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Financial Planning

June 3, 2024

The Many Benefits of a 529 Savings Plan

529 Plans are an effective way to save for college if you want tax efficient investing that is easy to set up, fairly flexible, and allows other family members to participate.

By 2X Wealth Group

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Types of 529 Plans

A 529 Savings Plan is an investment account that offers tax-free growth and withdrawals when used to pay for qualified education expenses. In addition to covering college tuition, room and board, qualified expenses include apprenticeship programs, up to $10,000 per year for K-12 tuition, and even paying off up to $10,000 in student loans. Starting in 2024, a new provision enables 529 beneficiaries to roll up to $35,000 of unused balances into a Roth IRA, allowing ongoing tax advantaged investing.

A 529 Prepaid Tuition Plan lets you prepay all or part of the costs of an in-state public college education, which offers protection against rising education costs. Typically, you or the student must reside in the state offering the plan. If circumstances change, you can convert the funds for use at private or out-of-state colleges.

Advantages of a 529 Savings Plan

Tax Benefits

Offers tax-free growth and withdrawals for qualified education expenses
Plan contributions are tax deductible in most states, but not California

In the following chart, we show how the tax advantages of a 529 plan can allow your money to grow significantly more than a taxable account with the same investments.

Difference Between Investing in a 529 plan and a Taxable Account Over an 18 Year Time Period

J.P.Morgan Asset Management. Illustration assumes an initial $10,000 investment and monthly investments of $500 for 18 years. Chart also assumes an annual investment return of 6% compounded monthly, and a federal tax rate of 32%. Investment losses could affect the relative tax-deferred investing advantage. This hypothetical illustration is not indicative of any specific investment and does not reflect the impact of fees or expenses. Each investor should consider his or her current and anticipated investment horizon and income tax bracket when making an investment decision, as the illustration may not reflect these factors. These figures do not reflect any management fees or expenses that would be paid by a 529 plan participant. Such costs would lower performance. This chart is shown for illustrative purposes only. Past performance is no guarantee of future results.

Estate Planning Benefits

Plan contributions and investment gains are removed from the estate of the account owner who provided the funds.
Contributions can be front end loaded. Up to five times the standard gift tax exclusion amount can be contributed to a 529 plan, or $90,000 per donor per child. If this option is used, no additional gifts can be made to the same beneficiary over a 5-year period.

Control and Flexibility

The plan beneficiary can be changed to another ‘family member’ as defined by the IRS (e.g. siblings, step siblings, grandchildren, adopted children, even first cousins).
Anyone can contribute to the 529 plan, and grandparents are common donors.
Money can be kept in a 529 plan indefinitely, allowing for legacy educational funding.
Leftover funds, up to $35,000, can be rolled into a Roth IRA for the 529 beneficiary. Some restrictions apply: the account must have been in effect for 15 years and a maximum of $7000 can be transferred in any given year.

Ease of Use

No income limits for contributors
No age limits on beneficiaries
Minimal impact on financial aid
No mandatory withdrawals
High total contribution limits, as much as $400,000 per beneficiary.
Many plan providers to choose from

Disadvantages of a 529 College Savings Plan

Non-qualified withdrawals may be subject to federal income tax, a 10% penalty tax and state and local taxes. This can be a problem if you fully funded college and your child decides not to attend.
Investment choices can be limited, although the options are much better now than in the past.

How Do You Decide When and How Much to Put Into a 529 plan?

Your own financial situation will affect whether you fund a 529 savings plan up front or over time. The earlier you contribute, the lower your contributions need to be to reach your goal - since there will be more time for the 529 plan investments to grow.

If desired, plan providers will set up automatic monthly deductions from your bank account, aiding regular contributions. At the other extreme, front end loading a 529 plan at birth with up to $90,000 can potentially fund all of college. This strategy is best when you have other beneficiaries in mind (in case the original beneficiary doesn’t need educational funding).

If you are uncertain whether your child(ren) will attend a cheaper in-state college or one out of state, you can choose to fund the lower cost option plus a bit extra which can be rolled to a Roth IRA. Keep in mind, many students don’t graduate in 4 years, making college costs even higher. We often suggest combining taxable savings with 529 savings plans to add flexibility and avoid withdrawal penalties from an overfunded 529 account.

Lastly, try to avoid these pitfalls…

Don’t use retirement funds for 529 plan contributions.
Don’t borrow from a home equity line to fund a 529 plan.
Be careful not to overspend with K-12 withdrawals, which could jeopardize college funding.

If you’d like to know more, please contact us.

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The material included herein is not to be reproduced or distributed to others without the Firm’s express written consent. This material is being provided for informational purposes, and is not intended to be a formal research report, a general guide to investing, or as a source of any specific investment recommendations and makes no implied or express recommendations concerning the manner in which any accounts should be handled. Any opinions expressed in this material are only current opinions and while the information contained is believed to be reliable there is no representation that it is accurate or complete and it should not be relied upon as such. Investing involves risk, including loss of principal, and no assurance can be given that a specific investment objective will be achieved.

The Firm accepts no liability for loss arising from the use of this material. However, Federal and state securities laws impose liabilities under certain circumstances on persons who act in good faith and nothing herein shall constitute a waiver or other limitation of any rights that an investor may have under Federal or state securities laws.

2X Wealth Group is a team at Ingalls & Snyder, LLC., 1325 Avenue of the Americas, New York, NY 10019-6066. If you would like to unsubscribe, please click here.

Financial Planning

August 1, 2024

2Q 2024 Investor Letter:
‍What’s Happening Under the Covers

Why the U.S. Economy Has Remained Resilient in Spite of the Fed Raising Interest Rates and Reducing Their Balance Sheet

By 2X Wealth Group

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In this blog, we explain how the Treasury’s actions have allowed the Federal Reserve to keep the federal funds rate above 5% and reduce its balance sheet without stalling the economy. It is a bit academic, so we recommend you read this piece with a cup of coffee instead of a glass of wine.

TLDR: We love economics, but we realize you may not, so we provide this analogy to explain liquidity in the financial system.

Imagine the U.S. financial system is a large tank of water holding various boats. Let’s say the boats in the tank are different assets in the financial system – stocks, bitcoin, etc. When the Federal Reserve shrinks its balance sheet, it is taking water out of the tank, which typically would cause the boats in the tank to float at lower levels. Using this analogy, stocks and bitcoin would go down as water comes out of the tank. Recently, the U.S. Treasury has put more water into the tank than the Fed has removed, so boats aka stocks and bitcoin go to higher levels. In the blog below, we explain in more detail the effect the Treasury and Fed’s actions are having on risk assets like stocks and cryptocurrency.

Background

The U.S. Federal Reserve has 2 mandates: to achieve maximum employment and keep prices stable. The economy naturally ebbs and flows – a stronger economy causes employment and prices to go up and a slower economy causes employment and prices to come down. If these trends get out of control, the Fed has a number of tools to either stimulate or slow the economy, but their principal tool is changing short-term interest rates.

During the Great Recession (the housing crisis of 2008- 09), when the economy slowed dramatically and unemployment rose, the Fed cut interest rates to zero hoping to stimulate business activity. But 0% rates didn’t suffice, so Fed Chair Ben Bernanke introduced a new way to add financial liquidity called Quantitative Easing (QE). The Fed purchased Treasury and Mortgage-backed bonds from banks and investors and essentially added cash and reserves to the financial system. It worked. We avoided deflation, negative interest rates and a depression. However, QE caused the Fed’s balance sheet to rise dramatically, from about $1 trillion to $5 trillion.

During the pandemic slowdown, the Fed used QE once again to add liquidity and ballooned its balance sheet further to $9 trillion. Because the U.S. government also added money to the financial system by sending people checks, we entered an era of too much money chasing too few goods, compounded by pandemic shipping issues which reduced the supply of goods substantially. High inflation was the result.

Today

To deal with high inflation and an oversized balance sheet, the Fed took two steps beginning in 2022.

The Fed raised interest rates at the fastest pace in history, from 0 to 5.5%
The Fed began to gradually reduce its balance sheet¹

There are several reasons for the Fed to reduce its balance sheet - to take some liquidity out of the financial system, to make room to buy bonds in the next crisis, and to avoid losses as the cost of their liabilities is greater than what they are earning on their assets.

The Fed’s actions were intended to reduce inflation and slow the economy - which has occurred. However, while inflation has come down, it remains sticky and above the Feds’ target 2% level. Further, while economic growth has slowed from its rapid pace in 2021, it continues to be stronger than most expected.

Why Haven’t the Fed’s Actions Slowed the Economy as Much as Expected?

The short answer - what the Fed has taken away, the Treasury has more than given back.

The Fed is reducing its balance sheet (both the asset side and the liability side) by letting some of its Treasury and Mortgage holdings mature and not replacing them. This process is called ‘roll off’. Since the middle of 2023, when the Fed receives cash for certain maturing bonds, it no longer puts that cash back into the financial system. This process reduces currency in circulation and/or bank reserves. Typically, these actions by the Fed would drain liquidity from the financial system.

However, we now have the largest peacetime fiscal deficit that still needs funding. Enter Treasury Secretary, Janet Yellen, who needs to finance the U.S. deficit by selling Treasury bills, notes and bonds. Last fall, she chose to sell more Treasury bills and fewer longer maturity notes and bonds. Her actions took supply pressure off the 10-year Treasury bond causing 10-year rates to fall and the stock market to rally. (See our last blog “Janet Yellen takes the Prize”)

Why Would Janet Yellen Want to Increase the Government’s Funding Costs by Issuing More Treasury Bills (which have higher rates than notes and bonds)?

Not only did she want to reduce long-term interest rates and buoy the stock market, but she also found a way to add liquidity to the financial system without affecting the Fed’s balance sheet, a win-win scenario.

A special situation involving the Federal Reserve’s Reverse Repo facility made all these financial machinations possible. This facility allows banks and money market funds (MMFs) to briefly swap their extra cash for treasury securities on the Fed’s balance sheet and earn some interest. The reverse repo facility grew to $1.4 trillion in 2023 because banks and MMFs didn’t have a better investment to make with their money. Secretary Yellen realized that she could issue Treasury bills at an interest rate that would cause money market funds to exit the reverse repo facility and purchase Treasury bills instead. Thus, reverse repos (a liability on the Fed’s balance sheet) would be reduced and the Treasury General Account (TGA), also a liability, would go up. Yellen would use the money at the TGA to cover the costs of running the government, ultimately increasing cash in circulation. Even as she changed the complexion of the Fed’s balance sheet, she didn’t increase it. “By issuing more bills, the Treasury enabled money market funds to fund most of the deficit using otherwise inert liquidity parked at the reverse repo facility.”²

Why do we care?

Nothing good lasts forever.

Since October 2023, the reverse repo facility has gone from 1.4 trillion to $400 billion and may disappear completely this fall.
Once the reverse repo facility is gone, net new issuance by the Treasury will likely start draining reserves from the financial system.
If liquidity is in fact what is buoying assets, tightening may hurt risk assets including the stock market and bitcoin.
“Regional banks are among those who may face a particular challenge from declining liquidity, making another bank failure a distinct possibility. It’s when those sort of choppy waters hit that the Fed will probably see fit to curtail QT altogether.”³
The Fed is aware of the risks listed above and has slowed their balance sheet roll off from 60 billion to $25 billion per month.
Subsequent Treasury issuance may no longer be so concentrated in bills and be more evenly distributed across longer maturities.
The large supply and likely higher rates on U.S. treasuries (considered risk free) would ‘crowd out’ private sector borrowers.

Are politics involved?

It seems as though Fed Chair Powell and Treasury Secretary Yellen would like to see stable markets going into elections.

The support of the government combined with the ongoing strength of the economy, and historical performance of the stock market during election years makes us comfortable with our equity exposure, but seasonally it may be a wild summer into the fall.

After the election, all bets are off.

If the Treasury issues debt further out the interest rate curve, rates may rise.
Higher rates coupled with reduced liquidity are likely to cause the stock market to fall as it did in October 2023.

And if you have forgotten our 10 Surprises for the New Year written in November of 2023, #8 was “The U.S. Presidential election will not be Trump versus Biden.” For the entire list, visit our Market Insights page.

¹Fed’s BS:
‍
Assets
Treasuries
Mortgages
Residual - Agency Bonds, etc.
Repos
‍
Liabilities
Reverse Repos
TGA (Treasury Gen Acct)
Currency in Circulation
Bank Reserves

As the bonds on the Fed’s balance sheet mature, they take the cash and do not buy new bonds to replace the maturing bonds.

^{2, 3}Simon White, “Liquidity Saps from the System as Treasury Issues Fewer Bills” Bloomberg.

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Financial Planning

December 21, 2023

Safe Withdrawal Rates During Retirement

There is no such thing as a free lunch. This popular adage, suggesting it is impossible to get something for nothing, comes from a common practice in the 1930s where American bars would offer a free lunch to entice drinking customers. Since the 1970s, it has been used in economic literature to describe opportunity costs, or trade-offs, in financial decision making. For retirees, we think the concept applies quite well to decisions about withdrawal strategies from their investment portfolios.

By 2X Wealth Group

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As the time for retirement approaches, our clients become more focused on how they are going to live off their portfolios for the rest of their lives. The change from earning money and saving to no longer working and spending those savings can be anxiety producing and sometimes leads to poor decisions. In this blog, we discuss the various options, pitfalls, and benefits of various strategies.

Safe Withdrawal Rate

The safe portfolio withdrawal rate is defined as the amount of savings you can withdraw each year without running out of money before you die. Academic research on this topic typically uses a 30-year time horizon with a 90% probability of success (i.e. not running out of money). All expected withdrawal amounts are adjusted for inflation. Success rates beyond 90% generally lead to large portfolio balances when you die and a reduced lifestyle while still alive.

The 4% Withdrawal Rate Rule of Thumb

For many years, a 4% withdrawal rate was considered the gold standard. However, when interest rates fell dramatically in 2021, safe withdrawal rates declined as well. According to Morningstar, the highest starting safe withdrawal rate for a 30-year time horizon was only 3.3% in 2021, 3.8% in 2022 and returned to 4% in 2023. Because portfolios can rely heavily on income from bonds, when bond yields rise, they provide higher cash flows to retirees, and allow for higher safe withdrawal rates - which happened in 2022 and 2023.

Sequence of Return Risk

Negative market returns occurring late in working years or early in retirement can reduce the amount of money you can withdraw over the entire course of your retirement.

When you withdraw money from your portfolio after it has gone down in value, you must sell more investments to raise a set amount of cash. This process leaves you with fewer assets that can appreciate during subsequent market rallies, hurting your ability to spend money in the future. A more conservative investment approach during these periods can mitigate sequence of return risk.

The Withdrawal Strategy You Choose Depends on Your Goals

There is a tradeoff between higher withdrawal rates, steadier cash flow streams and having more money for beneficiaries at death. Some people want to maximize withdrawals while living and have almost nothing left when they die. Others want to live comfortably but also provide for heirs or other beneficiaries. Some are more concerned about having very steady cashflows even if it means their spending levels will be lower. To evaluate the six strategies presented below, we used the Morningstar report The State of Retirement Income: 2023 published in November of this year. We divide the strategies between those with a primary goal of steady income versus a goal of higher spending levels.

Primary Objective: Predictable Income Stream

Your deductibles and coinsurance payments can quickly add up under original Medicare. If you want insurance to pay for healthcare costs not covered by the government, there are basically two choices, both in the form of private insurance.

Fixed Real Withdrawal Rate– the most commonly used strategy. The retiree starts with a fixed withdrawal amount in the first year of retirement. Today that would be 4% of the portfolio (based on the 2023 safe withdrawal rate). Subsequent withdrawal dollar amounts are adjusted by inflation every year.

Pros:
- Predictable paycheck like income
- Likely high ending portfolio value at death for beneficiaries
Cons:
- Doesn’t maximize lifetime withdrawal rates
- Can lead to lower than preferred lifestyle and may leave too much money to beneficiaries
Good balance of lifestyle and opportunity to leave money to heirs.
Forgo Inflation Adjustment– compared with Strategy 1, the retiree starts with a higher fixed withdrawal amount in the first year of retirement. Subsequent withdrawals amounts are typically adjusted by inflation every year. However, to increase the likelihood of success, when the portfolio goes down substantially in value, you forgo the inflation adjustment in the following year. This change has a ripple effect through all subsequent withdrawal amounts.

Pros:
- Paycheck like equivalent, with some minor variation
- Allows for higher initial spending than Strategy 1
- The tradeoff for higher initial withdrawals is modest income reductions in the future if portfolios decline
- Leads to lower but still healthy ending portfolio values than Strategy 1
Cons:
- While starting withdrawal amounts are higher, lifetime withdrawals will be lower in the case of adverse portfolio performance
Good for retirees who want consistent income but a higher starting withdrawal amount.
Treasury Inflation Protected Securities (TIPS) – This strategy involves purchasing individual TIPs foreach year of retirement and creates an essentially risk-free fixed withdrawal retirement strategy. Each year, an individual TIP matures and provides a fixed dollar amount adjusted for inflation.
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Pros:
- 100% success rate assuming the U.S. Government doesn’t default
- Provides a higher safe withdrawal rate
Cons:
- Very rigid strategy and portfolio goes to zero after the last TIP matures
- No equity upside for possible beneficiaries
- More difficult strategy to implement
Good for retirees who don’t have longevity risk and don’t plan to leave anything behind.
Primary Objective: Highest Possible Withdrawal Rate
Required Minimum Distributions (RMDs) - calculated by dividing the prior year’s ending account balance by your remaining life expectancy. The resulting number is the dollar amount you can withdraw during the year. This strategy allows for the highest starting and lifetime withdrawal rate of all the strategies analyzed by Morningstar.
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Pros:
- Much higher starting and lifetime withdrawal rates than other strategies
Cons:
- Annual spending amounts vary significantly - by 60% on a typical 60% equity/40% bond portfolio
- Portfolio values at death are low if you want to leave money to beneficiaries
Good for retirees with shorter than average life expectancy or have substantial other sources of income to cover fixed living expenses and don’t plan to leave money to beneficiaries.
Higher Spending in Early Years – Withdrawal rates are based on a specific plan of spending, more in the first part of retirement and less in later years. Beware if income in later years is too low to support long term care unless a long-term care plan is in place.
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Pros:
- High cash flow predictability
- More money available for spending when retirees are likely to spend the most
- High expected ending portfolio value at death
Cons:
- Very low spending late in retirement can be a problem for long-term care
- Does not maximize lifetime withdrawal rates
Good for retirees who want to spend more in early retirement but still want the opportunity to leave substantial money to beneficiaries.
Guardrails – After an initial withdrawal rate is set, guardrails determine future withdrawal rates dependent on market performance. If the portfolio goes up substantially withdrawal rates can increase, and if portfolio values decline substantially, withdrawal rates must decrease. This strategy is similar to the RMD, but it has slightly more stable cash flows.
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Pros:
- Allows for high initial and lifetime withdrawal rates.
Cons:
- More complicated and difficult to implement.
- Highest cash flow volatility other than RMD strategy.
- Low portfolio value at death if you want to leave money to beneficiaries.
Good for retirees who prioritize spending over leaving money behind and don’t mind altering their spending based on portfolio performance.

Impact of Portfolio Investment Style

The amount of equities in investment portfolios can have a significant impact on withdrawal rates and the success of your withdrawal strategy. Morningstar’s analysis assumes 40% in equities with the remainder in cash and bonds. Many find that level of equities too conservative.

What happens if you use more than 40% percent in equities? During the years shortly before retirement and shortly after, portfolios with higher equity levels can experience more severe sequence of return risk if the stock market falls dramatically (or for an extended period of time). Further, in the RMD and Guardrail strategies, higher equity percentages increase the variability of cash flows significantly. Higher equity percentages aren’t all bad. If you are willing to use a variable investment strategy such as RMD or guardrails, higher equity percentages can lead to higher lifetime withdrawal rates and more money to leave to heirs.

Conclusion

In developing a withdrawal strategy, the first step is to decide what is most important to you - steady income, higher spending or leaving money to beneficiaries. The rest of your choices flow from your priorities. Keep in mind the following:

Even though you may have been good at saving for retirement, living off a retirement portfolio is entirely different.
Understand your risks - those you can control and those you can’t control
Over time, your goals may change, and you can always readjust your strategy.

If we can help, please get in touch.

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529 Plans are an effective way to save for college if you want tax efficient investing that is easy to set up, fairly flexible, and allows other family members to participate.

Why the U.S. Economy Has Remained Resilient in Spite of the Fed Raising Interest Rates and Reducing Their Balance Sheet

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