Due Diligence

One of our main goals as holistic financial professionals is to help our clients recognize tax reduction opportunities within their investment portfolios and overall financial planning strategies. Staying current on the ever-changing tax environment is a key component to help our clients benefit from potential tax reduction strategies.

2021 has been an unusual year and there is still major legislation being discussed that could have an effect on your taxes. It is the first year of a new administration, so investors should consider taking into consideration the impact of possible future tax strategies. This report includes information on possible tax law changes and some notable changes proposed in the Build Back Better Act that you should be aware of. The main focus of this report is on what individual taxpayers can do to potentially save money on their 2021 taxes.

The Tax Cuts and Jobs Act (TCJA) enacted in 2017 brought many changes to the tax code. The Tax Cuts and Jobs Act included many provisions for individuals that took effect in 2018 but are currently set to expire after 2025. One big uncertainty for all taxpayers is what will happen to the tax code after 2025.

As financial professionals, we try to be proactive when it makes sense. The objective of this report is to share strategies that could be effective if considered and implemented before year-end. Please note that this report is not a substitute for using a tax professional. In addition, many states do not follow the same rules and computations as the federal income tax rules. Make sure you check with your tax preparer to see what tax rates and rules apply for your particular state.

Income Tax Rates for 2021

For 2021 there are still seven tax rates.  They are 10%, 12%, 22%, 24%, 32%, 35%, and 37%. Under current law this seven-rate structure will phase out on January 1, 2026.

Year-end Tax Planning for 2021

One of our primary goals is to help our clients try to optimize their tax situations. This report offers many suggestions and reviews strategies that can be useful to achieve this goal.

Everyone’s situation is unique but it is wise for every taxpayer to begin their final year-end planning now! Choosing the appropriate tactics will depend on your income as well as a number of other personal circumstances. As you read through this report it could be helpful to note those strategies that you feel may apply to your situation so you can discuss them with your tax preparer.

Some items to consider include:

Evaluate the use of itemized deductions versus the standard deduction.

For 2021 tax returns, the standard deduction amounts will increase to $12,550 for individuals and married couples filing separately, $18,800 for heads of household, and $25,100 for married couples filing jointly and surviving spouses.

As a reminder, the Tax Cuts and Jobs Act roughly doubled the standard deduction. Its goal was to decrease tax payments for many of those who typically claim this standard deduction. Although personal exemption deductions are no longer available, the larger standard deduction, combined with lower tax rates and an increased child tax credit, could result in less tax. You should consider running the numbers to assess the impact on your situation before deciding to take itemized deductions.
The TCJA still eliminates or limits many of the previous laws concerning itemized deductions. An example is the state and local tax deduction (SALT), which is still currently capped at $10,000 per year, or $5,000 for a married taxpayer filing separately.

Consider bunching charitable contributions or using a donor-advised fund.

For those taxpayers who are charitably inclined it makes sense to think about a plan. One way to utilize the tax advantages of charitable contributions is through a strategy referred to as “bunching”. Bunching is the consolidation of donations and other deductions into targeted years so that in those years, the deduction amount will exceed the standard deduction amount.

Another strategy is to consider using a donor-advised fund. A donor-advised fund, or DAF, is a philanthropic vehicle established at a public charity. It allows donors to make a charitable contribution, receive an immediate tax benefit and then recommend grants from the fund over time. Taxpayers can take advantage of the charitable deduction when they’re at a higher marginal tax rate while actual payouts from the fund can be deferred until later. It can be a win-win situation. If you are charitably inclined and need some guidance, please call us and we can assist you.

Review your home equity debt interest.

For mortgages taken out after October 13, 1987, and before December 16, 2017 (i.e. enters into a binding contract by that date), mortgage interest is fully deductible up to the first $1,000,000 of mortgage debt. The threshold has been lowered to the first $750,000 or $375,000 (married filing separately) on homes purchased after December 15, 2017. All interest paid on any mortgage taken out before October 13, 1987 is fully deductible regardless of your mortgage amount (called “grandfathered debt”). This change under the TCJA law applies to all tax years between 2018 and 2025. Many mortgage holders refinanced for lower rates in the last few years so remember for larger mortgages, that could change your situation.

Home equity lines of credit (HELOCs) are deductible as well, but only if the funds were used to buy or substantially improve the home that secures the loan. Please share with your tax preparer how the proceeds of your home equity loan were used. If you used the cash to pay off credit card or other personal debts, then the interest isn’t deductible.

Revisit the use of qualified tuition plans.

Qualified tuition plans, also named 529 plans, are a great way to tax efficiently plan the financial burden of paying tuition for children or grandchildren to attend elementary or secondary schools. Earnings in a 529 plan originally could be withdrawn tax-free only when used for qualified higher education at colleges, universities, vocational schools or other post-secondary schools. However, they changed that so 529 plans can now be used to pay for tuition at an elementary or secondary public, private or religious school, up to $10,000 per year. Unlike IRAs, there are no annual contribution limits for 529 plans. Instead, there are maximum aggregate limits, which vary by plan. Under federal law, 529 plan balances cannot exceed the expected cost of the beneficiary’s qualified higher education expenses. Limits vary by state, ranging from $235,000 to $529,000. Some states even offer a state tax credit or deduction up to a certain amount.

Contributions to a 529 plan are considered completed gifts for federal tax purposes, and in 2021 up to $15,000 per donor, per beneficiary, qualifies for the annual gift tax exclusion. Excess contributions above $15,000 must be reported on IRS Form 709 and will count against the taxpayer’s lifetime estate and gift tax exemption amount ($11.7 million in 2021).

There is also an option to make a larger tax-free 529 plan contribution, if the contribution is treated as if it were spread evenly over a 5-year period. For example, a $75,000 lump sum contribution to a 529 plan can be applied as though it were $15,000 per year, as long as no other gifts are made to the same beneficiary over the next 5 years. Grandparents sometimes use this 5-year gift-tax averaging as an estate planning strategy. If you want to explore setting up a 529 plan, call us and we would be happy to assist you.

Maximize your qualified business income deduction (if applicable).

One of the most talked about changes from the Tax Cuts and Jobs Act enacted in 2017 is the qualified business income deduction under Section 199A. Current proposals want to change this deduction, but for 2021, taxpayers who own interests in a sole proprietorship, partnership, LLC, or S corporation may be able to deduct up to 20% of their qualified business income. Please be careful because this deduction is subject to various rules and limitations.

There are planning strategies to consider for business owners. For example, business owners can adjust their business’s W-2 wages to maximize the deduction. Also, it may be beneficial for business owners to convert their independent contractors to employees where possible, but before doing so, please make sure the benefit of the deduction outweighs the increased payroll tax burden and cost of providing employee benefits. Other planning strategies can include investing in short-lived depreciable assets, restructuring the business, and leasing or selling property between businesses. This piece of tax legislation is complicated and would take an entire report to discuss, so we recommend that if you are a business owner, you should talk with a qualified tax professional about how this new Section 199A could potentially work for you.

Consider All of Your Retirement Savings Options for 2021

If you have earned income or are working, you should consider contributing to retirement plans. This is an ideal time to make sure you maximize your intended use of retirement plans for 2021 and start thinking about your strategy for 2022. For many investors, retirement contributions represent one of the smarter tax moves that they can make. Here are some retirement plan strategies we’d like to highlight.

401(k) contribution limits unchanged. The elective deferral (contribution) limit for employees under the age of 50 who participate in 401(k), 403(b), most 457 plans, and the federal government’s Thrift Savings Plan is $19,500. The catch-up contribution limit for employees aged 50 and over who participate in 401(k), 403(b), most 457 plans, and the federal government’s Thrift Savings Plan increases also to an additional $6,500 ($26,000 total). As a reminder, these contributions must be made in 2021.

IRA contribution limits unchanged. The limit on annual contributions to an Individual Retirement Account (IRA) which was increased in 2019, remains at $6,000 for 2021.  The additional catch-up contribution limit for individuals aged 50 and over is not subject to an annual cost-of-living adjustment and remains $1,000 (for a total of $7,000). IRA contributions for 2021 can be made all the way up to the April 15, 2022, filing deadline.

Higher IRA income limits. The deduction for taxpayers making contributions to a traditional IRA is phased out for singles and heads of household who are covered by a workplace retirement plan and have modified adjusted gross incomes (MAGI) of $66,000 and $76,000 for 2021.  For married couples filing jointly, in which the spouse who makes the IRA contribution is covered by a workplace retirement plan, the income phase-out range is $105,000 to $125,000.  For an IRA contributor who is not covered by a workplace retirement plan and is married to someone who is covered, the deduction is phased out in 2021 as the couple’s income reaches $198,000 and completely at $208,000. For a married individual filing a separate return who is covered by a workplace retirement plan, the phase-out range remains at $0 to $10,000 for 2021. Please keep in mind, if your earned income is less than your eligible contribution amount, your maximum contribution amount equals your earned income.

Increased Roth IRA income cutoffs. The MAGI phase-out range for taxpayers making contributions to a Roth IRA is $198,000 – $208,000 for married couples filing jointly in 2021. For singles and heads of household, the income phase-out range is $125,000 – $140,000.  For a married individual filing a separate return, the phase-out range remains at $0 to $10,000. Please keep in mind, if your earned income is less than your eligible contribution amount, your maximum contribution amount equals your earned income.

Larger saver’s credit threshold. The MAGI limit for the saver’s credit (also known as the Retirement Savings Contribution Credit) for low- and moderate-income workers is $66,000 for married couples filing jointly in 2021, $49,500 for heads of household and $33,000 for all other filers.

Be careful of the IRA one rollover rule. Investors are limited to only one rollover from all of their IRAs to another in any 12-month period. A second IRA-to-IRA rollover in a single year could result in income tax becoming due on the rollover, a 10% early withdrawal penalty, and a 6% per year excess contributions tax as long as that rollover remains in the IRA. Individuals can only make one IRA rollover during any 1-year period, but there is no limit on trustee-to-trustee transfers. Multiple trustee-to-trustee transfers between IRAs and conversions from traditional IRAs to Roth IRAs are allowed in the same year. If you are rolling over an IRA or have any questions on IRAs, please call us.

Roth IRA Conversions

There are some rule change proposals that are discussed later in this report for Roth IRA conversions, but in 2021, some IRA owners may want to consider converting part or all of their traditional IRAs to a Roth IRA. This is never a simple or easy decision. Roth IRA conversions can be helpful, but they can also create immediate tax consequences and can bring additional rules and potential penalties. Under the current laws, you can no longer unwind a Roth conversion by re-characterizing it. It is best to run the numbers with a qualified professional and calculate the most appropriate strategy for your situation. Call us if you would like to review your Roth IRA conversion options.

Capital Gains and Losses

Looking at your investment portfolio can reveal a number of different tax saving opportunities. Start by reviewing the various sales you have realized so far this year on stocks, bonds and other investments. Then review what’s left and determine whether these investments have an unrealized gain or loss. (Unrealized means you still own the investment, versus realized, which means you’ve actually sold the investment.)

Know your basis. In order to determine if you have unrealized gains or losses, you must know the tax basis of your investments, which is usually the cost of the investment when you bought it. However, it gets trickier with investments that allow you to reinvest your dividends and/or capital gain distributions. We will be glad to help you calculate your cost basis.

Consider loss harvesting. If your capital gains are larger than your losses, you might want to do some “loss harvesting.” This means selling certain investments that will generate a loss. You can use an unlimited amount of capital losses to offset capital gains. However, you are limited to only $3,000 ($1,500 if married filing separately) of net capital losses that can offset other income, such as wages, interest and dividends. Any remaining unused capital losses can be carried forward into future years indefinitely.

Be aware of the “wash sale” rule. If you sell an investment at a loss and then buy it right back, the IRS disallows the deduction. The “wash sale” rule says you must wait at least 30 days before buying back the same security in order to be able to claim the original loss as a deduction. The deduction is also disallowed if you bought the same security within 30 days before the sale. However, while you cannot immediately buy a substantially identical security to replace the one you sold, you can buy a similar security, perhaps a different stock, in the same sector. This strategy allows you to maintain your general market position while utilizing a tax break.

Always double-check brokerage firm reports. If you sold a security in 2021, the brokerage firm reports the basis on an IRS Form 1099-B in early 2022. Unfortunately, sometimes there could be problems when reporting your information, so we suggest you double-check these numbers to make sure that the basis is calculated correctly and does not result in a higher amount of tax than you need to pay.

Long-term Capital Gains Tax Rates

Tax rates on long-term capital gains and qualified dividends did not change for 2021. You may qualify for a 0% capital gains tax rate for some or all of your long-term capital gains realized in 2021.  In 2021, the 0% rate applies for individual taxpayers with taxable income up to $40,400 on single returns, $54,100 for head-of-household filers and $80,800 for joint returns. If this is the case, then the strategy is to figure out how much long-term capital gains you might be able to recognize to take advantage of this tax break.

The 3.8% surtax on net investment income stays the same for 2021. It starts for single people with modified AGI over $200,000 and for joint filers with modified AGI over $250,000.

NOTE: The 0%, 15% and 20% long-term capital gains tax rates only apply to “capital assets” (such as marketable securities) held longer than one year. Anything held one year or less is considered a “short-term capital gain” and those are taxed at ordinary income tax rates.

Some Notable and Continuing Tax Changes for 2021

Some previous itemized deductions are still affected in 2021 under the tax laws. They include:

The floor for deductible medical expenses is still at 7.5%. The 2021 threshold for deducting medical expenses on Schedule A is 7.5% of your 2021 adjusted gross income (AGI). The IRS on IRS.gov provides a long list of expenses that qualify as “medical expenses,” so it can be a good idea to keep keeping track of yours if you think you may qualify.

State and local income, sales, and real and personal property taxes (SALT) are still limited to $10,000.

The deduction for casualty and theft losses is currently allowed only for presidentially declared disaster areas.

Alimony deductions.  For divorce and separation instruments executed or modified after December 31, 2018, alimony and separate maintenance payments are not deductible by the payor-spouse, nor includible in the income of the payee-spouse.

Education Planning

Education benefits.  The student loan interest deduction, education credits, exclusion for savings bond interest, tuition waivers for graduate students, and the educational assistance fringe benefit are all still available in 2021. 529 plan funds can be used to pay for fees, books, supplies and equipment for certain apprenticeship programs. In addition, up to $10,000 in total (not annually) can now be withdrawn from 529 plans to pay off student loans.

The 2020 lifetime learning credit, which allows you to claim 20% of your out-of-pocket costs for tuition, fees and books, for a total of $2,500, phases out for couples at $160,001 and $180,000. The AGI range for singles is $80,001 and $90,000.

Charitable Giving

This is a great time of year to clean your garage or house and give your items to charity. Please remember that you can only write off donations to a charitable organization if you itemize your deductions. Sometimes your donations can be difficult to value. You can find estimated values for your donated items through a value guide offered by Goodwill at https://goodwillnne.org/donate/donation-value-guide/

Send cash donations to your favorite charity by December 31, 2021 and be sure to hold on to your cancelled check or credit card receipt as proof of your donation. If you contribute $250 or more, you also need a written acknowledgement from the charity. If you plan to make a significant gift to charity this year, consider gifting appreciated stocks or other investments that you have owned for more than one year. Doing so boosts the savings on your tax returns. Your charitable contribution deduction is the fair market value of the securities on the date of the gift, not the amount you paid for the asset and therefore you avoid having to pay taxes on the profit.

Do not donate investments that have lost value. It is best to sell the asset with the loss first and then donate the proceeds, allowing you to take both the charitable contribution deduction and the capital loss. Also remember, if you give appreciated property to charity, the unrealized gain must be long-term capital gains in order for the entire fair market value to be deductible. (The amount of the charitable deduction must be reduced by any unrealized ordinary income, depreciation recapture and/or short-term gain.)

The law allowing taxpayers age 70½ and older to make a Qualified Charitable Distribution (QCD) in the form of a direct transfer of up to $100,000 directly from their IRA over to a charity, including all or part of the required minimum distribution (RMD) was made permanent in 2015. If you meet the qualifications to utilize this strategy, the funds must come out of your IRA by December 31, 2021. Please call us if this is a strategy you are interested in considering.

Additional Year-end Tax Strategies and Ideas

Make use of the annual gift tax exclusion. You may gift up to $15,000 tax-free to each donee in 2021. These “annual exclusion gifts” do not reduce your $11,700,000 lifetime gift tax exemption. This annual exclusion gift is doubled to $30,000 per donee for gifts made by married couples of jointly held property or when one spouse consents to “gift-splitting” for gifts made by the other spouse.

Help someone with medical or education expenses. There are opportunities to give unlimited tax-free gifts when you pay the provider of the services directly. The medical expenses must meet the definition of deductible medical expenses. Qualified education expenses are tuition, books, fees, and related expenses, but not room and board. You can find the detailed qualifications in IRS Publications 950 and the instructions for IRS Form 709 at www.irs.gov.

Make gifts to trusts. These gifts often qualify as annual exclusion gifts ($15,000 in 2021) if the gift is direct and immediate. A gift that meets all the requirements removes the property from your estate. The annual exclusion gift can be contributed for each beneficiary of a trust. We are happy to review the details with your estate planning attorney.

Estate, Gift, and Generation-Skipping Tax Changes

Exemption amounts for gift, estate, and generation-skipping taxes are another issue that proposals are trying to change. For 2021 the limits are at $11.7 million ($23.4 million for married couples), up from $11.58 million in 2020 and the income tax basis step up/down to fair market value at death is in place. Any amount over that is subject to 40% Federal taxes. This high amount provides high net worth individuals a significant planning window to make gifts and set up irrevocable trusts.
As a reminder, as of now, in 2026, the estate tax exclusion is due to revert to pre- 2018 levels of $5 million (adjusted for inflation).

On November 26, 2019, the Treasury Department and the Internal Revenue Service issued final regulations under IR-2019-189 confirming that individuals who take advantage of the increased gift tax exclusion or portability amounts in effect from 2018 to 2025 will not be adversely impacted when TCJA sunsets on January 1, 2026. Claiming the portable exemption will remain an important discussion topic for decedents with large estates. For those who have large estates, please call us to discuss your situation.

Tax Law Proposals

As of the late-October writing of this report, tax law changes were still not finalized. Some of the noteworthy proposals as they were proposed by either President Biden or the House Ways and Means Committee in September are currently no longer being discussed. These include the restoration of the 39.6% top tax bracket and a retroactive increase of 20% capital gains rate to 25% for individuals earning over $400,000 and married filing jointly taxpayers earning more than $450,000.

Other proposals that are currently not being pursued include changes to Roth IRA conversion rules and the termination of the temporary increase in the Unified Credit (replacing the current $11.7 million estate and gift tax exemption with an exemption of approximately $6 million per person starting in 2022).

As of October 28, several proposals were still being considered starting in 2022. They include:

• Expansion of 3.8% Net Investment Income Tax (NIIT): The proposal calls for the expansion of the 3.8% tax to apply to net income derived in the ordinary course of trade or business for taxpayers with a taxable income of more than $500,000 for joint filers and $400,000 for single filers.

• A new surtax on high income earners: The current proposal calls for a new additional tax on individuals with a modified adjusted gross income of over $5,000,000 that increase for those with AGI’s over $25,000,000. Please note this does not include state taxes.

Another noteworthy item being discussed is the possible changing of SALT tax limitations starting in 2022. Please remember it is uncertain as of our late-October writing of which tax changes, if any, will be passed into law. We only include this section in an attempt make clients aware of any potential key proposals for tax planning purposes.

Our goal is to keep clients updated when tax laws change so that they can proactively plan. If you would like to discuss any of these potential tax law changes with us, please feel free to contact us and we’d be happy to assess your unique financial situation.

Conclusion

One of our primary goals is to keep clients aware of tax law changes and updates. This report is not a substitute for using a tax professional. Please note that many states do not follow the same rules and computations as the federal income tax rules. Make sure you check with your tax preparer to see what tax rates and rules apply for your particular state.
There are many other additional tax reduction strategies that will vary depending on your financial picture. We encourage you to come in so that we can review your particular situation and hopefully take advantage of those tax rules that apply to you. We will try to monitor impactful changes and as always, we appreciate the opportunity to assist you in addressing your financial matters and look forward to seeing you soon!

Interest rates play a crucial role in the American economic system. They influence the return on savings, the costs of borrowing and can have a bearing on the direction of many investments. The direction of interest rates is also known to provide insight into future economic and financial market activities.

After the Federal Reserve’s August 2021 meeting, Fed Chairman Jerome Powell stated that, should hiring numbers continue to improve, it will begin dialing back the ultra-low interest rate policies that were put in place to help stave off the effects of the pandemic-induced recession. In an effort to encourage borrowing and spending, the Fed has been buying $120 billion worth of mortgage and Treasury bonds per month. Short-term interest rates were also decreased to near zero to spur consumer spending, encourage hiring, and keep investors in the stock market.

Powell stated that the Fed will begin “tapering” off the bond buying program. “Tapering” refers to the gradual, not sudden, decrease in the Fed’s purchases. This is done in an effort to progressively remove monetary stimulus from the economy.

Powell stressed that this action does not mean an interest rate hike would shortly follow. Many variables, including the recent increase in Covid cases, are being watched and considered in any moves the Federal Reserve decides to take.

“The timing and pace of the coming reduction in asset purchases will not be intended to carry a direct signal regarding the timing of interest-rate liftoff, for which we have articulated a different and substantially more stringent test,” Powell said.

He continued, “We have said that we will continue to hold the target range for the federal funds rate at its current level until the economy reaches conditions consistent with maximum employment, and inflation has reached 2% and is on track to moderately exceed 2% for some time. We have much ground to cover to reach maximum employment, and time will tell whether we have reached 2% inflation on a sustainable basis.”
(Source: Bloomberg.com 8/27/2021)

One of our goals as your financial professional is to maintain a watchful eye on any changes that may affect your situation. Although the Fed has not determined when interest rates will be increased, interest rates can play a vital role in your financial planning. We feel now is a good time to review and prepare for how rising interest rates could affect some areas that your financial plan may include.

Winners and Losers of Rising Interest Rates

Here are a few major areas that interest rates could have a positive or negative impact.

Mortgage Rates
Historically, we are still seeing very low mortgage rates, however, an increase in interest rates could convince some potential home purchasers to push the pause button. Home prices are still high, and if interest rates increase, this double whammy may have many homebuyers deciding to stay put until the prospect of a better time to purchase a home arises.

Savings Accounts
A rise in interest rates could be favorable for savings account and certificate of deposits (CDs) holders. While rates are still very low, if interest rates rise, the yields on these accounts typically increase.

Bond Holdings
With the economy continuing to strengthen and unemployment numbers decreasing, most Fed officials are expecting the Fed to reduce bond purchases this year. What exactly does this mean for bond holders and purchasers?

As you many know, bond and interest rates move in the opposite direction. When interest rates rise, existing bond prices tend to fall, and conversely, when interest rates decline, existing bond prices tend to rise. As interest rates rise, new bond yields are likely to change.

Yield is a straightforward concept. It is the current income return you receive when, for instance, you own a bond, as measured by a percentage. If the bond you bought for $1,000 pays you $30 per year — that’s a 3% annual yield.

For example, if you invest $10,000 in a 10-year U.S. Treasury bond with a 3% yield, that interest rate is fixed even as prevailing interest rates change with economic conditions—especially the rate of inflation. Let’s say after five years you decide to sell that bond, but interest rates have risen and now similar new bonds are paying 4%. Obviously, no one wants to pay $10,000 for a bond yielding 3% when a higher-yielding bond costs the same. Therefore, the bond’s value will decrease.

Bonds are many times considered a good option for a conservative, balanced portfolio. Although they could provide modest returns, many high-grade bonds are usually considered more stable than stocks and can provide income. However, investors who put a high percentage of their portfolios in bonds with the hopes of producing stable returns, could see lackluster results if interest rates rise.

Investments
Converse to bonds, interest rates don’t directly affect stocks. They can, however, indirectly affect stock prices. When interest rates rise, banks increase their rates for consumer and business loans. Reduced consumer and business spending could lower the value of a stock. When interest rates are increased, this usually means that there is economic growth or strengthening.

Portfolios that are well balanced, diversified, and planned to weather volatility should be well positioned to face rising interest rates.

Recommendations to Consider

In summary, when interest rates rise, the following usually happens:
-Mortgage rates increase
-Interest rates increase on savings accounts and CDs
-Existing bond prices decrease
-Commodity prices decrease
-Equity markets may become more volatile

Since each individual has different financial goals, interest rate fluctuations can affect investors differently. Having a solid financial plan, sticking to that plan, and working with a financial professional before making any decisions to sway from that plan is always advised. We offer the following five basic items for consideration if and when the Federal Reserve raises interest rates.

1. Maintain complete liquidity for all short-term and near-term needs. Liquid accounts in today’s interest rate environment will probably not keep pace with inflation. Although it is always important to maintain a liquid component in your portfolio, you should think about what major expenses you will incur in the next two years and consider keeping a larger than typical liquid pool of assets.

2. Consider shorter terms over high yields. Although shorter term bonds yield less than longer term bonds, they typically lose less value when rates rise. They are less sensitive to interest rates increases and may provide a more conservative but comfortable choice for some investors.

3. Review all of your income-producing investments. As wealth managers, we help our clients review their income-producing investments. Our primary goal is to match your portfolio to your timelines and personal financial situation.

4. Lock in mortgage rates. Refinance or lock in a low mortgage rate before they rise.

5. Monitor your portfolio regularly. Interest rates can move quickly or slowly. We stay apprised of the Fed and its decisions on interest rates so we can suggest adjustments to your portfolio as needed in a timely and educated manner.

Closing Thoughts

Interest rates can be complex. As mentioned earlier, we keep a watchful eye on interest rates and how they may affect our clients. In today’s interest rate environment, we are monitoring your investments with us. If you have any questions or would like us to review your specific situation, please let us know.

We are here to help! We are always available to review your investment portfolio with you. We will always consider your feelings about risk and the markets and review your unique financial situation when providing any recommendations.

We pride ourselves in offering:

• consistent and strong communication,
• a schedule of regular client meetings, and
• continuing education for members of our team on the issues that affect our clients.

A good financial professional can help make your journey easier. Our goal is to understand our clients’ needs and then try to create plans to address those needs. While we cannot control financial markets, inflation, or interest rates, we keep a watchful eye on them. We can discuss your specific situation at your next review meeting or you can call to schedule an appointment. As always, we appreciate the opportunity to assist you and your financial matters.

Every investor normally has personal goals in mind that they would like to achieve. Although most non-retired adults have some savings, only 36% say their nest egg is “on track,” according to the Federal Reserve. Sometimes, those eager to boost retirement savings could become more aggressive and start considering more volatile assets in an attempt to achieve higher returns. Sadly, this might be a recipe for a huge disappointment. Discipline has always played a fundamental role in investing and many best practice approaches start by having investors define their personal goals.
(Source: CNBC 6/27/2021)

Knowing what your goals are is traditionally the first step to achieving them. The second step is creating a plan that is best suited to reach those goals. The third, and hardest part, is sticking to that plan even through volatile and uncertain times. It is easy to forget about your financial plan and focus on other aspects of your life when things are going well. However, when inevitable fluctuations or market moves arrive, even the steadiest investors could become nervous and veer off course.

Volatility in both equity and bond markets is part of the investing experience. Although historically, stocks have provided higher long-term returns than bonds or short-term investments, stock prices are not destined to move in a straight line. Understanding what you can, and perhaps more importantly, what you cannot control in the investing world, can help even the savviest investor better weather any storms that arrive.

Three things an investor can control are:
1.Your risk tolerance or appetite;
2.Your time horizon; and
3.Your behavior.

If you have a firm grasp of each of these, you should be able to maintain discipline and remain calm when volatility and market fluctuations arise.

Risk Tolerance or Appetite

Risk tolerance or appetite is the degree to which you are able or willing to withstand fluctuations in the stock market and your portfolio in return for growth potential. If your risk appetite is low, you will likely want to be a conservative investor. If it is high, you are more likely to take more aggressive moves and accept any potential downside.

Knowing what your risk appetite is and having risk awareness should be a part of your financial strategy. Four good questions to ask yourself to assess your risk tolerance are:

1.What is my overall financial position?

2.What is my time horizon?

3.Do I have the financial ability to endure market declines?

4.How will I emotionally react to market volatility?

It is important that you determine your risk appetite before making investment choices. Considering your comfort level, emotional capacity to ride out volatility, and your time frame for investing before making your final decisions is crucial when implementing your financial plan.

As your financial professional, one of our primary goals is to help you create a plan that considers your risk appetite If you are not sure what your risk appetite is, call us so we can assess your situation and determine this with you.

Time Horizon

Your time horizon is another vital component that you can control. Knowing how much time you have to reach your goals will help you determine other key elements like your risk tolerance. While no one can determine what will happen in equity markets during either the short- or long-term, if your horizon is longer, you may have more choices or a willingness to take on more risk. An investor who can commit to a 10-year time horizon can consider different selections, as compared to someone who needs to use that money in six months.

Generally speaking, the investor time horizon can be simplified to three major classifications: short, medium, and long. Please keep in mind there is no officially defined time frame for each of these classifications and the advice on how each should be considered is not universal.

Short term: two years or less
Medium term: two to ten years
Long term: ten years or more

Determining what your time horizon is will allow you to develop a plan around that timeline. While long-term investing typically could give you a better chance at minimizing any anxieties that could be caused by short-term market noise or volatility, some investors can have a medium- to short-term horizon. No matter what your time horizon is, we suggest focusing on your personal timeline instead of trying to time the market.

By helping you determine what your specific time horizons are, we can help you establish a financial strategy that is best suited to help you pursue your goals.

Investor Behavior

While you can determine your risk and time horizons, ultimately, your ability to emotionally endure the ups and downs of your investments will be a primary factor. A foundational rule of investing behavior is, don’t panic! In times of market volatility, many investors tend to become unnerved and anxious. This is usually not the best mindset to make rational decisions. Instead of making an emotion-based decision, three questions you need to ask yourself are:

1.Have my financial timelines changed?

2.Have my financial goals changed?

3.Has my risk tolerance changed?

Our goal is to help clients avoid making impulsive investing decisions. If you answer “yes” to any of these questions, we suggest you call us to discuss those changes before making any decisions.
We want to make sure you are comfortable with your investments. Equity markets will always have the potential to move up and down. Even if your time horizons are long, short-term downward movements in your portfolios are possible. Make sure your investing plan is centered on your personal goals and timelines.

Conclusion

Risk tolerance, time horizon, and your behavior should all be considered when investing. Many investors may feel they have the emotional fortitude to withstand volatility, however, they may not have the financial stability to ride it out. Conversely, some investors may have the financial stability and time horizon but simply have a high aversion to any sort of financial loss or fluctuations.

As your financial professional, we take all these key elements into consideration when assessing your financial pictures and determining a plan that gives you the best chance to achieve your goals. We are always available to revisit your financial holdings to make sure they are still compatible with your timeline goals and risk tolerance.

As a reminder, please keep us apprised of any changes (such as health issues or changes in your retirement goals). The more knowledge we have about your unique financial situation the better equipped we will be to best advise you.
We pride ourselves in offering:

• consistent and strong communication,
• a schedule of regular client meetings, and
• continuing education for every member of our team on the issues that affect our clients.

In the first half of 2021, investors welcomed a new administration in the United States of America, saw the reopening of many countries, experienced volatility in equity markets and ended a second quarter that produced many new highs.

The S&P 500 has now gained ground for five quarters in a row. Notably, it has gained more than 5% for five quarters in a row, only the second time since 1945 that the index has been able to pull off that feat. The previous occasion was in 1954, according to Bespoke Investment Group, a time when the Fed was also trying to emerge from a period of ultralow interest rates. Needless to say, through a whirlwind of change, investors who stayed the course could have experienced a continued drive toward better economic and financial health. (Source: Barron’s 6/2021)

“Better news on Covid, vaccinations, re-openings, economic growth, and earnings fueled the advance.  Nearly equal gains were achieved in both quarters by a rotation in leadership allowing broad participation,” said Jim Paulsen, Leuthold Group’s Chief Investment Strategist. (Source: cnbc.com 06/30/2021)

On the last day of Quarter 2, the S&P 500 rose 0.1% to end at 4,297. This marked the S&P 500’s 24th record close of 2021. The Dow Jones Industrial Average (DJIA) closed 210.22 points higher at 34,502, a gain 0.6%. This close was just 1% shy of its May 7 record close of 34,777.76. (Source: marketwatch.com 7/1/2021)

Historically, positive first halves of the year are usually followed by positive second halves. If there is a double-digit gain in the first half both the S&P 500 and the DJIA have never ended the year with an annual decline according to Refinitiv data dating back to 1950. (Source: www.cnbc.com 06/29/2021)

However, amidst all the positive momentum toward recovery, there is still concern about the condition of the job market, inflation, and uncertainty about the path of the virus and the severity or impact that new strains may have. Theoretically speaking, the stock market tends to be a forward-looking mechanism, so its price can reflect an economic recovery well before it actually occurs.  With COVID variants and many potential challenges still ahead, investors need to continue being watchful.

As a financial professional, it is our goal to stay apprised of the issues that we feel may directly impact you and your financial goals. We will be keeping a watchful eye on the progress of the economic recovery.

Inflation & Interest Rates

Two of the most talked about issues at the end of the second quarter were inflation and interest rates.

In June, the Federal Reserve held their two-day meeting and concluded that due to more aggressive inflation than expected this year, they anticipate raising interest rates sooner than previously expected. Back in March 2021, the Fed expected not to raise rates until at the earliest, 2024. At its June meeting, the Fed’s latest dot-plot projections moved the timeline to potentially 2023, where there could possibly be two interest rate hikes.

“As the reopening continues, shifts in demand can be large and rapid and bottlenecks, hiring difficulties and other constraints could continue the possibility that inflation could turn out to be higher and more persistent than we expect,” Powell said during the press conference. (Source: www.cnbc.com 06/16/2021)

Powell also stated, “The dots are not a great forecaster of future rate moves … it’s because it’s so highly uncertain. There is no great forecaster — dots to be taken with a big grain of salt,” he said. (Source: www.cnbc.com 06/16/2021)

The inflation expectation for 2021 was raised to 3.4%. Back in March, the Fed had anticipated a 2.4% inflation rate. Powell continued, “You can think of this meeting that we had as the ‘talking about talking about’ meeting, if you’d like.” The sentiment of the Fed is that inflation pressures are “transitory”.
(Source: www.cnbc.com 06/16/2021)

The Federal Open Market Committee (FOMC) still kept its benchmark short-term rate near zero at 0 – 0.25%. After the Fed’s announcement in June, the stock market experienced a temporary drop but quickly regained losses. (Source: www.bankrate.com 6/2021)

Bond yield percentages also pulled back from their high. 10-year treasury yield last traded at 1.56% on June 16 after Powell’s remarks.

Inflation is a real concern for savers because it eats into purchasing power and lifestyle. While we are nowhere near the last 90 years highest or lowest periods of inflation, investors still should try to at least keep pace with or exceed inflation rates.

Treasury Yields

During the quarter, longer-term Treasury yields moved sharply higher, with the yield on the benchmark 10-year U.S. Treasury note jumping from 0.93% to 1.74%, its highest level since early 2020. At quarter’s closing, the 10-year treasury yield was 1.456% and the 30-year treasury yield was 2.08%. (Source: cnbc.com 06/30/2021)

Interest rates are still at or near all-time lows and rates of 0 to 2% will not help many investors reach their goals. Also, during periods of rising interest rates, bond prices fall. Interest rates are critical when creating a diversified and balanced portfolio, therefore, investors need to pay attention to interest rate movements.

Investor’s Outlook

With the swift distribution of vaccines and the subsequent lifting of restrictions, the economy is seeing a dramatic uptick and is positioned to recover even more in the coming months. While equity markets are still looking favorable, all eyes are on inflation. This may cause some volatility in stocks.

Although history is just data and cannot be predictive of future events, as mentioned earlier, historically, a positive first half of the year has traditionally brought a positive second half.

Blackrock, one of the world’s largest asset managers in their midyear report noted that, “We remain constructive on U.S. stocks as the economic restart gains pace. Yet as the cycle evolves, investors will increasingly divert their attention toward the potential party spoilers. A chief concern is inflation, and whether the rising prices seen in some pockets of the economy are transitory or the first signs of an enduring new regime. We expect fears of inflation will be enough to stoke volatility in stocks, even amid Fed assurances of continued accommodation. Similarly, tax policy may become a volatility trigger as lawmakers debate the proposal”. (Source: Blackrock.com 7/1/2021)

Russell Investments in their mid-year outlook, stated, “We still like the pandemic-recovery trade that favors equities over bonds’’. However, they did caution that, “We’re watching indicators for whether the inflation spike becomes an issue for the Fed.” They concluded that, “We expect strong economic growth in the United States through the second half of this year”. (Source: RussellInvestments.com 7/1/2021)

Seeking Alpha in their midyear outlook shares, “A chief concern is inflation, and whether the rising prices seen in some pockets of the economy are transitory or the first signs of an enduring new regime.” They also remind us that equity markets are forward looking and they share that inflation and taxes could bring market volatility in this year’s second half. (Source: Seeking Alpha.com 6/25/2021)

Investors understand that it is not what you make, but what you keep, so another area we will be paying careful attention to is proposed new tax policy. With interest rates still near ultra-low levels, investors need to examine the use of equities in their portfolios. With equities at or near all-time highs, investors need to fully understand their personal timelines and risk appetites. Our role as financial professionals is to help find the right balance for our clients so they can pursue their goals.

Caution is still the principal notion for investors.

We still advise to proceed with caution. Regardless of how equities are performing, investors should always focus on their personal objectives and long-term goals. Even when investing for the long-term, there is no guarantee that market volatility will decrease, stabilize, or increase over any timeframe. While you cannot control the return on investment you will see, there are three things you can control, and of which should be your main focus:

1.Your risk tolerance
2.Your time horizon
3.Your behavior.

Our advice is not one-size-fits-all. We will always consider your feelings about risk and the markets and review your unique financial situation when making recommendations. If you would like to revisit your specific holdings or risk tolerance, please call our office, or bring it up at our next scheduled meeting. If you ever have any concerns or questions, please contact us!

Note: The views stated in this letter are not necessarily the opinion of LPL Financial, and should not be construed, directly or indirectly, as an offer to buy or sell any securities mentioned herein. Investors should be aware that there are risks inherent in all investments, such as fluctuations in investment principal. With any investment vehicle, past performance is not a guarantee of future results. Material discussed herewith is meant for general illustration and/or informational purposes only, please note that individual situations can vary. Therefore, the information should be relied upon when coordinated with individual professional advice.

This material contains forward looking statements and projections. There are no guarantees that these results will be achieved. All indices referenced are unmanaged and cannot be invested into directly. Unmanaged index returns do not reflect fees, expenses, or sales charges. Index performance is not indicative of the performance of any investment.

The S&P 500 is an unmanaged index of 500 widely held stocks that is general considered representative of the U.S. Stock market. The S&P 500 is an unmanaged index of 500 widely held stocks that is general considered representative of the U.S. Stock market. The modern design of the S&P 500 stock index was first launched in 1957. Performance prior to 1957 incorporates the performance of the predecessor index, the S&P 90. Dow Jones Industrial Average (DJIA), commonly known as “The Dow” is an index representing 30 stocks of companies maintained and reviewed by the editors of the Wall Street Journal. Past performance is no guarantee of future results. CD’s are FDIC Insured and offer a fixed rate of return if held to maturity. Due to volatility within the markets mentioned, opinions are subject to change without notice. Information is based on sources believed to be reliable; however, their accuracy or completeness cannot be guaranteed.

There is no guarantee that a diversified portfolio will enhance overall returns or out outperform a non-diversified portfolio. Diversification does not protect against market risk.

Sources: cnbc.com; marketwatch.com; bankrate.com; cnbc.com; Barron’s; blackrock.com; russellinvestments.com; seekingalpha.com; Contents provided by the Academy of Preferred Financial Advisors, 2021

Our firm was founded on the principles of integrity, professionalism and exceptional client service. We are also deeply committed to continuous improvement. Our dedication to doing what is best for you, our clients, prompted us to engage CEFEX, the Centre for Fiduciary Excellence, LLC to audit our processes.

Every year, we contact the CEFEX organization and request an independent analyst provide us with a comprehensive independent review. This process is rigorous and their assessment takes months to complete. Now, after going through this year’s audit and carefully evaluating our procedures, we are proud to share with you that Daniel S. Romero, CFP® is a renewed as a CEFEX certified Investment Advisor.

This certification signifies our commitment to uphold the highest level of fiduciary care and that has a direct impact on you, your plan and your employees. As a plan sponsor, the Department of Labor (DOL) identifies the following as your fiduciary responsibilities:

• Act solely in the interest of plan participants and their beneficiaries and with the exclusive purpose of providing benefits to them;
• Act prudently in the faithful performance of all duties;
• Follow the plan documents (unless inconsistent with ERISA);
• Diversify plan investments; and
• Pay only reasonable plan expenses.¹

By working with Romero Wealth Management, you can rest assured that our actions align with these responsibilities; our prudent process aims to help you limit liability and build a retirement plan that strives to improve retirement outcomes.

CEFEX is an independent global assessment and certification organization. They work closely with industry experts to provide comprehensive assessment programs designed to improve the fiduciary practices of investment advisors, stewards (retirement plans, foundations and endowments, etc.), investment managers, and other financial service providers. CEFEX confers a formal certification for those firms that are willing to undergo an independent audit and able to demonstrate that they fully conform to high standards which are substantiated in case law and fiduciary best practices.

At Romero Wealth Management, we follow well-defined processes, grounded in best practices, so that we can make sound, objective, and consistent decisions in service to our clients. CEFEX certification offers testament to the fact that we understand the importance of paying close attention to everything from high level strategies and policies all the way down to the details of our business practices. The CEFEX Mark seeks to make our clients confident that we are worthy of their trust.

We wanted to share news of the important recognition of our commitment to fiduciary excellence and continuous improvement. CEFEX certification is yet another way we tangibly demonstrate that serving our clients’ best interests is our highest priority.

For more information, please contact Jessica Hansen at (714) 547-8787.

About CEFEX®:
CEFEX®, Centre for Fiduciary Excellence, LLC, a Fi360® company, is an independent certification organization. CEFEX works closely with industry experts to provide comprehensive assessment programs to improve the fiduciary practices of investment stewards, advisors, recordkeepers, administrators and managers. CEFEX is based in Pittsburgh, PA. Learn more at www.cefex.org via Twitter or on LinkedIn.

CEFEX, Romero Wealth Mgmt. Inc, and LPL Financial are separate, unaffiliated entities.
Daniel S Romero is a registered representative with, and securities offered through, LPL Financial, Member FINRA/SIPC. LPL Financial, Romero Wealth Management and CEFEX are all separate entities.

Market volatility is a part of the investment experience and seasoned investors understand that acting emotionally can be more harmful than helpful. It is always appropriate to understand and prepare for market volatility and downturns, even when markets are going up. Investors should not let market movements force them to lose focus. A knowledgable investor understands that makets go up but they also can go down.

Volatility is a statistical measure of the distribution of returns for a given security or market index. For example, when the stock market rises and falls more than one percent over a sustained period of time, it is called a “volatile” market.

The U.S. economy is not supposed to be highly volatile, but equity markets are a different story. Market volatility doesn’t mean that stocks are headed for a down or bear market. Even if there are market corrections along the way an investor can still potentially experience reasonable returns over a long period of time.

What is stock market volatility?

Stock market volatility is a measure of how much the stock market’s overall value fluctuates up and down. Just like equity markets, individual stocks can also experience volatility. An investor can calculate volatility by looking at how much an asset’s price varies from its average price. Standard deviation is the statistical measure commonly used to represent volatility.

Some stocks are more volatile than others. Shares of an established large blue-chip company may not make very big price swings, while shares of a high flying and newer tech company may do so often. Stock market volatility can occur, especially when external events create uncertainty.

Why is volatility important?

By understanding how volatility works, you can put yourself in a better position to evaluate stock market conditions as a whole. You can then analyze the risk involved with any particular security and construct a stock portfolio that is a great fit for your growth objectives and risk tolerance.

It’s important for investors to be aware that volatility and risk are not the same thing. For stock traders who look to buy low and sell high every trading day, volatility and risk are deeply intertwined. Volatility also matters for those who may need to sell their equities in a short time-frame, such as those who are older and closer to retirement.

For long-term investors who tend to hold equities for many years, the day-to-day movements of those equities need to be understood. Volatility is part of the noise that could come while you are allowing your investments to compound long into the future.

Long-term investing still involves risks, but those risks are usually related to being wrong about a company’s growth prospects or paying too high a price for that growth — not volatility.

A quick review of some market terms.

Oftentimes, we hear the wrong words used in the wrong context. For educational purposes, we feel it is important to clarify some stock market words and their definitions.

“Dip” –  a short-lived downturn from a sustained longer-term uptrend.

Example: Equity markets increased by 5% and maintained that level and then dipped back down to 3% all within a few days or weeks.

“Correction” –  a 10% drop in the market from recent highs. Historically corrections occur an average of about every eight to 12 months and last about 54 days. (thebalance.com 3/9/20)

Example: On December 17, 2018, both the DJIA and the S&P 500 dropped over 10% and declines continued into early January.

“Bear Market” – a long, sustained decline in the stock market. If the market declines 20% from its recent high, this is considered the start of a bear market.

Example: On Wednesday, March 11, 2020, The DJIA dropped 5.9%, for a total decline of 20.2% from a record high on February 12, 2020.

“Crash” –  a sudden and dramatic drop in stock prices, often on a single day or week. Crashes are rare, but typically happen after a long-term uptrend in the market.

Example: In 1929 the market crashed when it lost 48% in less than two months, ushering in the Great Depression.

Position yourself to best navigate market volatility.

No matter what equity markets are doing, your plan should align itself with these three items.

1.Your investing goals;
2.Your financial timeline; and
3.Your risk tolerance.

Your Investing Goals

Every investor has unique goals they would like to attain. Knowing what your goals are is the first step to creating a path to achieve them. Your goals will determine your time horizon and risk tolerance.

Your Financial Timeline

Focus on your personal timeline instead of trying to time the market. During downturns, it may be tempting to pull out of the market, but you may miss out on a healthy recovery. Try to plan for your equity investments to maintain a long-term horizon and ignore the short-term fluctuations.

Remember, short-term movements of the market are unpredictable and do not abide by any average. For many long-term investors there is no reason to even subject themselves to daily market headlines. If you have a long-term investment horizon for your equity holdings of at least five years, chances are the current volatility will pass – possibly in a couple of weeks, months or at the most, a few years.

According to a JP Morgan analysis, even missing a few days of a market recovery can be costly. This analysis looked at the S&P 500 over a 20-year period (January 2000 to December 2019). Investors who stayed fully invested would have earned more than 6% annually. However, those investors who missed just 10 of the days with the highest daily returns would have earned only 3% annually. During those 20 years, six out of the 10 best days occurred within two weeks of one of the worst 10 days.

Your Risk Tolerance

Risk tolerance is the level of uncertainty you are willing to accept in order to reap potentially greater rewards. Knowing what your risk tolerance is, or risk awareness, should be part of your financial plan. As your financial professional, one of our primary goals is to help you create a plan that considers your risk tolerance. If you are not quite sure what your risk tolerance is, call us and we can help assess and determine this for you.

What should an investor do in a volatile market?

First, make sure you know what not to do: and that is panic. In times of market volatility, investors tend to become unnerved and anxious. This is usually not the best mindset to make rational decisions.
When equity markets experience unsettling fluctuations, we suggest you ask yourself three questions:

1.Have my financial timelines changed?
2.Have my financial goals changed?
3.Has my risk tolerance changed?

If you can answer “YES” to any of these questions, we highly suggest that you discuss these changes with us.

As an investor, you need a plan that includes risk awareness. One of our primary responsibilities as your financial professional is to help create a plan with risk awareness. We know that an integral part of this is to consistently keep in touch with you and monitor your situation.

Orange, CA — May 27, 2021 — Daniel Romero an independent LPL Financial advisor at Romero Wealth Management in Orange, today announced his inclusion in LPL’s Chairman’s Club. This elite award is presented to less than 5% of the firm’s more than 17,000 financial advisors nationwide*.

“On behalf of LPL, I congratulate Daniel S. Romero, CFP® on reaching this milestone in their professional career,” said Angela Xavier, LPL executive vice president, Independent Advisor Services. “Business owners, American investors and industries at large faced extraordinary challenges throughout 2020. In the advisor-mediated financial advice market, investors showed how much value they place on a trusting relationship with a financial advisor. We applaud Daniel for his commitment to clients and resiliency as a business owner, and we are inspired by his dedication to making a meaningful impact in the lives of his clients. It is an honor to support Daniel and wish his entire team continued success as they continue to add value for clients and in their business in the years ahead.”

Romero is affiliated with LPL Financial, the nation’s largest independent broker-dealer** and a leader in the retail financial advice market. LPL provides the resources, tools and technology that support advisors in their work to enrich their clients’ financial lives.

About LPL Financial
LPL Financial is a leader in the retail financial advice market and the nation’s largest independent broker/dealer**. We serve independent financial advisors and financial institutions, providing them with the technology, research, clearing and compliance services, and practice management programs they need to create and grow thriving practices. LPL enables them to provide objective guidance to millions of American families seeking wealth management, retirement planning, financial planning and asset management solutions. LPL.com

*Achievement is based on annual production among LPL Advisors only.
**Based on total revenues, Financial Planning magazine June 1996-2020

The financial representatives of Romero Wealth Management are registered with and securities and advisory services offered through LPL Financial, a registered investment advisor, member FINRA/SIPC.

Click here to download a PDF of this report.

It is extremely important that we all take our retirement into our own hands. The concept of not preparing and relying on a government-sponsored retirement might not be the best plan. Financial woes combined with the fact that the U.S. population is continuing to age, means that there are fewer working-aged people remaining to contribute to our Social Security systems. On a positive note, strong retirement savings can not only help you, but it could potentially help your family and loved ones. With today’s retirement challenges, more people are using retirement vehicles as a healthy way to help family members. As advisors, we get great satisfaction helping parents and grandparents contribute to their loved ones lives by properly gifting funds to a retirement account (if the loved one has earned income and qualifies). Most financial professionals can agree that consistently funding your retirement plans is a healthy activity. Funding retirement accounts at younger ages can increase your chances of a better funded and more comfortable financial situation at your retirement.

You can contribute to a 2020 IRA until the new tax filing deadline of May 17, 2021. The annual contribution limit for 2020 is $6,000, or $7,000 if you are age 50 or older. Your ability to use a Roth IRA contribution can be limited based on your filing status and income(see box in this report). The annual contribution limit for IRAs in 2021 will remain at $6,000, (or $7,000 if you are age 50 or older). Now is also a good time to consider making your 2021 retirement contributions.

For complete rules on IRA’s (including who qualifies), please visit www.irs.gov Publication 590a or consult with a qualified professional. Here is some timely information that may be helpful. To discuss your overall retirement strategy please call us and schedule an appointment.

Traditional IRAs

A traditional IRA (Individual Retirement Account) is a way in which individuals can save for retirement and receive tax advantages. Traditional IRAs come in two varieties: deductible and nondeductible. The contributions you make to a traditional IRA may be fully or partially deductible, depending on your circumstances (i.e., taxpayer’s income, tax-filing status and other factors) and generally, amounts in your traditional IRA (including earnings and gains) are not taxed until they are distributed.

A clear advantage of traditional IRA accounts is that you can benefit from deferring taxes on all dividends, interest and capital gains earned inside the IRA account and they can potentially compound each year without being reduced by taxes. This may allow an IRA to have faster growth potential than a taxable account.

Roth IRA

A Roth IRA is an IRA that is subject to many of the same rules that apply to a traditional IRA with some major exceptions. Unlike traditional IRAs which for some taxpayers can be tax deducted, you cannot deduct contributions to a Roth IRA. Some Roth IRA advantages include:

• If you satisfy the requirements, qualified distributions are tax-free.
• If you satisfy the requirements, qualified distributions are tax-free.
• Beneficiaries inherit your Roth IRAs tax-free, if account requirements have been satisfied.

Many investors know and understand that the largest benefit of the Roth IRA is its tax-free withdrawal of contributions, interest and earnings in retirement, but Roth IRAs can also help you leave a legacy to your heirs with proper estate planning.

Spousal IRA

If your spouse does not work, they can still have a spousal traditional or Roth IRA. This allows non-wage-earning spouses to contribute to their own traditional or Roth IRA, provided the other spouse is working and the couple files a joint federal income tax return. If the working spouse is covered by a retirement plan at work, deductibility of contributions to a spousal traditional IRA would be phased out at higher incomes. Eligible married spouses can each contribute up to the contribution limit each year to their respective IRAs (spousal IRAs are also eligible for a $1,000 catch-up contribution for those 50 and older). To discuss spousal IRA strategies, call us.

Custodial Roth IRA

Starting retirement savings early can allow you the potential advantage of growing money in a tax efficient account over a long period of time. Many children work before they reach age 18. The income they earn makes them eligible to contribute to a Roth IRA, which can be an extremely smart move for teenagers. This can also provide an excellent opportunity for you to teach or reinforce with your children the importance of saving money.

Some of the rules regarding custodial Roth IRAs are:

• To be eligible to open a custodial Roth IRA, the child must meet all the same requirements as an adult. The minor must have earned income and contributions are limited to the lesser of total earned income for the year and the current maximum set by law, which for 2020 and 2021 is $6,000.

• Adjusted gross income for the child must be below the thresholds above which Roth IRAs are not allowed.

• Even though the custodian is the legal owner of the account, the Roth IRA must be managed for the benefit of the minor child. 

• As the custodian, you make the decisions on investment choices—as well as decisions on if, why, and when the money might be withdrawn—until your child reaches “adulthood,” defined by age (usually between 18 and 21, depending on your state of residence). Once they reach that age, the account will then need to be re-registered in their name and it becomes an ordinary Roth IRA. 

If you are the parent of a child who has earned income, a Custodial IRA can be a great way to teach the value of saving and investing. Besides getting a head start on saving, your child may be able to use the funds for college expenses—or even to buy a first home.

There are several ways to fund a Custodial Roth. For example, you can potentially use your annual ability to gift to children or grandchildren to make this happen. If your child or grandchild is earning money, call us to discuss options for setting up a Custodial Roth.

“Back-door” Roth IRA

The traditional contribution (“front door”) for Roth IRAs is currently not available for higher income earners. Married couples earning $206,000 or more and singles earning $139,000 or more in 2020 are still fully excluded from contributing directly to Roth IRAs.

In 2010, Congress changed the rules and since then anyone can convert a traditional IRA to a Roth IRA. However, higher income earners are still ineligible to contribute to a Roth IRA. A Backdoor Roth IRA is a strategy for some higher income earners to participate in Roth IRAs. It is a way for higher income earners to put money into a traditional IRA and then roll that into a Roth IRA, getting all the benefits. While this strategy sounds simple, there are several rules that you must know and follow to make sure you do not incur unintended tax consequences. This is where working with a knowledgeable financial or tax professional can provide guidance and value.

How Does the Backdoor Roth IRA Conversion Work?

The Backdoor Roth conversion can consist of two simple steps:

1)You make a nondeductible contribution to your traditional IRA.
2)Then, after consulting with your financial or tax professional, you convert this IRA into a Roth IRA.

There is one big caveat: this strategy may work best tax-wise for people who do not already have money in traditional IRAs. That is because in conversions, earnings and previously untaxed contributions in traditional IRAs are taxed—and that tax is figured based on all your traditional IRAs, even ones you are not converting. (Please read the section on the Pro Rata Rule.)

For an investor who does not already hold any traditional IRAs, creating one and then quickly converting it into a Roth IRA may incur little or no tax, because after a short holding period there is likely to be little or no appreciation or interest earned in the account. However, if you already have money in traditional deductible IRAs, you could face a far higher tax bill on the conversion (again, this is covered later in the section on the Pro Rata Rule).

If you choose to attempt a backdoor Roth IRA conversion, please consult a knowledgeable tax planner prior to doing so because the rules for Roth conversions can be complicated.

Example of a Backdoor Roth IRA

Jack, a high-income earner, decides on January 2nd to put $6,000 into a traditional IRA.  Jack’s income is too high to be able to deduct these contributions from his taxes. After consulting with his financial professional or tax advisor, he then converts the traditional IRAs to Roth IRAs completely tax-free. His income is too high for him to make a direct contribution into a Roth IRA, but there is no income limit on conversions. Since Jack could not deduct the contribution anyway, he might as well get the advantage of never paying taxes on that money again available through the Roth IRA.

Beware of the Pro Rata Rule for Roth Conversions

The Pro Rata rule for Roth conversions states that if you have any other deductible IRAs (i.e., a previous 401k that you have rolled over), the conversion of any contributions becomes a taxable event that you will need to pay taxes on upfront.

The Pro Rata rule for Roth conversions determines whether your conversion will be taxable. For taxation purposes, the IRS will look at your entire IRA holdings (even if they are in different accounts), not just the traditional IRA you are converting to a Roth IRA and will determine what your tax bill will be based upon a ratio of IRA assets that have already been taxed to those IRA assets in total.

The IRS determines the tax on this conversion based on the value of all your IRA assets. For example, Julie, a high-income earner, already has $94,000 in an IRA account, all of which has never been taxed. She decides on January 2nd to put $6,000 into a new traditional IRA. The next day she converts the new traditional non-deductible IRA to a Roth IRA.  Julie’s income is too high for her to make a direct contribution into a Roth IRA, but there is no income limit on conversions. She has $94,000 in other IRAs (previously non-taxed), so her total IRA assets are now $100,000. When she converts $6,000 to a Roth IRA, the IRS pro-rates her tax basis on the previous taxation of her total IRA assets, therefore making this conversion 94% taxable ($94,000/100,000 = 94%).

If you plan on using this backdoor IRA strategy, you want to be clear as to whether or not you have any other IRAs. As you can see, this can be a confusing area, and this is where we can help. If you are a high-income-earner we would be happy to review your situation to determine if this strategy is in your best interest.

Also, please remember that your spouse’s IRA is separate from yours.

Am I a Candidate for a Backdoor Roth IRA?

Backdoor Roth IRAs can be appropriate for investors who:

• Only have retirement accounts through their jobs (i.e., 401k’s) and want to increase their retirement savings in tax-advantaged accounts, but whose income is too high to qualify for standard Roth IRA contributions; and

• Have the time and ability to wait for five years or until they are 59½, whichever is later, to avoid the 10% penalty on early withdrawals.

A Backdoor Roth IRA is probably not recommended if you:

• Do not want to contribute more than the maximum retirement limit through your workplace retirement account.

• Already have money in a traditional IRA and because of the Pro Rata rule may end up in a non-tax advantageous position when converting to a Backdoor Roth IRA.

• Plan or expect to withdraw the funds in the Roth IRA within the first five years of opening it. A Backdoor Roth is considered a conversion and not a contribution. Therefore, the funds may incur a 10% penalty if withdrawn within five years no matter your age.

• Are in a high tax bracket now and expect to be in a lower tax bracket in the future.

• Plan to relocate to a lower or no income tax state.

Note: While Backdoor Roth IRAs can be beneficial to many investors, they are not for everyone. They come with their limitations and complications. There are precautions that need to be taken to reap the full benefits of any financial decision. Please consult and review your situation with a qualified professional prior to choosing to use this strategy.

Conclusion

To further discuss funding your retirement plans, please call us. This is an area where a highly informed financial professional can help you make an educated and calculated decision. As with all tax sensitive decisions, you should always consult with your financial and tax professional to help avoid tax ramifications.

As always, we are here to help and can look at your specific financial situation and chart the right path for you. We enjoy the opportunity to assist clients in addressing all financial matters.

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