018, www.frbsf.org/economic-research/publications/economic-letter/2018/march/economic-forecasts-with-yield-curve

2. Federal Reserve Bank of New York, “Probability of US Recession Predicted by Treasury Spread,” August 2, 2019, https://www.newyorkfed.org/medialibrary/media/research/capital_markets/Prob_Rec.pdf?mod=article_inline

The Pitfalls Of Sudden Wealth

Sudden wealth can take many forms, including selling a business, winning the lottery, reaching a legal settlement, or the result of an inheritance.

Receiving a large windfall, especially when tied to the death of a loved one, can trigger powerful and conflicting emotions that may lead to risky financial decision making.

Below are some common pitfalls of sudden wealth and ways to overcome them.

Pitfall #1 – Hasty decision making

Do you ever hear of lottery winners going broke only a few years after they won a large sum of money? How is that even possible?

I think it’s because these ordinary people all of a sudden became extraordinary. They become euphoric and lose all sense of reality.

No matter the source of the windfall, it can oftentimes trigger those visceral emotional responses and all logical thinking goes out the window.

The best course of action to take after a windfall is to do nothing – at least for a while. Take a step back and figure out your priorities and create a plan.

Determine what decisions you have to make in the short-term, like tax planning, and what decisions you can wait to make, such as how to maximize the impact of your newfound wealth.

Pitfall #2 – caving to the pressure

Once friends and family learn that you’ve received a large sum of money, they may have an expectation that they are entitled to it. Depending on your relationship with those people, it can be hard to say no.

Once you start giving money away though, it’s difficult to reverse course.

The easiest solution is to rely on a third party to act as a gatekeeper, such as your financial advisor or attorney, to intercept the flood of requests and take the emotion out of the decision-making process.

Pitfall #3 – Withholding information

A windfall can prompt people to be more close-lipped about their finances. Some feel uncomfortable about their new wealth, others feel isolated from their former peers, and still, others are wary of those seeking handouts.

This instinct to withhold information often extends to your financial adivsor as well.

However, during every big transition, especially sudden wealth, it is critical to provide your advisor with a full picture of your financial situation. Your advisor will serve as a partner to assist you through the decision-making process and help you to spot issues before they become problems.

Pitfall #4 – Failing to update plans

After receiving a financial windfall, it is crucial to review the financial planning framework you previously had in place.

Financial plans will almost always need to be revisited, along with insurance policies and estate plans.

Your financial advisor can lead this team — financial advisor, lawyer, accountant, and insurance agent — to create a plan for your future that stays true to your priorities and goals as your financial situation changes.

Are Brokered CDs FDIC Insured?

Certificate of Deposits, or CDs, are typically issued by banks directly to a customer and have a fixed interest rate and date of withdrawal, known as the maturity date.

They also are insured by the Federal Deposit Insurance Corporation (FDIC) which covers up to $250,000 of your money in traditional types of bank deposit accounts – including checking and savings accounts, money market deposit accounts (MMDAs), and certificates of deposit (CDs).

As such, CDs are generally considered to be simple, conservative products that carry few risks.

But what if you buy a certificate of deposit through a broker, do you get the same FDIC protection as if you individually bought it?

The reality is that it depends on a number of factors. Some brokered CDs may actually be securities and, if they are, they won’t qualify for FDIC insurance at all.

what is a brokered cd?

Brokered CDs are CDs issued by banks to brokers, which in turn sell interests in the CD to individual investors.

Brokered CDs are sometimes arranged by a broker directly for a single client, but it’s more common that they’re bought in the name of the brokerage firm and sold to many clients.

In general, brokered CDs have longer maturity dates (in some cases, 20 years from the date of issuance), than traditional CDs. The interest rate terms of brokered CDs can also differ significantly from the simple interest rate terms usually used by traditional CDs.

For example, some brokered CDs have their interest rates tied to a market index, such as the S&P 500. Brokered CDs also may have special features that allow the issuing bank to terminate the CD after a specified period of time if interest rates drop.

To compensate for these additional features, brokered CDs frequently pay a higher interest rate than traditional CDs.

Although brokered CDs may have certain features that traditional CDs do not have, as long as a banking institution issues the brokered CDs and sets all of their features, brokered CDs are generally considered bank products — not securities — and FDIC insurance applies to them.

When does a Brokered CD become a Security?

However, there are several circumstances under which a brokered CD may be considered a security.

For example, if a broker materially alters the terms and features of a brokered CD (e.g., offering a different interest rate than the interest rate set by the issuing depository institution), the brokered CD is arguably a different investment vehicle that could be considered a security.

Additionally, some brokers maintain a limited secondary market for customers who have bought brokered CDs. If a broker, as an incentive to purchase brokered CDs, offers and/or maintains a secondary market for customers to rely upon to provide additional liquidity to their brokered CDs, this may make brokered CDs securities.

Something else to keep in mind is when a broker buys CDs as an agent for many clients, all bank information passes through the brokerage. Each client is protected only if the broker meets FDIC record-keeping requirements.

Those requirements include titling the account so it’s clear that the funds are being held in a fiduciary capacity. In other words, if it’s actually owned by the investment broker, and not you personally, the FDIC insurance may not apply.

If the institution that issued the CD fails, the FDIC would make payment to the brokerage since the only name on the account records would be the broker’s. Whether the brokerage transfers this payment to you or not is up to them.

Make sure all of your deposit will be fully insured.

To protect your brokered CD from loss if the bank fails, follow these steps to confirm that your money is placed in a properly titled deposit account at an FDIC-insured bank and that all of it is within the deposit insurance limits.

First, get the name of the bank where your money is to be deposited and verify that it is FDIC-insured by calling the FDIC toll-free at 1-877-275-3342 or searching BankFind, the FDIC’s database of insured institutions at http://research.fdic.gov/bankfind.

Second, ask your broker to confirm that the deposit account records for its brokered CDs reflect the broker’s role as an agent for its clients (for instance, by titling the account “XYZ Brokerage, as Custodian for Clients”). This will ensure that your portion of the CD qualifies for full FDIC coverage.

You’ll also need to be aware of how much money you have at one particular bank. Your brokered CDs are added to any traditional CDs that you have at the same bank when calculating FDIC coverage. So, if your combined brokered and traditional deposits at a single bank exceed $250,000, you won’t have protection on the amount above the $250,000 limit.

Keep in mind that brokerages are also required to insure the assets in your account which they hold on their balance sheets (cash, bonds, stocks, and mutual funds). This is provided by SIPC, the equivalent of FDIC in the brokerage world.

So even if your brokered CD is considered a security, you’re still insured against the risk that the brokerage firm goes bankrupt.

The Basics of a Credit Score

Your credit score is a three-digit number that lenders use to determine whether or not you are a trustworthy borrower.

Many lenders use the Fair Isaac Corporation (FICO) model for credit scores, which grades borrowers on a point range, with a higher score indicating less risk to the lender and a more favorable rate for you.

Take for example this credit savings illustration available at myFICO.com.

Borrowers with excellent credit scores — between 720 and 850 — save as much as $9,601 in interest over the life of a 60-month, $25,000 car loan compared to borrowers with scores ranging from 500 to 589. That is real money saved!

While the above example shows the effect of differing FICO scores on a hypothetical auto loan, the same principle applies to any other line of credit — credit cards, personal loans, mortgages, etc.

That’s why it’s important to know what factors are taken into consideration when calculating your credit score so you can take proactive steps in building good credit and qualifying for the lowest rates possible.

Payment History

Repaying past debts is the largest factor that makes up your credit score. Payment history amounts to 35 percent of your score and includes both revolving credit, such as credit cards, and installment loans, like mortgages. In short, payment history is used in credit formulas to determine future long-term payment behavior. Making on-time payments is one of the best ways to improve or maintain a high score.

Amounts Owed

The amounts owed factor accounts for 30 percent of your credit score. The formulas used to compute scores tend to see borrowers who reach or exceed their credit limit as a higher risk. Keeping card balances low can positively impact your score. Utilizing a high percentage of available credit will do just the opposite.

Length of Credit History

Opening a credit account early can pay off in the long run. The length of credit history factor, specifically the age of your first account, makes up 15 percent of your credit score. As time goes on, account holders with a positive history will have more data that influences their credit report.

New Credit

New credit amounts to 10 percent of your credit score. Opening new credit accounts on a whim can negatively impact your financial health, as it is a sign of greater risk. A 20-percent store discount for opening a new credit account may sound great, but it could make getting a loan, or a lower interest rate, more difficult. Only open new credit accounts when necessary to give your score a small boost.

Credit Mix

The fifth and final factor that contributes to your financial health is your credit mix. Credit mix is comprised of the various accounts you currently have open. This can include but is not limited to, credit cards, installment loans, and finance company accounts. Credit mix makes up the final 10 percent of your overall credit score.

Knowing the factors that affect your credit score can help you build and maintain a high credit score which will allow you to borrow from lenders at lower rates, saving you money in the long run.

If you are using credit cards to build credit, make sure you are using your available credit wisely, paying off the balances at each cycle, and only opening new lines of credit when absolutely necessary.