Economic Data Influences Stocks – U.S. Equity Update

Major equity indices all posted gains for the third quarter, with the S&P 500 advancing 7.2%, the Dow Jones Index gaining 9%, and the Nasdaq rising 7.1%. It was the single best quarter for stocks since 2013, buoyed by recent corporate tax cuts, improving earnings, and stable economic growth.

A notable shift occurred in the third quarter as equities surpassed real estate as the largest portion of household wealth. Real estate has out-valued equities as a percentage of household wealth for nearly 20 years.

Investments by companies in the S&P 500 Index increased to $341 billion in the first half of 2018, exceeding the same period last year by 19 percent. The increase in investments is on pace to be the most significant in nearly 25 years.

Several analysts are forecasting that the positive effects of the recent tax cuts will begin to fade as higher interest rates begin to inflate capital borrowing costs.

Growth estimates from the Organization for Economic Cooperation and Development (OECD) place U.S. economic growth at 2.9% for 2018, up from 2.2% in 2017, making it the fastest pace of growth since 2005. (Sources: S&P, Bloomberg, OECD, Dow Jones, NASDAQ)

International Markets Struggle – International Equities Update

European markets reacted to a possible impasse regarding negotiations surrounding the exit of Britain from the EU, also known as Brexit. Six months remain before the formal separation between the two occurs.

Developed and emerging market equity indices are having a tough time keeping up with U.S. equities, with most major international indices posting negative returns for the year. Emerging markets welcomed a weaker dollar as trade tensions wore on the U.S. currency.

Rising oil prices levied an additional burden on larger developing nations including Turkey, India, the Philippines, and South Africa as these countries import the majority of their oil. Higher oil prices tend to spur inflation for countries dependent on imports and laden with debt payments.

Sources: Eurostat, Reuters

Rates On The Rise – Fixed Income Update

The Fed announced its third rate hike for the year, indicating another rate increase anticipated in December and three more to follow in 2019. The Fed’s key policy rate, the Federal Funds Rate, now stands at a range of 2% – 2.25%, the highest in ten years. Borrowing rates are gradually increasing in various consumer sectors including autos, appliances, and home mortgages.

Many analysts believe that the current Fed Chairman, Jerome Powell, may have the ability to orchestrate a soft landing, meaning raising interest rates gradually without triggering a recession or economic slowdown.

Of the various fixed income sectors, U.S. corporate high-yield bonds had the least amount of price declines in September, outperforming both government and investment grade debt. Some analysts view this as a validation of improving financial conditions for U.S. companies and their ability to repay debt.

Sources: Treasury Dept., Federal Reserve, Bloomberg

Tax on Social Security In Retirement – Retirement Tax Planning

A prudent and effective tax strategy during your employment years will mostly likely need to be modified in retirement. Once earned income ceases and income from retirement plans, investments, and Social Security commences, tax liabilities change.

The impact of the changes is primarily driven by the assets that we have little tax control over once we reach 70.5, which include IRAs, 401ks, and pensions. Reaching age 70.5 triggers RMDs (Required Minimum Distributions). Distributions from tax deferred retirement accounts such as an IRA or a 401k are generally taxed at the ordinary tax rate. Distributions from a Roth IRA or Roth 401k are income tax free as long as the account has been opened for at least five years and the account holder is 59.5.

Investment income such as stock dividends and bond interest are taxed differently, especially when they are held outside of a retirement account. Realizing gains on stocks that have been held for one year or more can be taxed at a more favorable rate than the ordinary rate. Interest on bonds and gains realized on short-term positions less than one year, are taxed at the ordinary rate.

Retirement also introduces us to Social Security which, contrary to popular belief, can be taxed. Eligibility for Social Security benefit payments begins at age 62, but can be postponed until age 70. A key determinant as to when to start receiving Social Security may be contingent on the amount of retirement assets in retirement accounts subject to RMDs. This is where tax strategies can vary dramatically.reflecting less confidence in their future income and/or overall financial position.

Retirees with excessive assets in retirement accounts subject to RMDs and with non-retirement investment income may want to confer with a tax professional to help determine when to take Social Security. Conversely, retirees with minimal assets in retirement accounts and investments may have little concern about paying taxes on their Social Security benefits.

The IRS determines if and how taxes are owed on Social Security by the “provisional income” measure. Provisional income includes gross income, tax-free interest, and 50% of Social Security benefits. If the provisional income is above a certain amount, then a portion of the Social Security income becomes taxable.

One way to potentially lower taxes in retirement is to start taking distributions from tax-deferred accounts before it’s required. Again, once you reach age 59½, you can withdraw funds from those accounts without paying the 10% early withdrawal penalty. The withdrawals are still taxed as ordinary income, but over time they reduce the size of tax deferred accounts, and thus the size of your RMDs. Another reason to access those funds before 70½ is that it could help you delay taking your social Security benefit, which increases in size the later you take it, up to age 70.

Another strategy for reducing the potential tax consequences of RMDs is converting a traditional IRA or 401(k) plan into a Roth IRA before the age of 70½. A Roth conversion may make sense when you’re certain you’ll be in a higher bracket when you eventually withdraw the money, which is often the case once RMDs and Social Security are factored in.

Sources: Social Security Admin., IRS, Tax Policy Center