Between market highs and lows, rapidly changing information, and threats of a looming recession, many people are facing feelings of anxiety during the Coronavirus pandemic and wondering: what, if anything, can I do to regain some control over my financial security?
Despite the chaos & panic ensuing from the COVID-19 outbreak, we believe there are several things we know, we can control, and we can even take advantage of during this time. The swift change in legislation and the markets offers opportunities for tax-efficient saving, low cost-basis buy-ins, and compounded benefits for those savvy enough to take advantage of them.
Before we go in-depth on the various moving parts of your personal financial well-being impacted by the Coronavirus, here are the topics we will be covering in this article at a glance:
- Government legislation: the CARES Act
- Tax-planning and financial planning opportunities
- Optimizing your personal finances and savings
- Investment considerations during the COVID-19 outbreak
- Preparing for life after Coronavirus
How is the U.S. Government Handling Coronavirus?
The New CARES Act Offers a Relief Check For Individuals & Families
On Friday, March 27th, the CARES Act (Coronavirus Aid, Relief, and. Economic Security Act) was passed as an emergency relief effort for the widespread pandemic. Among the provisions included in the bill, one of the most widely-discussed provisions of the new law are the relief checks that the Treasury will send to people. While there are many differing opinions on the matter, the goal of the checks, often referred to as rebates, is to offer money to people who are unable to work for a month (or two) to help tide them over to cover the costs of necessities such as groceries, rent, and utilities.
The rebates will be based on the most recent tax return on file (2018/2019) and distributed to the same account where a taxpayer’s 2018/2019 tax refund was deposited. This rebate will be adjusted based on the AGI reported on an individual's 2020 tax return. For individuals receiving Social Security benefits, their Recovery Rebate will be deposited into the same account they receive their Social Security benefits in. Other payments will be sent to the last known address on file for the taxpayer.
How much will taxpayers receive?
The government is providing a tax credit of $1,200 per person plus an additional $500 for each minor child. A married couple with three minor children at home can receive up to $3,900.
For households exceeding certain thresholds, they will begin being phased out from qualifying for the relief. The phaseout for the tax rebates begin at the following adjusted gross income levels:
- Married Filing Jointly: $150,000
- Head of Household: $112,500
- All Other Filers: $75,000
The phaseout is a $5 loss in credit for every $100 of income over the phaseout thresholds. Thus consider that, for 2020, you have an additional 5% ordinary income tax for incomes between:
- $150k - $198k if married, with no minor children
- $112,500 - $156,500 if head of household with 2 kids
- $75,000 - $99,000 for all other filers with no kids
To calculate your expected relief rebate, TaxFoundation.org offers a free calculator tool.
One of the planning opportunities we’re looking at with our clients is lowering their 2020 adjusted gross income to stay beneath these phaseout thresholds. In doing so, we can avoid having to pay the additional tax rates above these thresholds.
Important Note Regarding Charitable Contributions and the CARES ACT
A common way to reduce your annual Adjusted Gross Income (AGI) is through charitable contributions; however, it’s important to understand the nuances included in the CARES ACT before contributing this year. One of the new provisions dictates a new above-the-line deduction of up to $300 for contributions made to a qualified charity if they are made in cash. This deduction is structured so that it can only be taken if you do not itemize it on your tax return. Additionally, contributions to Donor Advised Funds do not count towards the deduction.
Additionally, the Adjusted Gross Income (AGI) limit on cash contributions has increased. In 2019, this limit was 60% of AGI, and, for 2020 it has increased to 100%. Most people are not donating anywhere near 100% of their AGI to charity in a given year, but there may be some that end up taking advantage of this new threshold for tax-savings. Again, contributions made to Donor Advised Funds do not count.
RMDs for 2020 are Waived
Another major change resulting from the CARES Act is the waiving of required minimum distributions (RMDs) from IRAs and 401k accounts for the 2020 year. If you would normally be required to take an RMD this year, you can elect to not take one and, instead, allow your IRA or 401k to continue to grow tax-deferred. Doing so can offer a substantial tax saving for the 2020 year which may help you qualify for the refundable tax credit (ie. the government relief checks).
Who, besides retirees, can waive an RMD?
- Inherited IRAs: If you are receiving payouts from inherited IRAs, you are also eligible to skip an RMD for this year.
- Those who've already withdrawn an RMD: If you already took your RMD for the 2020 year, you may be able to return that money to an IRA by way of the 60-day rollover rule. Before you do so, make sure you understand the calendar year limitations. If you are past the 60 day mark, the CARES Act provides an exemption that still allows a distribution to be rolled back into an IRA. Specifically, if it can be shown that the individual has been impacted by the COVID-19 crisis enough to qualify under the liberal guidelines outlined earlier for a Coronavirus-Related Distribution, then the rollover can still be completed anytime over the next three years (we are expecting additional regulations to be provided clarifying what qualifies).
Additionally, it may be even more beneficial to consider a Roth conversion this year. Because the RMD is not required, you’re likely to be in a lower tax bracket, but we’ll discuss that in more depth later in this article.
COVID-19 Legislation Offers Opportunities for Tax Credits and Unemployment Benefits to the Self-Employed
While there is still a lot of uncertainty surrounding the recently passed Families First Coronavirus Response Act, various agencies are authorized to issue regulations offering further guidance. What we do know is that there are numerous benefits that contractors and the self-employed can take advantage of right now.
Who Qualifies for Self-Employed Unemployment Benefits?
Self-employed individuals that are unable to work due to 1) taking care of a child where care is unavailable 2) sick themselves 3) are told to quarantine 4) taking care of sick family member 4) or other COVID-related reasons as determined by future regulators, are able to receive tax credits from the government to offset these losses. Additionally, the CARES Act established a temporary Pandemic Unemployment Assistance program in which previously ineligible self-employed individuals are now able to receive unemployment benefits. This includes independent contractors, freelancers, and gig workers. Those that have experienced reduced demand and, therefore, reduced earnings may now qualify for unemployment insurance to partially replace lost wages.
Residents of Texas can apply for unemployment benefits at the Texas Workforce Commission website. Historically, it has taken 2-3 weeks after application to start receiving payment, but, with the increased demand, many economists are recommending applicants expect 4-5 weeks before receiving their first paycheck.
Employees Receiving Severance Packages Can Receive Better Unemployment Benefits During Coronavirus Outbreak
Upon the COVID-19 outbreak, many energy companies also announced impending lay-offs and severances. While this may seem doubly concerning, many of these severed employees are able to receive unemployment benefits in addition to receiving their organization’s severance package. Because many of these organizations require a sign-off to receive severance benefits, waiving them from any hardship liability, the employees can apply for the extensive unemployment benefits offered in wake of the Coronavirus pandemic. Due to the COVID-19 pandemic there are additional benefits to unemployment including higher weekly compensation, pay starting as early as the first week after employment, and an extension of unemployment benefits by 13 weeks.
Are you facing a layoff at one of Houston’s major energy companies?
Whether you’ve been waiting for a package or you’re caught off-guard, re-organizations at these companies can be tough to navigate. Between optimizing your benefits and getting your next steps in order, our 4-step guide is designed to ensure you’re not missing any opportunities available to you. Get your guide by clicking your company below:
Take Advantage of the Tax-Planning Opportunities Brought On by Coronavirus Concerns
It’s important to ensure you have adequate liquidity and accessible cash, especially during these uncertain times. We are constantly reviewing our client’s balance sheets to ensure they have an appropriate emergency reserve and that we’re doing what we can to lower their expected tax burden before the tax bills are due.
Tax Payments Can Be Deferred
One relief the IRS has offered is providing more time until your next tax bill is due. If you normally owe taxes due on April 15th alongside your 2019 tax return, you can defer paying your tax bill (and filing your tax return) until July 15th, 2020. Taking advantage of the option to defer paying taxes until they are owed is a strategy we are actively discussing with our clients to maximize the necessary on-hand cash.
You may find yourself asking, why should I defer my taxes? Why not just get it out of the way now? Deferring taxes owed from April until July ultimately offers more flexibility with cash on-hand. By waiting to pay your tax bill, you can hold the money you would owe in taxes in an FDIC-insured interest-bearing bank account and receive interest for a few extra months. Additionally, if due to recent circumstances, you don’t have the cash on-hand (or would be forced to liquidate investments at non-ideal prices to generate the cash), this deferral provides you with more time before you must make a payment.
Use Roth Conversions for Tax Planning
Another way to set yourself up for tax-efficient income in retirement is through a Roth conversion. As we mentioned earlier in this article, RMDs are waived for the 2020 year. So, if you would normally take an RMD, this year you don’t have to, which can make it a great time to do a Roth conversion instead.
Many of our clients are retired, and some are in low tax bracket years prior to beginning pensions, Social Security, and RMDs. This could be a great time to do a Roth conversion to move some of their pre-tax money over to Roth IRAs at both low tax rates and low points in the market.
Historically, we tend to wait until the 4th quarter to make Roth conversions for our clients after Congress removed the ability to recharacterize (reverse a Roth conversion) in 2017. Given the lows we are seeing in the market,however, it may be better not to wait and do the Roth conversions now. When we do see a rebound from the COVID outbreak, it’s likely that the market will recover quite quickly and you could miss the opportunity. Remember, you can convert a Roth “in-kind.” This means you can simply move the existing assets from your conventional IRA to a Roth. How could this play out in your scenario -- Do you have a stock you love which has been battered in the market volatility melee? You could move it to your Roth account before it rebounds and capitalize on the run-up in your Roth account.
Tax Bracket Considerations for Roth Conversions
With our clients, we compile estimated tax-calculations to determine which tax bracket they are likely to be in for the upcoming tax year. In doing this, we consider their current tax bracket as well as where we would expect them to be in the future, particularly in retirement. If we think it is highly likely they will be in a higher tax bracket in the future, then we are likely to recommend a Roth conversion as a strategy.
Oftentimes, when working with clients on their future cash flow, we will use “bracket-topping” as a strategic target to determine how much we want to contribute to Roths in a given year.
For example, let’s say a client is in the bottom of the 22% bracket now, but is likely to be in the 35% tax bracket at some point in the future. We may consider converting enough money from the IRA to the Roth to put them at the top of the 22% bracket. By paying taxes on the conversion now while they’re in a lower bracket, this client would save more on taxes than if they tried to execute this conversion when they’re in the 35% tax bracket down the road.
Remember, the tax brackets are going to go up in 2026 once the Tax Cuts and Jobs Act of 2017 expires. Since these brackets will increase, even if you are earning the same amount of income, you are likely to be in a higher tax bracket down the road.
Market Downturns Make Roth IRAs Look Attractive for Savings
By the end of March, the market began trading near 3-year lows. The peak-to-trough drop in the S&P500 this year is over 35% already. Are we at the bottom? Nobody knows.
What we do know is that this too will end, and will likely lead to a bull market. Historically, the market has done very well in the 1, 3, and 5 years following 20% drops in the market. As such, now is likely a great time to be buying equities for the long-term investor. What’s better than buying into a cheap market? Doing it tax-efficiently.
If you have enough cash reserves and liquidity, it is likely a great time to get your money invested at these near-term lows. Roth IRAs are one of our favorite ways to get this money invested because of the long-term benefit of tax-free growth for qualified distributions. Additionally, with the passage of the SECURE Act, Roths are not subject to RMDs at age 72.
What If I Can’t Contribute to a Roth?
If you are over the income limits of $198,000 for married couples in 2021 ($125,000 for single individuals), then you cannot directly contribute to a Roth IRA. Despite this, you can still maximize the tax-free growth using a Backdoor Roth IRA strategy.
A married couple over 50 can contribute up to $7,000 per person ($14,000 total) to a backdoor Roth for the 2021 year. Additionally, if they missed out on taking advantage of this strategy in 2020, then they can contribute for the 2020 year as well, bringing the total contribution up to $28,000. If you are taking advantage of the backdoor Roth IRA strategy, make sure you don’t forget to include form 8606 with your tax return or you could accidentally end up paying taxes twice on the money!
If you don’t have the cash on-hand to contribute to a backdoor Roth but still want to take advantage of the strategy, consider pulling money from invested after-tax accounts. Selling equities (which likely have losses), moving the cash into the Roth, and immediately investing it can put you in a situation where a rebound in stock prices is tax-free instead of taxable. Typically, Roth IRAs are a much more tax efficient option than a brokerage account.
Compound After-Tax Savings Through Mega-Backdoor Roths
If your employer’s 401k plan allows for non-Roth after-tax contributions, you have the opportunity to take advantage of the Mega Backdoor Roth strategy. Depending on the plan, you may be able to contribute up to $37,000 over and above the $26,500 that you can contribute pre-tax to the plan ($19,500 if single) for 2021. This non-Roth after-tax money can then subsequently be rolled out to a Roth IRA where any future growth is tax free. By combining the Mega Backdoor Roth strategy with the regular backdoor Roth strategy, you can amplify the amount of tax-free funds in your Roth IRA for long-term growth.
One key caveat during these times of uncertainty: Make sure to not deplete your emergency fund or cash reserves in pursuit of maxing out the funding for the Mega Backdoor Roth and Backdoor Roth IRA strategy. You want to ensure you have the liquidity necessary to cover an emergency if you need it.
How Your Personal Finances and Savings Can Benefit From the Market Volatility Surrounding the Coronavirus
Utilize the Market Pullback for Future Education Expenses
With schools closing left and right for the remainder of the 2019-2020 school year, putting aside money for future educational expenses may not be top-of-mind. However, 529s are like Roth IRAs can only be used for education expenses (without a penalty).
If you have available cash on hand (that you don’t need for your emergency reserve), now may be a great time to contribute to a child’s or grandchild’s 529 account. After the pullback in the market, we expect the next 3-5 years of returns to be better in the market than average. Remember, the greatest value of the 529 is the compounding tax-free growth, so this strategy works best for young children that have many years of growth. We’d be wary of contributing to a 529 account for a child that has only one year left before college. Additionally it’s important to note that due to the Secure Act you can now use 529s to cover private school costs for K-12.
Ensure that Your Estate Planning Documents are Up-To-Date Including Power of Attorney, Medical Power of Attorney and Your Will
We are hopeful that our global leaders and healthcare professionals will find a resolution to COVID-19. Despite that, it’s hard to ignore the dire predictions regarding infection rates and mortality. We recommend that everyone ensures their Powers of Attorney, Medical Powers of Attorney, alongside Wills and other Estate documents are up-to-date. It’s almost equally important to ensure that the appointed individuals know to access these documents and, if possible, to provide them a digital copy. Hopefully, it’s an unnecessary precaution, but it’s better to have these documents ready and not need them then it is to need them and not have them.
Lowered Treasury Rates Make Refinancing for Mortgages Attractive
To keep the economy pushing forward, the Fed has been lowering rates in recent months. We’ve seen a massive drop in the 10-year treasury from around 1.9% in early 2020 to a low of 0.6% at the height of the Coronavirus panic in March 2020. Many people expect an imminent drop in mortgage rates, which would make this an ideal time to refinance, but we haven’t yet. Why not? To us, there are two primary reasons.
First off, there has been a spike in demand for refinancing recently. Banks are slow to lower rates on mortgages while there is plenty of current demand, because they don’t need to yet. They still have plenty of business, and we expect that it will take some time before this demand works its way through the system.
Additionally, given the economy’s recent setbacks from the widespread shutdown over COVID-19, banks are worried about the credit quality of refinancers. In this higher-risk environment, a borrower who has never missed a payment may end up in a situation they can’t control (ie. being laid off, unable to work, or can’t find work in an economy where companies have generally frozen hiring) and unable to repay these mortgages.
We still see refinancing as an opportunity for many of our clients, but for many of them, it’s better to hold off for a while. We need to wait to see the high level of demand work its way through the system. Continue watching the 30-year mortgage rates for refinancing opportunities, but we may not see these lows in mortgages for another quarter or two. Also, remember the rule of thumb of refinancing: Don’t consider it unless you are getting at least a 1% drop in your rate, otherwise the fees and costs to refinance typically don’t make sense.
Market Implications on Your Investments
By the end of the first quarter in 2020, we’ve already seen the market’s peak-to-trough drop of over 35% forcing the question: have we reached the bottom? The only answer: We don’t know yet. We do know that the market has presented great buying opportunities for long-term investors as it’s traded near 3-year lows, and historically, the market has done significantly well in the years following massive drops like these. We believe that, in addition to saving in the various Roth vessels, now is a great time to utilize financial planning strategies in your portfolio to take advantage of the market downturn.
Is it Time to Rebalance?
We are firm believers that, in the long-run, the market and economy will be fine. It’s scary right now, but when navigating this pandemic, the right thing to do is often the hardest thing to do--sticking with the long-term investment strategy and rebalancing accounts where necessary.
Oftentimes, this means bringing more of what has already taken a hit back towards its long-term allocation even if that means trimming what has held up--fixed income and cash--and buying what has gotten beaten up--equities. For our clients this means trimming profits from equities in December and January, and after the drop in the market, adding to equities in March.
Rebalancing should not involve massive moves from cash and fixed income to equities. Instead, it’s small additions to equities to take advantage of the opportunities at these price points for the long-term investor. For our clients, this is a continual part of our process as we rebalance their accounts towards their long-term allocation.
Tax Loss Harvesting
With the volatility in the market, many investors are seeing prominent losses in returns and recovery strategies are top-of-mind. Some people see this as a major concern, however, we utilize a strategy known as tax-loss harvesting with our clients to make the most of these situations. With tax-loss harvesting, you get both the tax benefits of losses while staying invested for the eventual rebound. For this strategy, you sell a security in your taxable account that’s at a loss to take a tax benefit this year (and in the future), while simultaneously buying an investment that should have similar returns going forward. You can use up to $3,000 of losses against ordinary income on your tax return. Additionally, you can use the losses to offset any capital gains you receive now, and if you don’t use up all the losses, you can carry any unused losses into the future.
The Energy Sector During COVID-19
Many of our clients working in oil and gas have seen substantial losses on energy stock recently. Over the recent months, we’ve seen the sector get hit with a double-whammy: while they’re facing the economic impact of COVID-19 reducing demand for oil, OPEC is flooding the market with supply.
Energy has sold off significantly more than broad based equities, and many of our clients with long careers in energy believe that the stock they own in energy is oversold. Additionally, many of the major players are paying attractive dividends at this junction.
If you believe energy stock is oversold compared to the market and you believe it will rebound more than the market, an option is to sell the energy security that you rode down to harvest the losses and buy a similar energy security to ensure participation in the upside. For example: if you rode the market down with Shell stock, consider selling your Shell stock, and buying BP, Exxon, or Chevron. Alternatively, consider buying a mutual fund or ETF that invests only in the energy sector to ride the market back up.
COVID-19’s Impact on Your Pension
Defer taking that lump sum pension until interest rates drop further. For individuals facing retirement or severance considering taking their pension as a lump sum, it will likely make sense to wait until segment rates drop further to yield the greatest benefit. Many companies look at where segment rates were in the past to determine the discount rates used to calculate these lump sum benefits. One benefit of this economy is that lower interest rates correlate to higher lump sum values.
At BP, if you are planning to take your pension lump sum in April, the calculation will be based off segment rates from three months prior (January). In January, the 10-year treasury rate was close to 1.8%. As of August 4th, it had fallen to .52%.
At Chevron, the blended rates from 3 to 6 months prior determine the value of your lump sum payout. Segment rates tend to follow the 10-year treasury, and we have only just seen a dramatic drop in yield in the 10-year treasury in March.
Given this trajectory, it will likely be very beneficial to defer starting the pension lump sums until the 3rd or 4th quarter of 2020 to obtain the highest value.
Preparing For Life After Coronavirus
There are a lot of opportunities to deploy cash into what will likely be tax-beneficial long-term investment strategies. I’ve talked to numerous clients who see attractive buying points on the recent pullbacks in the market.
Don’t Deplete Your Emergency Reserve
Despite the opportunities, it’s important to be prepared. Ensure adequate liquidity in case unforeseen expenses arise. Holding 6-months worth of living expenses in savings as an emergency reserve is a good starting point. For some clients, we aim to have closer to an 18-month reserve. It’s great to take advantage of long-term opportunities but don't put your near-term needs at risk.
Ask For Advice When You Are Unsure
While we don’t have an exact timeline for recovery in the markets, at Willis Johnson & Associates, we work with our clients to ensure their portfolio considers both personal needs and financial risk exposure to get the maximum amount of savings. As part of our comprehensive asset management and planning process, we sit down with clients regularly to review portfolios and assess market conditions, educating them on options and assisting them in making the changes necessary to optimize their specific situation. If you have any questions or would like to discuss your portfolio, please contact your advisor or schedule a complimentary meeting with one of our financial planning experts.