When financial markets turn volatile, some investors show their frustration by fleeing the markets in search of alternatives that are designed to offer stability.

For example, in the first quarter of 2020, the S&P 500 lost nearly 20% of its value, over $5 trillion, due to market volatility.¹

For those looking for a way off Wall Street’s roller-coaster ride, annuities may offer an attractive alternative.

Annuities are contracts with insurance companies. The contracts, which can be funded with either a lump sum or through regular payments, are designed as financial vehicles for retirement purposes. In exchange for premiums, the insurance company agrees to make regular payments — either immediately or at some date in the future.

Meanwhile, the money used to fund the contract grows tax-deferred. Unlike other tax-advantaged retirement programs, there are no contribution limits on annuities. And annuities can be used in very creative and effective ways.

The Split

One strategy combines two different annuities to generate income and rebuild principal. Here’s how it works:

An investor simultaneously purchases a fixed–period immediate annuity and a single premium tax-deferred annuity, dividing capital between the two annuities in such a way that the combination is expected to produce tax-advantaged income for a set period of time and restore the original principal at the end of that time period.

Keep in mind that any withdrawals from the deferred annuity would be taxed as ordinary income. When the immediate annuity contract ends, the process can be repeated using the funds from the deferred annuity (see example). Remember, the guarantees of an annuity contract depend on the issuing company’s claims-paying ability.

Diane Divides

Diane divides $300,000 between two annuities: a deferred annuity with a 10-year term and a hypothetical 5% return, and an immediate annuity with a 10-year term and a hypothetical 3% return. She places $182,148 in the deferred annuity and the remaining $117,852 in the immediate annuity. Over the next 10 years, the immediate annuity is expected to generate $1,117 per month in income, with a few dollars left at the end of the period. During the same time, the deferred annuity is projected to grow to $296,700 — effectively replacing her principal.

Annuities have contract limitations, fees, and charges, including account and administrative fees, underlying investment management fees, mortality and expense fees, and charges for optional benefits. Most annuities have surrender fees that are usually highest if you take out the money in the initial years of the annuity contract. Withdrawals and income payments are taxed as ordinary income. If a withdrawal is made prior to age 59½, a 10% federal income tax penalty may apply (unless an exception applies). Annuities are not guaranteed by the FDIC or any other government agency. With variable annuities, the investment return and principal value of the investment option are not guaranteed.

Variable annuities are sold by prospectus, which contains detailed information about investment objectives and risks, as well as charges and expenses. You are encouraged to read the prospectus carefully before you invest or send money to buy a variable annuity contract. The prospectus is available from the insurance company or from your financial professional. Variable annuity subaccounts will fluctuate in value based on market conditions and may be worth more or less than the original amount invested if the annuity is surrendered.

Some of the biggest challenges many face when it comes to education are financial. Luckily, a 529 college saving plan can help. And they’re not just for college anymore – added to the tuition eligibility are K-12, private and religious schools. These funds can also be used for four and two-year colleges, trade schools, graduate programs, and some international institutions.

A 529 plan is a college savings plan that allows individuals to save for college on a tax-advantaged basis. State tax treatment of 529 plans is only one factor to consider prior to committing to a savings plan. Also, consider the fees and expenses associated with the particular plan. Whether a state tax deduction is available will depend on your state of residence. State tax laws and treatment may vary. State tax laws may be different from federal tax laws. Earnings on non-qualified distributions will be subject to income tax and a 10% federal penalty tax.

Here’s a list of 529 qualified educational expenses:

Educational Strategy

To take advantage of the 529 distribution for educational costs, you must submit your request for the funds during the same calendar year. If you request cash during the academic year, you may end up owing taxes as a non-qualified withdrawal.

• Higher Education – Post-secondary students (after high school) are eligible to participate in the federal student aid program administered by the U.S Department of Education and qualify for the use of 529 funds.
• Vocational or Trade School – Culinary students can draw from their 529 accounts to pay expenses related to culinary institute courses. The institution must participate in the U.S Department of Education for federal student aid.
• Early Education – K-12 schools, public, private, and religious institutions can now use 529 plan distributions up to $10,000 per student for tuition.

Lifestyle and School Supplies

Learning how best to use your 529 distributions while establishing a manageable budget for qualified and non-qualified purchases can be tricky. Here are some tips to keep in mind.

• Housing – Campus housing can be paid through 529 distributions, including college room and board fees. Off-campus housing rentals qualify up to the same cost of the room and board on campus.
• Books and Supplies – paper, pens, and textbooks required by the specific course are qualified expenses. Schools set the budget limit for books and supplies.
• Needs and Services – Special needs equipment and services qualify for 529 distribution. Students using equipment for mobility may be eligible for 529 distribution purchases. Depending on the circumstances, other modes of transportation may also apply.

Welcoming Technology

Finally, many don’t realize that computers and some electronics are included on the list of qualified education expenses. Keep in mind that these items must be required as part of the students’ study programs to qualify.

• Personal Computer – Computers must be used primarily by the student during any of the years the student is enrolled at the eligible educational institution.
• Software – software may qualify as a 529 distribution expense, but only if it’s used by the student and required by a class. For example, technical engineering or design classes may involve computerized assignments.
• Internet – Lastly, under certain circumstances, internet services can be paid for using 529 funds. Check with your internet service provider (ISP) for more details.

The above tips are sure to help get you started, but make sure to check with the school as well as chat with your financial professional to learn more. As mentioned earlier, each state and school may have different restrictions on using 529 funds. If you are unsure about anything, your plan sponsor may be able to provide some guidance.

Wall Street is always searching for a hero to embrace or a villain to blame. And right now, Fed Chair Jerome Powell is the villain.

After the September Fed meeting, Powell said interest rates may be heading higher for longer than anticipated and that “no one knows whether this process will lead to a recession, or if so, how significant that recession will be.”

But a closer look at available data suggests a different story.

In the chart below, we see that traders expect short-term rates to peak next year and perhaps trend lower by the end of 2023, which could mean that Wall Street is prepared to see its “villain” as a “hero” when the Fed tames inflation.

We know this year has had its ups and downs. Just when it appears to have turned a corner, something else happens, and the markets are under pressure again.

But I’m optimistic that the Fed has a plan, and I’m looking forward to the day when Fed Chair Powell has good news to share.

The reason withdrawals from a Traditional Individual Retirement Account (IRA) prior to age 59½ are generally subject to a 10% tax penalty is that policymakers wanted to create a disincentive to use these savings for anything other than retirement.¹

Yet, policymakers also recognize that life can present more pressing circumstances that require access to these savings. In appreciation of this, the list of withdrawals that may be taken from a Traditional IRA without incurring a 10% early withdrawal penalty has grown over the years.

Penalty-Free Withdrawals

Outlined below are the circumstances under which individuals may withdraw from an IRA prior to age 59½ without a tax penalty. Ordinary income tax, however, generally is due on such distributions.

1. Death — If you die prior to age 59½, the beneficiary(ies) of your IRA may withdraw the assets without penalty. However, if your beneficiary decides to roll it over into his or her IRA, he or she will forfeit this exception.^2,3
   
   
2. Disability — Disability is defined as being unable to engage in any gainful employment because of a mental or physical disability, as determined by a physician.⁴
   
   
3. Substantially Equal Periodic Payments — You are permitted to take a series of substantially equal periodic payments and avoid the tax penalty, provided they continue until you turn 59½ or for five years, whichever is later. The calculation of such payments is complicated, and individuals should consider speaking with a qualified tax professional.⁴
   
   
4. Home Purchase — You may take up to $10,000 toward the purchase of your first home. (According to the Internal Revenue Service, you also qualify if you have not owned a home in the last two years). This is a lifetime limit.
   
   
5. Unreimbursed Medical Expenses — This exception covers medical expenses in excess of 7.5% of your adjusted gross income.
   
   
6. Medical Insurance — This permits the unemployed to pay for medical insurance if they meet specific criteria.
   
   
7. Higher Education Expenses — Funds may be used to cover higher education expenses for you, your spouse, children, or grandchildren. Only certain institutions and associated expenses are permitted.
   
   
8. IRS Levy — Funds may be used to pay an IRS levy.
   
   
9. Active Duty Call-Up — Funds may be used by reservists called up after 9/11/01, and whose withdrawals meet the definition of qualified reservist distributions.

Preparing For Anything

Did you know September is National Preparedness Month? This event promoted by FEMA guides Americans in ensuring their families and communities are ready in case of natural disasters or other emergencies.

But did you also know that the Financial Industry Regulatory Authority requires me to have a business continuity plan in case of emergency or significant business disruption? It’s true. I designed your financial strategy to weather everything from market turbulence to earthquakes.

My business continuity plan includes data backups, an alternate office location, and access to various means of communication if needed. You can rest easy knowing I have a game plan in place for disruptive situations of many kinds, such as what we see currently unfolding in Puerto Rico.

We’ve got your back financially, but you should prepare yourself and your household for unexpected events. Check out ready.gov to see FEMA’s suggestions.

Stay safe and be well.

Four Reasons Millennials Need an Estate Strategy

You’re young, have little in savings, and might not have anyone relying on you, financially. So, why do you need to think about estate management?¹
Here are four great reasons:

Estate Strategies: They’re Not Just for the Elderly

1. You need a will. You may ask yourself why a will is important if you don’t have much to pass on. A will is not just about transferring assets. It can be used to accomplish other tasks, such as naming who should manage your social media accounts once you’re gone or inherit items you’ve accumulated, like collectibles or your car.
2. Don’t burden others with burial expenses. Funerals can be expensive, and if you don’t have the savings to meet those costs, that burden gets shifted to others.
3. Consider a medical directive. This important document states your wishes for end-of-life care. In the case of an unfortunate accident, a medical directive provides instructions about the level of care you want, e.g., palliative care only.
4. Create a durable power of attorney for health care. In the event that you are unable to make medical decisions for yourself, this gives the individual of your choice the legal power to act as a health care proxy for you.

A medical directive and health care durable power of attorney can ensure that you are provided the level of care consistent with your wishes. They can also prevent family discord in the event of differing opinions.

Though the multiple financial goals of many young adults often require more resources than present earnings can meet, these important planning steps can be accomplished at a small cost.

The CEO’s Unofficial Q2 Buzzword

You may have heard the expression, “You can talk yourself into just about anything.” If that’s true, corporate America better watch out.

As publicly traded companies report quarterly sales and earnings, they often review critical economic conditions. Last quarter, nearly 50% of the S&P 500 companies mentioned the term “recession” during their Q2 conference calls with shareholders, according to FactSet. This breaks the previous record set in Q1 2020, at the start of the pandemic.

Unsurprisingly, America’s corporate leaders are preparing for potential economic turbulence. After all, we often see volatility in the financial markets when economic reports raise questions about recession and the Fed’s policies. Words are powerful.

This time next year, the buzzword of the quarter could be something else entirely. Here’s hoping for something like “recovery,” “rebound,” or “growth.”

A Look at Diversification

Ancient Chinese merchants were said to have developed a unique way to manage their risk. They would divide their shipments among several different vessels. That way, if one ship were to sink or be attacked by pirates, the rest stood a good chance of getting through. Thus, the majority of the shipment could be saved.

Your investment portfolio may benefit from that same logic.

Diversification is an investment principle designed to manage risk. However, diversification does not guarantee against a loss. The key to diversification is to identify investments that may perform differently under various market conditions.

On one level, a diversified portfolio should be diversified between asset classes, such as stocks, bonds, and cash alternatives. On another level, a diversified portfolio also should be diversified within asset classes, such as a diverse basket of stocks.

A Diversified Approach

For example, let’s say a stock portfolio included a computer company, a software developer, and an internet service provider. Although the portfolio has spread its risk among three companies, it may not be considered well diversified, as all the firms are connected to the technology industry. A portfolio that includes a computer company, a drug manufacturer, and an oil service firm, however, may be considered more diversified.

Similarly, a bond portfolio that invests exclusively in long-term U.S. Treasuries may have limited diversification. A bond fund that invests in short-term and long-term U.S. Treasuries, plus a variety of corporate bonds, may offer more diversification.

Mutual Funds and ETFs

The concept of diversification is one reason why mutual funds and Exchange Traded Funds (ETFs) are so popular among investors. Mutual funds accumulate a pool of money that is invested to pursue the objectives stated in the fund’s prospectus. The fund may have a narrow objective, such as the auto sector, or it may have a broader objective, such as large-cap stocks. ETFs also can have a narrow or broader investment objective. Keep in mind, though, the more narrow an investment objective, the more limited the diversification. Furthermore, a narrow investment objective may result in more volatility and additional risks associated with a particular industry or sector.

The concept of diversification is critical to understand when you are evaluating a portfolio. If you want more information on diversification or have questions about how your money is invested, please call us to review your situation.

What is Happening with CPI and Inflation?

Believe me, everyone on Wall Street wants inflation to go away, or at least shrink back to below 2%, a level we enjoyed not so long ago.

But Tuesday’s Consumer Price Index report showed it might be some time before we see 2% again. Consumer prices ticked slightly lower in August, but not as much as what Wall Street wanted. Economists, pointing out that gasoline prices dropped in the past month, made bold predictions for August inflation. Too bold, as it turned out.

Stocks got clobbered, and bonds didn’t fare much better. The inflation report showed that higher food, shelter, and medical services costs were to blame. Higher costs in those areas indicate inflation could be more persistent and entrenched than we thought.¹

So now the question is, “What will the Fed do at its upcoming meeting?” In the chart below, the green highlights show the most likely outcomes for the next several Fed meetings, according to the CME Group. Keep in mind that in early September, the CME’s indicator said smaller increases were possible. But no more.

All too often this year, I haven’t had great news to pass along about the markets. But I want to assure you that I’m committed to staying on top of the news in good times, bad times, and in-between times.

If Tuesday’s drop raised some new concerns, please give me a call. Thanks for your trust.

Systematic Withdrawals in Retirement

Many of us grew up with the concept that making regular, periodic contributions to our retirement account was a sound investment strategy. The idea was that, in a fluctuating market, regularly investing a set amount would enable an individual to buy more shares when prices were low and fewer shares when prices were high.¹

Does this mean that taking regular, periodic withdrawals during retirement makes similar good sense?

Actually, it can be quite problematic.

Systematic withdrawals do the precise opposite of systematic investments by selling fewer shares when the price is high and more shares when the price is low. This, in effect, reduces the number of shares that may be able to participate in any subsequent market recovery.

Here’s an example.

In the accumulation phase, if a portfolio falls by 25%, it will require approximately a 33% return to get back to its pre-decline value.²

In the distribution phase, if you withdraw 5% of your portfolio for income and suffer the same 25% market decline, you would need to see a 43% market rebound to get back to pre-decline value.²

Sequence of Returns

In the accumulation phase, investors tend to focus on average annual rates of return and less on the sequence of the returns. If you’re a buy-and-hold investor, ignoring short-term fluctuations may be a sound long-term approach.

If you are in retirement, however, you absolutely care about the sequence of the annual returns.

For instance, comparable portfolios might deliver the same average annual return over a 20- or 30-year period, but they could have radically different outcomes in terms of account balance and income production. Generally speaking, negative returns in the early years of your retirement can potentially reduce how long your assets can be expected to last.

American writer H.L. Mencken once remarked that “For every complex problem, there is an answer that is clear, simple, and wrong.”

Anticipating a lifetime of withdrawals from a defined asset pool over an indefinite period of time is a complex challenge for which there is no simple solution. Pursuing this challenge can require creative approaches and persistent vigilance.