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WashingtonWise Investor: Episode 4


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New retirement legislation is pending in Washington. Here’s what investors need to know.

In this episode of WashingtonWise Investor, Mike Townsend breaks down the progress toward trade deals—with China, as well as Mexico and Canada—and weighs in on the chances of a government shutdown.

With major retirement legislation pending in Congress, Mike and his guest, Demetra Sullivan, a regional branch executive at Schwab, discuss key components of the SECURE Act and their potential impact on retirement savers.

WashingtonWise Investor is an original podcast from Charles Schwab.

If you enjoy the show, please leave a rating or review on Apple Podcasts.

Click to show the transcript

MIKE TOWNSEND: Congress is back in the nation’s capital after a two-week recess at the beginning of the month. The impeachment inquiry inches forward. U.S.-China relations seem to be taking a turn for the better. The news out of Washington never seems to stop.

Welcome to another episode of WashingtonWise Investor, an original podcast from Charles Schwab. I’m your host, Mike Townsend. We’ve got a great show for you this week.

Coming up in a few minutes, I’ll speak with my Schwab colleague Demetra Sullivan about the pending retirement savings legislation in Congress and its potential impact on investors. Demetra does a great job at explaining why investors need to be aware of some of the changes that are possible if this bill becomes law.

But as usual I’ll begin with some quick observations on the top stories this week. I’ve got a lot of choices of topics this week—the ongoing impeachment inquiry, a deadline coming up for Brexit at the end of the month—but I’m going to focus on the status of the two big trade deals that the markets and investors are watching carefully.

First, the most recent round of U.S.-China trade talks earlier this month seemed to provide a breakthrough. The president announced a “phase one deal” that reportedly includes an agreement for China to increase its purchases of U.S. agricultural products and also to make it easier for foreign financial services companies to offer their products and services to the Chinese people.

Market reaction was positive initially but quickly cooled. And I think that’s because the market realizes that turning what is essentially a handshake deal into a written agreement is going to be tricky.

The next few weeks are going to very important. President Trump and Chinese President Xi Jinping will be in Santiago, Chile, November 16 and 17 for a summit of Asian heads of state. It’s an obvious place for a signing of a formal U.S.-China agreement, but there is a ton of work to be done to make that happen.

And keep in mind that this deal—if one does emerge—represents essentially the low-hanging fruit, the easiest issues to resolve. The thornier issues, like intellectual property, China’s currency policies, and China’s state support for businesses, will be left to a later round of negotiations.

The bottom line: I think this is a positive development—just the fact that the talks were productive and cordial and resulted in a handshake deal represents significant progress from earlier this year. But until we see the details on paper, I think the markets will remain cautious in their optimism.

And the second trade issue of the day is the U.S.-Mexico-Canada trade agreement, known as USMCA. This is the deal that would replace the North American Free Trade Agreement, or NAFTA.

The USMCA has not been in the headlines in recent weeks, but a lot of behind-the-scenes discussions have been going on in Washington to resolve some areas of concern. Now there is real optimism that Congress can take a vote on the agreement prior to the Thanksgiving break.

There are significant numbers of both Republicans and Democrats who are enthusiastic about the deal, which is good for farmers, for auto companies, for technology companies, for pharmaceutical companies, and many others. Labor and environmental protections have reportedly been addressed, which was key for some Democrats. Congressional approval of the deal would be good for the markets. And the sense is that it does have enough votes to pass both the House and the Senate.

The big risk, however, is just the uncertainty of the environment on Capitol Hill, particularly as the impeachment inquiry progresses. Can Congress set aside the partisanship, on that and so many other issues, to find a bipartisan way forward on the USMCA? That question should be answered between now and Thanksgiving.

Now it’s time for my Why It Matters segment, where I look at a story you may not have been following and explain why it’s important for investors. Now this one’s a bit complicated, but I think investors stand to really benefit.

Earlier this month, the SEC proposed a rule change that would require a public review process whenever one of the market data utilities wants to change the fees they charge for market data. Now market data is the lifeblood of our capital markets system—it’s the information that lets investors know the current bid and ask prices, as well as other information, for any particular security.

Under what is known as the National Market System, fee changes from any of the operators of the market data utilities have to be proposed to the SEC. But in a quirk of those rules, those changes become effective as soon as they are proposed—in other words, they are effective immediately. In recent years, the result has been hundreds of fee changes that essentially get a rubber stamp from the SEC, without any input or comment from investors.

But the SEC’s proposed change would end that practice. Instead, each fee change proposal would have to go through the normal regulatory process, where there is a public comment and review period, and then a formal approval or disapproval decision by the SEC. That will put more pressure on market data operators to justify fee increases—and should have the effect of keeping the costs for market information fair.

For investors, it means more transparency into the cost of market data and, potentially, lower costs for the information that helps investors compete on a level playing field with high-speed traders and other market professionals.

For now, this change is just a proposal—and it will have to go through its own public review and comment period. At Schwab, we’re hopeful that the change is finalized soon, because we think it would help keep the system fair for individual investors.

In my Deeper Dive this week, I want to explore the retirement savings bill that is pending in the Senate and its potential implications for investors.

The bill is known as the SECURE Act, and it passed the House overwhelmingly back in May. The vote was 417-3, which is a pretty striking level of bipartisanship in a time when the two parties have struggled to find things to work together on.

The bill is currently awaiting action in the Senate, where it’s been hung up for the past few months. There’s a lot of support in the Senate for the bill, but as with any piece of legislation, there are some senators who would like to propose changes to the version passed by the House. Senate leaders are negotiating those issues now, and the hope is that the bill will come to the full Senate for consideration later this fall.

The bill has several provisions that are designed to help small businesses offer a retirement savings opportunity to their employees, and I think everyone is in agreement that that’s a good thing. But I want to focus on some elements of the bill that apply more directly to individual savers.

Now, it’s important for investors to understand that the bill has not passed yet. But we think some of the provisions are so significant for investors that we wanted to get ahead of it so that everyone will know what to expect.  

To help me dig into this, I’m joined today by Demetra Sullivan, who is a regional branch executive here at Schwab. She oversees about 18 branches in places like St. Louis and Denver, and everywhere in between. Demetra, thanks for joining me today.

DEMETRA SULLIVAN: Thanks for having me, Mike!

MIKE: Well, Demetra, this bill has a number of provisions that are potentially very significant for people in retirement or saving for retirement, so let’s explore some of those. One important one is that the bill would change the age at which individuals have to begin taking required minimum distributions from their retirement account, from 70½ to 72. So let’s start with, what is a required minimum distribution, and why do we have them?

DEMETRA: A required minimum distribution, or RMD, is something that everyone who has an IRA or other qualified retirement account should be familiar with. Basically, these retirement accounts offer the benefit of tax-deferred growth, but not indefinitely. At some point the IRS requires we start taking distributions from the account and pay taxes on those withdrawals. So the term RMD refers to the minimum amount of cash that must be withdrawn from your retirement plan once you reach a specified age—today, that age is 70½.

MIKE: Well, by raising the age from 70½ to 72, the bill would essentially delay the start date of those required distributions by 18 months, which doesn’t seem very long, but it’s still significant. What’s the benefit to investors of this change?

DEMETRA: So here is where financial planners get excited—because while 18 months may not seem very significant, it prompts a bigger question about the overall strategy each investor chooses to utilize for their retirement account. We love the opportunity to talk to clients about these decisions, because if you can be proactive and plan ahead, it allows us to customize a plan that meets your ultimate goal.

We want to start by understanding the goal for these funds. Is this money that you need to live on during retirement, or is it considered extra, and you plan to leave it to your beneficiaries?

We would also want to understand your tax situation. Given that any money that comes out of your IRA is considered taxable income, should we expect these RMDs to kick you into a higher tax bracket?

And finally, how will the RMDs impact other pieces of your financial life, like Medicare taxes, and when you decide to start Social Security?

So where I’m going with all of this is that depending on your situation, there could be advantages to actually taking distributions sooner rather than later, despite the traditional teachings that say to take from your retirement accounts last.

Think of it this way—if you have a very large IRA account, delaying the RMD by 18 months may just be kicking the tax can down the road a bit, at which time it will have an even bigger impact on your tax situation.

Taking the distributions early, on the other hand, may smooth out the tax implications and allow greater flexibility from a legacy-planning perspective.

Those distributions could be invested back into a non-retirement account, used for gifting purposes, or even charitable inclinations you may have. These are conversations we would want to involve your tax advisor or CPA in, because it’s really about being purposeful and managing your income according to the federal income tax brackets.

Early distributions are just one method that some of our clients are using. Another powerful strategy we often discuss with clients is to actually convert portions of your IRA into a Roth IRA. You effectively pay the taxes on the distributions, but then immediately that distribution is allowed to get back to work—however, this time as a Roth, where the funds grow tax deferred, and qualified distributions are tax free. This strategy has a lot of upside and is popular for folks who know they don’t need their retirement account and plan to leave it to their beneficiaries and also want to pay the taxes in advance, thereby maximizing the growth benefit to their heirs. Now, to maximize the impact of this strategy for your heirs, we do recommend paying the taxes from a non-retirement account. You want to leave as much in the Roth as possible to take advantage of the market growth moving forward.

MIKE: Demetra, as you said, it’s really important for everyone to consider their own individual situation. Let’s look at another potential change if this legislation becomes law. The bill would allow people who are over 70½ to continue contributing to a traditional IRA, which isn’t allowed today. Now, I’m assuming this is to help people who are working longer to be able to continue saving. But does it make sense for someone in their 70s to keep contributing to a traditional IRA?

DEMETRA: It’s a good question, Mike, and it’s hard for me to justify it. While the ability to continue saving is helpful, if they also have to turn around and take required distributions, even starting at age 72, it becomes complicated quickly and really diminishes the savings impact. And for those who are still working because they want to, not because they have to, they’re already dealing with an impending tax burden from the RMDs, so why would they want to compound that?  

MIKE: Well, how will these two provisions work together? I mean, if you’re age 72, it sounds like you could be putting money into your IRA on the one hand while also being required to take money out of the same IRA at the same time. That sounds kind of strange, but is that something people should be doing, if they can?

DEMETRA: This one is strange to consider. For someone with significant wealth, and a large IRA balance, I wouldn’t recommend it. However, let’s say your IRA is small, around $80,000, and you are 72 and still working. Theoretically, you could contribute $6,000, benefit from the tax deduction, and then withdraw your RMD, which would be something like $3,000. Same if you are contributing to a 401(k). You have a little bit more time to continue making your contributions before you have to start RMDs. It’s possible—it allows a bit more tax-deferred growth but probably doesn’t have a significant impact on the big picture.

MIKE: Well, again, it’s important for you to figure out your own situation when this bill happens. Let’s switch to another important provision. This one would change the rules around inherited retirement accounts. So today, if you inherit a retirement account from, say, your grandmother, you are allow to “distribute” those assets over the course of your lifetime. But the proposed bill would require you, as the heir, to distribute those assets within 10 years. That’s a big change from an estate-planning perspective, isn’t it? What’s your take on how this would impact your thinking if you have an IRA that you were hoping to leave to a child or grandchild?

DEMETRA: Yeah, this is probably the most impactful provision to the bill, and certainly doesn’t benefit the investor. Let me illustrate the impact using some round numbers. Let’s say Jane is 30 years old and inherits a $1,000,000 IRA from her grandmother. Under today’s rules, she can stretch those required distributions over her entire life expectancy, so roughly 53 years. That means her distributions would be about $18,000 a year, and the bulk of the account could achieve significant growth over time. However, under the new provision, as you mentioned, she would have to take out roughly $100K per year, pay significant taxes on those funds depending on what other income she has, and the account would be completely depleted by age 40.

From a financial-planning perspective, the impact of this provision is significant and could be a reason to reconsider the structure of your beneficiary decisions, such as which beneficiary inherits what type of asset. For example, if you have two adult children, one who has very high taxable income and the other who doesn’t, you may think about how to leave Traditional IRA and other taxable investment accounts to the one in the lower income tax bracket and perhaps real estate to the one in the high income tax bracket. This is obviously a very personal decision, but one that we help our clients think through in terms of the different options and the financial implications.

We do get into bigger picture estate-planning conversations at that point.

MIKE: Well, that’s really helpful advice, Demetra. You know, even though this bill has not passed yet, I just think this is one provision worth discussing with a financial professional now, before it happens.

This provision is one of the trade-offs that results from a bill like this. It’s in the bill because it raises revenue for the Treasury, by requiring individuals to pay taxes more quickly than they do under current rules. And that offsets other elements of the bill that cost Treasury money, like the change in the required minimum distribution age. The goal is to make sure the retirement bill does not add to the federal deficit, though choosing to do so by changing the inherited IRA rules is one of the points of contention in the Senate right now.

Well, Demetra, there’s one other item in this bill that I wanted to get your perspective on. The bill would require something called “lifetime income disclosure.” Basically, it would be like a little box on the front of your statement that looks at how much you’ve saved for retirement and how that would translate into a monthly income in your retirement years. It’s kind of like a progress report. Do you see this as a helpful tool for people?

DEMETRA: I think it’s a good step. Unfortunately, for so many, saving for retirement started too late in life or wasn’t aggressive enough to amount to what’s needed to support 20 or 30 years of life in retirement. Some companies have moved to an “opt-out” retirement plan structure, which means that employees are automatically enrolled in a retirement savings plan without doing anything, as opposed to the burden being on the employee to sign up for the plan on their own. I think this is a great step; however, the problem we are seeing is that the employee contribution levels are too low if no action is taken by the employee to increase them. The employee is underinvesting but may not realize that’s the case. The provision you mention should bring more awareness to individuals about what income they could expect from their savings and hopefully spurs them to save more aggressively using their employer’s plan or other retirement accounts.

In the end, no matter the situation, being proactive and strategic about your financial planning can mean a difference of hundreds of thousands of dollars. And this is the work our Financial Consultants at Schwab really love to help clients with.

MIKE: Well, many thanks to Demetra Sullivan, regional branch executive here at Schwab, for joining me today to provide some great perspective.

As you can see, there are a number of elements of this bill that investors should be aware of. We’ll be watching this bill carefully in the next few weeks to see whether it makes its way through the Senate. If and when it does, the president has indicated that he will sign it into law.

I’m introducing a new segment this week called Question of the Week. As many of my listeners know, I travel around the country talking to investors about what’s going on in Washington, and I get lots of questions from my audiences. Going forward, I’ll occasionally share one that I think is particularly relevant.

Over the last few weeks, I’ve been in Maryland, Massachusetts, North Carolina and Oregon. One question that has come up a few times is what are the chances of a government shutdown in November, now that Congress has passed a temporary extension of funding?

Well, I think the chances are pretty low, actually. Congress passed a bill that keeps the government open and operating through November 21. While the overall spending total has been agreed to, lawmakers still have to pass the 12 appropriations bills to allocate those dollars to each federal agency and program. At this point, the process is so bogged down that no one thinks it is possible for Congress to get those bills passed before the November deadline.

That means Congress will need to pass another temporary extension between now and then. Maybe that extension will be for just a few weeks. But there is even talk of passing an extension that just keeps the funding going right through the end of the fiscal year, which is next September 30, 2020.

Now, I don’t think there is a big market risk here of a shutdown, because neither party seems to think a shutdown would be a good idea, especially right before the holidays—although, of course, that didn’t stop them from shutting down the government right before Christmas last year. But I think a repeat of that is unlikely.

There is one X factor though. As with many things in the nation’s capital, the element of unpredictability here is President Trump. He could veto a temporary extension, particularly because of his frustration over not getting more dollars for the southern border wall. I don’t have any sense right now that that would happen, but if it did, the market could react negatively. We’ll know more in the next few weeks as we approach that November 21 deadline.

Looking ahead at what’s on tap in Washington, there’s an interesting hearing scheduled for tomorrow. Facebook CEO Mark Zuckerberg will appear as the only witness at a hearing of the House Financial Services Committee. The hearing ostensibly will focus on Facebook’s proposal to launch its own cryptocurrency, which the company has dubbed “Libra.” Libra is very controversial, and Zuckerberg should get some tough questions from members of Congress about Facebook’s intentions in this area.

But there are no rules that members of Congress have to stick to the stated topic of a hearing. So expect a wide range of questions on all sorts of issues that members of Congress have with Facebook, including election interference, the company’s role in combatting hate speech, privacy, data security issues, and perceived bias. It should be quite a circus and Mr. Zuckerberg should probably buckle up for a tough day.

That’s all for now. I’ll be back with another episode of WashingtonWise Investor on November 5, when I’ll be taking a closer look at the state of the election one year out from Election Day.

Until then, thanks so much for listening. Please consider leaving a review or a rating on Apple Podcasts or your favorite listening app, and make sure you subscribe so you don’t miss an episode. For important disclosures, see the show notes or, where you can also find the transcripts of every episode.

I’m Mike Townsend, and this has been WashingtonWise Investor. See you next time—and keep investing wisely.

Important Disclosures

The policy analysis provided by the Charles Schwab & Co., Inc., does not constitute and should not be interpreted as an endorsement of any political party.

The information provided here is for general informational purposes only and should not be considered an individualized recommendation or personalized investment advice. The investment strategies mentioned here may not be suitable for everyone. Each investor needs to review an investment strategy for his or her own particular situation before making any investment decision.

All expressions of opinion are subject to change without notice in reaction to shifting market conditions. Data contained herein from third-party providers is obtained from what are considered reliable sources. However, its accuracy, completeness or reliability cannot be guaranteed.

Past performance is no guarantee of future results and the opinions presented cannot be viewed as an indicator of future performance.

Roth IRA conversions require a 5-year holding period before earnings can be withdrawn tax free and subsequent conversions will require their own 5-year holding period. In addition, earnings distributions prior to age 59 1/2 are subject to an early withdrawal penalty.

Investing involves risk including loss of principal.

This information is not intended to be a substitute for specific individualized tax, legal, or investment planning advice. Where specific advice is necessary or appropriate, you should consult with a qualified tax advisor, CPA, financial planner or investment manager.

All corporate names and sectors are for illustrative purposes only and are not a recommendation, offer to sell, or a solicitation of an offer to buy any security.

International investments involve additional risks, which include differences in financial accounting standards, currency fluctuations, geopolitical risk, foreign taxes and regulations, and the potential for illiquid markets. Investing in emerging markets may accentuate this risk.

Diversification strategies do not ensure a profit and do not protect against losses in declining markets.

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