Pekin Hardy https://pekinhardy.com Wealth Management Thu, 02 Apr 2020 20:06:39 +0000 en-US hourly 1 https://wordpress.org/?v=5.3.2 https://pekinhardy.com/wp-content/uploads/2015/09/cropped-PSS-Logo-Picture-1-32x32.jpg Pekin Hardy https://pekinhardy.com 32 32 The CARES Act: An Overview https://pekinhardy.com/the-cares-act-an-overview/ Thu, 02 Apr 2020 20:06:03 +0000 https://pekinhardy.com/?p=4680 This is the third article in a three-part series on the CARES Act, a $2 trillion stimulus bill that was signed into law on March 27th, 2020. The law is designed to offer wide-ranging assistance to households and businesses, providing everything from cash infusions to hospitals and expanded access to COVID-19 testing to small business loans to expanded unemployment benefits.

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This is the third article in a three-part series on the CARES Act, a $2 trillion stimulus bill that was signed into law on March 27th, 2020. The law is designed to offer wide-ranging assistance to households and businesses, providing everything from cash infusions to hospitals and expanded access to COVID-19 testing to small business loans to expanded unemployment benefits.

This article provides an overview of aspects of the law as a whole, including funding for large corporations and state and local governments. You can read our overview of relief provisions for small businesses here and provisions for individuals and families here.

The CARES Act, signed by President Trump on March 27th, is a $2 trillion stimulus package designed to bolster the economy through the coronavirus crisis. Prior articles in this series discussed the $600 billion in stimulus funding for individuals and families and $377 billion for small businesses, which only represents one-half of the total package. In this article, we will review the other major recipients of aid under the Act: large corporations, state and local governments, the health care sector, and safety net programs.

To provide some context for the size of the stimulus package, we estimate that $2 trillion is about 9% of GDP, with the entirety of this stimulus intended to be distributed within the next few months. The stimulus package passed in 2009 was one-half of the size—about 4.5% of GDP—and was spread over two years. The CARES Act is a stimulus package of truly enormous size and scope, but it will likely not be the only such package required to sustain the economy through the pandemic and its painful aftermath.

Large Corporations

Within the CARES Act is the Coronavirus Economic Stabilization Act of 2020, which focuses on emergency relief to large businesses. In other words, this part of the Act will provide bailouts primarily to large corporations, though large non-profits, municipalities, and other entities are also eligible. $500 billion is provided to support organizations that do not qualify for small business relief, with special funding dedicated to the airline industry. This pool of money will be distributed to companies in the form of loans, loan guarantees, and other investments with a maximum five-year term. Dedicated funding is as follows:

  • $25 billion in loans for passenger air carriers,
  • $4 billion in loans for cargo air carriers,
  • $17 billion in loans for businesses critical to national security, and
  • $454 billion in funds for the Treasury to backstop emergency actions by the Federal Reserve to help other types of distressed businesses.

Unlike some of the loans available to small businesses, loans to large corporations are not forgivable. The loans must also be “sufficiently secured” and will have interest rates determined by average Treasury rates. The Treasury has been instructed to ensure that the Federal government is compensated for the risk assumed in making these loans, and any interest payments or gains from the businesses will be returned to the Treasury or deposited in the Airport and Airway Trust Fund.

The challenge with a bailout fund is ensuring that assistance only goes to the financially needy and that the interests of taxpayers are protected, and the CARES Act, unfortunately, has limited power on these fronts. Notably, the loans do come with a set of conditions that are intended to ensure that the funding is not used to pay shareholders or leadership directly. Firms must agree to:

  • A prohibition on stock or equity buybacks, dividends, or capital distributions for one year from the date of the loan or until the loan guarantee is no longer outstanding
  • Limitations on the compensation of any officer or employee who made more than $425,000 in 2019 for two years following the loan date
  • Retention of at least 90% of their employment levels as of March 24th, 2020 through September 30, 2020 (this requirement will apply to many but not all loans)

However, the Secretary of the Treasury has the latitude to waive any of the above requirements, so it is unclear how many firms will actually operate under these restrictions.

There are other potential loopholes that could lead to questionable uses of funds. For example:

  • The $454 billion general distressed business fund will go into a special purpose vehicle (SPV), which the New York Fed will leverage to make $4 trillion in corporate loans, representing 18% of U.S. GDP. The New York Fed will, in turn, rely on Blackrock to disburse the cash. The entire process will lack transparency, as all parties will be subject to confidentiality agreements that survive the termination of the contract.
  • The Act includes a clause that bars bailout loans from going to companies controlled by the President, Vice-President, Cabinet members, or members of Congress. However, some businesses associated with politicians (including some of President Trump’s businesses) might still qualify for assistance through small business loans to the hospitality industry.
  • To receive a loan, a company must be headquartered in the United States; this registration requirement seemingly rules out big companies that are registered overseas for tax reasons. However, some of these large companies have subsidiaries that are based in the United States and may be eligible for a loan, which would effectively use U.S. taxpayers’ dollars to bail out firms that avoid paying U.S. taxes.

Additionally, there is some question as to whether loans were the appropriate bailout vehicle at all. Many people, including President Trump, had been supportive of giving taxpayers equity stakes in the companies they rescue, which is how bank bailouts during the Great Depression were structured. In March 1933, the Reconstruction Finance Corporation (RFC) was empowered to purchase preferred stock in banks in need of financing; previously, the RFC’s role was only to provide loans to distressed banks. This change gave taxpayers an equity stake in the banks while giving the banks more time to recover, as there was no fixed repayment plan, which dramatically reduced the number of bank failures.

State and Local Government

Overall, the CARES Act designates about $340 billion for programs to aid state and local governments. $274 billion of the total is earmarked generally for the COVID-19 response, with $150 billion of the response funding coming in the form of direct aid to state and local governments. That direct aid will be allocated to states by population with a minimum of $1.25 billion, and states will split the direct aid with local governments serving populations of more than 500,000 people. As an example, the Tax Foundation estimates that Illinois’ total allocation will be just under $5 billion, with $3.5 billion going directly to state government and the remaining $1.5 billion going to the five largest counties.

Outside of the broad COVID-19 funding category, the Act also includes $5 billion for Community Development Block Grants to provide services to senior citizens and the homeless, $13 billion for K-12 schools, $14 billion for higher education, and $5.3 billion for programs for children and families, which includes providing immediate assistance to child care centers.

While $340 billion may seem like an enormous amount of money, this provision of the CARES Act is already being criticized as providing too little aid to states and to municipalities with too many restrictions. State and local governments are on the front lines of the coronavirus crisis, and many were facing financial difficulties before the pandemic. Unlike the Federal government, state and local governments generally must balance their budgets, so as revenues drop during the unfolding economic crisis, so too will state and local government spending, leading to budget cuts that could hamper recovery efforts.

Public Health

The CARES Act provides $150 billion in funding for public health purposes. $100 billion of that fund will be used to create the Public Health and Social Services Emergency Fund, which will reimburse eligible heath care providers for expenses related to the coronavirus crisis: building or leasing additional space for patients, buying medical supplies or personal protective equipment, training the additional workforce, etc.

For patients, the Act requires that health plans cover diagnostic tests for COVID-19 without cost-sharing or prior authorization as long as the Food and Drug Administration (FDA) or state have approved the test. Health care providers will be required to reimburse at a negotiated rate or the price listed by the provider. Plans will also be required to cover qualifying preventive services that may ultimately be recommended by the Centers for Disease Control and Prevention (CDC).

The Act also makes some strategic allocations to help with the coronavirus crisis as a whole: $11 billion for diagnostics, treatments, and vaccines, including funding to the FDA to expedite new drug approval; $4.3 billion to the CDC for programs and response; and $16 billion to the Strategic National Stockpile to increase the availability of equipment like ventilators and masks.

Safety Net Programs

The CARES Act provides $26 billion in funding to bolster the safety net programs that focus on food security. Schools will receive additional funding to provide meals to students, additional money is allocated to the Supplemental Nutrition Assistance Program (SNAP) to cover the expected increase in applications due to the coronavirus crisis, and food banks will receive direct aid. This is the second round of emergency funding for most of these programs, as they received earlier support from the Families First Coronavirus Response Act in mid-March.

Coronavirus Response: What’s Next

Despite the enormous size and scope of the CARES Act, many people, including ourselves, are asking the same question: will it be enough? As significant as the Act is, it seems highly unlikely that this will be the only stimulus measure taken by the Federal government in the coming months. Much depends upon the severity of the coronavirus outbreak and the length of time that social distancing measures put so much activity, economic and otherwise, on hold. We are in uncharted territory: not even during the Great Depression did so much of the economy come to a screeching halt. While we should not expect the CARES Act to be a solution to all problems, it is an important and, for the most part, well-considered first measure to provide immediate relief to the individuals and businesses who desperately need it, although we expect that more aid will be required. While this emergency stimulus package seems both appropriate and necessary, the long-term inflationary consequences of the deficit spending that will occur in 2020, funded by money printing by the Federal Reserve, are also deeply concerning to us.

This article is prepared by Pekin Hardy Strauss, Inc. (“Pekin Hardy”, dba Pekin Hardy Strauss Wealth Management) for informational purposes only and is not intended as an offer or solicitation for business.  The information and data in this article does not constitute legal, tax, accounting, investment or other professional advice.  The views expressed are those of the author(s) as of the date of publication of this report, and are subject to change at any time due to changes in market or economic conditions. Although information has been obtained from and is based upon sources Pekin Hardy believes to be reliable, we do not guarantee its accuracy.   

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The CARES Act: Relief for Individuals and Families https://pekinhardy.com/the-cares-act-relief-for-individuals-and-families/ Wed, 01 Apr 2020 20:02:23 +0000 https://pekinhardy.com/?p=4665 This is the second article in a three-part series on the CARES Act, a $2 trillion stimulus bill that was signed into law on March 27, 2020. The law is designed to offer wide-ranging assistance to households and businesses, providing everything from cash infusions to hospitals and expanded access to COVID-19 testing to small business loans to expanded unemployment benefits.

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This is the second article in a three-part series on the CARES Act, a $2 trillion stimulus bill that was signed into law on March 27, 2020. The law is designed to offer wide-ranging assistance to households and businesses, providing everything from cash infusions to hospitals and expanded access to COVID-19 testing to small business loans to expanded unemployment benefits.

This article provides an overview of aspects of the bill that provide relief for individuals and families, including the individual stimulus payments. You can read our overview of relief provisions for small businesses here.

The CARES Act, signed by President Trump on March 27th, has set aside over $600 billion to help households weather the coronavirus crisis, with the vast majority of that funding going towards direct cash payments to households and providing larger unemployment payments to more people.

While the cash payments and unemployment insurance are the two most prominent pieces of the Act, numerous, less noticeable provisions will provide tangible benefits to many households. In this article, we review eligibility and payment amounts for both the stimulus payments and the expanded unemployment insurance as well as several other provisions of the Act that may benefit you.

Recovery Rebates (Individual Stimulus Payments)

What Is It: One-time cash payments
Who Is Eligible: All taxpayers below specific adjusted gross income (AGI) thresholds
When Is It Applicable: Payments estimated to arrive in April or May

One of the most discussed aspects of the CARES Act is the individual stimulus payments that the Act provides. These payments are being structured as tax “recovery rebates” for 2020 that use a taxpayer’s 2018 or 2019 tax return to calculate the size of the rebate. The Tax Foundation estimates that about 90% of taxpayers will receive some rebate under the Act.

Through the recovery rebate program, single filers will receive up to $1,200, married couples filing a joint return will receive up to $2,400, and an additional $500 will be provided for each child under 17 in the household. However, the adult rebate begins to be phased out above a specific adjusted gross income (AGI) depending on filing status:

  • Married filing jointly: $150,000
  • Head of Household: $112,500
  • All Other Filers: $75,000

Specifically, the recovery rebate will be reduced by $5 for every $100 of income above the threshold amount.

Example: A married couple who files a joint return has three children under the age of 17. If their AGI is $150,000 or lower, they will receive the maximum recovery rebate of $2,400 + $500 + $500 + $500 = $3,900. If instead their AGI is $170,000, their recovery rebate would be reduced by $20,000 x 5% = $1,000, so they would receive $2,900 in total.

A strange feature of the rebate is that the initial amount will be paid based on a taxpayer’s 2018 or 2019 tax return, but the rebate will be “finalized” in 2020 taxes. Essentially, the rebate will be paid now based on estimated need, but if a taxpayer’s 2020 return shows that they should have been entitled to more assistance, they will receive additional funds in 2021. On the other hand, if a taxpayer’s 2020 return shows that they were entitled to less assistance than they received, they will not need to return the overpayment.

This feature creates an unfortunate loophole for taxpayers who may have had higher income in 2018 or 2019 and have since lost substantial income. While those taxpayers should still benefit, they won’t receive any cash assistance until they file their 2020 tax return in 2021. If you had a high income in 2018 but an income below the threshold amount in 2019 and have not yet filed your 2019 tax return, you may want to file as soon as possible. We do not yet know what the cutoff date will be for calculating rebates, but filing your 2019 taxes early should increase the chance that your rebate is calculated based on the lower income amount.

Recovery rebates will be sent to the account in which a taxpayer receives their Social Security benefits, the account into which their 2018 or 2019 refund was deposited, or to the last known address on file. This has the potential to create problems for those who have closed bank accounts and/or moved, but as of now there is no guidance on how to correct potential issues before checks are sent. The CARES Act does at least provide for a hotline with the IRS for tracking down missing rebates, but making sure you receive the amount warranted may be painful.

If you would like to estimate your recovery rebate, first calculate your maximum possible benefit:

  • Add $1,200 for each adult taxpayer in the household
  • Add $500 per child under 17 in the household

Then, find your AGI from 2019 if you have filed already or 2018 if not. Compare your AGI to the phaseout amounts ($150,000 if married filing jointly, $112,500 if the head of household, $75,000 for all others).

  • If your AGI is below the phaseout amount, your recovery rebate is the maximum possible benefit.
  • If your AGI is above the phaseout amount, estimate your recovery rebate: your maximum possible benefit – [(your AGI – threshold amount) x 5%]

Expanded Unemployment Insurance (UI)

What Is It: Increased unemployment insurance payments
Who Is Eligible: Unemployed workers, including many who would not have qualified for UI before CARES
When Is It Applicable: Up to 39 weeks of benefits in 2020

The CARES Act significantly increases the number of people who are eligible to apply for unemployment insurance, the amount of money that unemployed workers will receive, and the length of the time they will receive the benefit.

Prior to the CARES Act, unemployment insurance was structured such that many of the people who are most directly affected by the pandemic (independent contractors, part-time workers, etc.) were not eligible to collect it. CARES provides a greatly expanded pandemic unemployment assistance program that includes self-employed individuals and many individuals who would be ineligible for regular UI.

The Federal government will also provide an additional $600 per week for four months to workers on unemployment insurance above what they would receive from their state and will fund an additional 13 weeks of benefits for those who are near the end of their regular UI period.

The CARES Act also hopes to incentivize states that have a “waiting week” provision to suspend that period. In many states, unemployed workers are unable to collect UI for the first week they are unemployed in an attempt to encourage them to find a new job quickly. Under the CARES Act, the Federal government will fully fund the first week of unemployment insurance in those states that suspend it and allow workers to collect benefits immediately.

Retirement Plan Loans and Distributions

What Is It: Coronavirus-related distributions and enhanced loans
Who Is Eligible: People affected by the coronavirus with IRA or employer-sponsored retirement plans
When Is It Applicable: 2020

The CARES Act creates special rules for coronavirus-related distributions and loans from retirement plans in calendar year 2020, which will allow taxpayers who are affected by the pandemic to more easily access their retirement savings in an emergency. Distributions and loans qualify for special treatment if they are:

  • $100,000 or less
  • Made from an IRA or employer-sponsored retirement plan
  • Made in 2020
  • Made by someone who has been impacted by the coronavirus, which means:
    • The individual or a spouse or dependent was diagnosed with COVID-19,
    • The individual was quarantined, furloughed, or laid off, or saw their work hours reduced,
    • The individual cannot work because they lost childcare due to the virus,
    • The individual owns a business that closed or had to operate under reduced hours, or
    • The individual suffers harm from the pandemic in some other way that the IRS approves.

Coronavirus-related distributions allow taxpayers to withdraw funding from their retirement accounts with the following advantages:

  • Individuals under the age of 59 ½ can access their retirement funds without paying the usual 10% penalty and without the usual mandatory Federal withholding of 20%.
  • Individuals have the option to roll all or a portion of their distribution back into their retirement account within three years of receiving the distribution.
  • By default, the income from a distribution is split evenly over 2020, 2021, and 2022, but a taxpayer can include all distribution income in their 2020 income if that is more tax-advantageous.

Instead of taking income from a qualified retirement plan, taxpayers can also take a loan against the value of their account. The CARES Act changes the rules for these loans:

  • The maximum loan has increased from $50,000 to $100,000
  • 100% of the account’s vested balance can be used for a loan. In normal years, an individual could only take a loan of 50% of a vested balance above $20,000.
  • Any payments due on the plan loan in 2020 can be delayed for up to one year.

Required Minimum Distributions (RMDs) Are Waived

What Is It: Waiver of RMDs
Who Is Eligible: Anyone who would have been required to take an RMD
When Is It Applicable: 2020

The CARES Act suspends RMDs for the entirety of 2020 for both account holders and beneficiaries taking stretch distributions. Voluntary distributions, of course, remain allowed, whether the account holder needs the income to offset their expenses or if they want to make a Qualified Charitable Distribution this year to use pre-tax dollars for giving.

Those individuals who turned 70 ½ in 2019 but had elected to take their first RMD between January and March of 2020 instead of during 2019 will receive a double benefit: they will not be required to take their 2019 or their 2020 RMD, as any RMD that would take place in 2020 is waived under the Act. (As a reminder, the SECURE Act changed the age at which RMDs begin to 72 starting in 2020, so if you turn 70 ½ in the coming year, none of this applies to you.)

If you have already taken your 2020 RMD but do not need the income this year, it is possible to “return” your RMD as long as you are the account holder and not a beneficiary. If the distribution was made within the last 60 days, you would simply be able to write a check or transfer the amount of the RMD back into the account as a rollover. If the distribution was made earlier than that and you can show that you have been impacted by the coronavirus, you should be able to roll the amount back into your account within the next three years under the same guidelines being used for coronavirus-related distributions.

Charitable Contribution Deduction

What Is It: $300 deduction for Qualified Charitable Contributions
Who Is Eligible: All taxpayers who do not itemize their taxes
When Is It Applicable: 2020 on

The Tax Cuts and Jobs Act eliminated the tax benefits of charitable contributions for the vast majority of taxpayers, but the CARES Act adds back an above-the-line deduction for donations for those who cannot itemize on their Federal return. The deduction is limited to only $300 and only contributions made in cash directly to qualifying non-profits (so contributions to donor-advised funds do not apply), but it can still provide most taxpayers with a small tax break.

Student Loan Payment Relief

What Is It: Suspension of Federal student loan payments
Who Is Eligible: Anyone making payments on Federal student loans
When Is It Applicable: Until September 30, 2020

The CARES Act suspends all required payments on Federal student loans and prevents additional interest from accruing on that debt through September 30, 2020. Involuntary debt collections such as wage garnishment are also suspended during that period. These months do still count towards forgiveness programs like the Public Service Loan Forgiveness program, so those who are hoping to take advantage of those programs will not see their eligibility affected.

If you have been making voluntary rather than required payments on your loans, those will not automatically be suspended under the CARES Act. You would need to contact your loan provider directly to suspend these payments, though any payments you can make before September 30 are effectively payments on 0% interest debt.

This article is prepared by Pekin Hardy Strauss, Inc. (“Pekin Hardy”, dba Pekin Hardy Strauss Wealth Management) for informational purposes only and is not intended as an offer or solicitation for business.  The information and data in this article does not constitute legal, tax, accounting, investment or other professional advice.  The views expressed are those of the author(s) as of the date of publication of this report, and are subject to change at any time due to changes in market or economic conditions. Although information has been obtained from and is based upon sources Pekin Hardy believes to be reliable, we do not guarantee its accuracy.   

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The CARES Act: Relief for Small Business Owners https://pekinhardy.com/the-cares-act-relief-for-small-business-owners/ Tue, 31 Mar 2020 21:04:01 +0000 https://pekinhardy.com/?p=4655 This is the first article in a three-part series on the CARES Act, a $2 trillion stimulus bill that was signed into law on March 27, 2020. The law is designed to offer wide-ranging assistance to households and businesses alike, providing everything from cash infusions to hospitals and expanded access to COVID-19 testing to small business loans to expanded unemployment benefits.

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This is the first article in a three-part series on the CARES Act, a $2 trillion stimulus bill that was signed into law on March 27, 2020. The law is designed to offer wide-ranging assistance to households and businesses alike, providing everything from cash infusions to hospitals and expanded access to COVID-19 testing to small business loans to expanded unemployment benefits.

This article provides an overview of aspects of the bill that provide relief for small business owners, including the greatly expanded small business loan program.

The CARES Act, signed by President Trump on March 27th, has set aside $377 billion to help small businesses weather the coronavirus crisis, with the vast majority of that funding going towards two loan programs through the Small Business Administration (SBA): a national Economic Injury Disaster Loan (EIDL) program and a new Paycheck Protection Program (PPP). The Act also greatly expands the number of small organizations that can receive loans from the SBA, so many businesses and non-profits with fewer than 500 employees are now eligible to apply.

Both EIDL and PPP loans are designed to offer significant assistance to small businesses, but businesses will only be able to receive either an EIDL or a PPL loan. In this article, we outline both programs, including loan structure, requirements, limitations, and application availability, to help business owners determine which program is best for their business. In addition, we review some of the tax breaks that the CARES Act offers to small businesses.

Economic Injury Disaster Loans (EIDL)

Who Can Apply: Most organizations with fewer than 500 employees
Loan Size: Up to $2 million
When to Apply: Now
Use of Funds: Working capital

Emergency Economic Injury Disaster Loans (EIDLs) are typically available to small businesses in the face of major disruption, but the CARES Act greatly expands eligibility. Under CARES, the following organizations are eligible for loans:

  • Businesses who were already eligible for SBA loans remain eligible (see here for eligibility by industry)
  • All organizations in all U.S. states and territories with fewer than 500 employees are eligible to apply, including:
    • Sole proprietorships
    • Independent contractors
    • Non-profits, and
    • Tribal small business concerns.

Organizations are eligible for the loan regardless of industry if they meet the size requirements and have been “substantially affected by COVID-19,” which, for the purposes of the Act, could include supply chain disruptions, staffing challenges, a decrease in sales or customers, or shuttered businesses.

Typically, these loans are only available to businesses that have been in operation for one year, but under CARES the only requirement is that your business or non-profit was in operation as of January 31, 2020.

EIDL loans can be used to cover a variety of ongoing expenses:

  • Payments on fixed debts
  • Payroll
  • Accounts payable, and
  • Other bills your organization is currently unable to pay.

Small businesses can expect to pay 3.75% interest and nonprofits will pay 2.75%. Loan terms will be flexible up to 30 years based on the individual business’s ability to repay, with the intention to keep payments affordable. For loans under $200,000, the SBA will not require a personal guarantee, but will take a collateral interest in your business’s assets if possible.

Apply for a loan and learn more about the program on the SBA’s website.

The Emergency Economic Injury Disaster Loan Advance

Who Can Apply: Organizations that are applying for the expanded EIDL
Loan Size: $10,000
When to Apply: As soon as possible
Use of Funds: Any business expenses

Businesses and non-profits that apply for an Economic Injury Disaster Loan are also eligible to apply for a $10,000 emergency advance that will be disbursed to you within three days of your application. As the larger SBA loans will take longer to be distributed, the emergency advance is intended to provide some immediate relief to businesses making applications. This EIDL advance will never need to be repaid, even for those businesses that are ultimately denied a loan under the program.

For those organizations who receive an advance and a forgivable loan under the Payment Protection Program (see more below), the amount forgiven under the PPP will ultimately be decreased by $10,000.

Importantly, the CARES Act only earmarked $10 million dollars for these advances, and the fund is first come, first served. Those who wish to apply for the advance should apply as soon as possible to ensure funds remain.

Apply for an advance and learn more about the fund on the SBA’s website.

Paycheck Protection Program (PPP)

Who Can Apply: Most organizations with fewer than 500 employees
Loan Size: Up to $10 million
When to Apply: To be determined, but likely after April 11, 2020
Use of Funds: Payroll and certain fixed expenses

The CARES Act created the Paycheck Protection Program (PPP), which is designed to encourage small businesses and non-profits to retain their employees through the coronavirus pandemic. The PPP has similar eligibility requirements to the EIDL, in that most organizations with 500 or fewer employees are eligible. Additionally, businesses that are classified as accommodation or food service that have 500 or fewer employees per physical business location are also eligible to apply. The organizations must have been in operation as of February 15, 2020.

Owners will be asked to make a good faith certification that their business is being impacted by the coronavirus pandemic and that the funds will be used to cover approved costs incurred between February 15 and June 30, 2020. Qualifying expenses include:

  • Payroll costs, which are defined under the Act as
    • Salaries, wages, commissions, tips, and paid time off for U.S. employees with a cap of $100,000 per employee
    • Group health care expenses
    • Retirement benefits
    • Payments to independent contractors
    • State and local taxes assessed on compensation
  • Interest on mortgage payments or rent payments
  • Utilities
  • Interest on other debt

PPP loans will be available through any bank that is an approved SBA lender and will be 100% backed by the Federal government. The maximum principal of a PPP loan is 2.5x the average total monthly payroll costs incurred in the one-year period before the date of the loan, with a cap of $10 million. The interest rate will not exceed 4% and the term can be as long as 10 years. The SBA will not require any collateral or guarantees, and no payments will be required on interest or principal for 6-12 months.

Businesses that received an EIDL after January 31, 2020 are allowed to refinance their current loan and roll it into a PPP.

Importantly, significant portions of the PPP loan can be forgiven if the business or non-profit maintains its workforce. Organizations are eligible for loan forgiveness equal to the amount spent in the eight weeks following the date of the loan on payroll costs (as defined above), rent, mortgage interest, and utilities. The amount of the loan that must be repaid will be based upon employee retention and payroll:

  • The amount forgiven will be reduced if an organization reduces its number of employees or if the amount of compensation paid to workers earning less than $100,000 declines by more than 25% during that eight-week period.
  • If a business hires back employees or reinstates compensation by June 30, the reduction would then be decreased.

Essentially, if a business or non-profit keeps all of its employees and pays them on average more than 75% of their normal rate for the eight weeks following the receipt of the loan, up to 100% of the loan could be forgiven.

Guidance on the application process and disbursement of loans will be provided by April 11, 2020. While waiting for applications to become available, employers should consider the following steps:

  1. Contact your SBA-approved lender (probably your local bank) about your intention to apply or find an approved lender if you don’t have one, and
  2. Collect records of payroll costs, lease or mortgage payments, and utility payments for the past year, plus documentation to prove your business existed before February 15, 2020.

Learn more about the program, find an approved lender, and follow progress towards an application on the SBA website.

Tax Relief

The CARES Act also provides a number of additional provisions to provide tax relief to small businesses. While the details of these provisions are best discussed with your accountant, the most significant changes are outlined below:

  • If your business was fully or partially suspended due to COVID-19 but you continue to pay your employees, you may be eligible for a credit against employment taxes up to 50% of wages paid between March 12, 2020 and January 1, 2021, depending on the number of employees. If you receive a loan under the CARES Act, you may not be eligible for this credit.
  • The employer’s share of Social Security taxes on employee wages (6.2% of wages) required to be paid between March 27, 2020 and January 1, 2021 may be deferred for up to two years. If an employer receives a PPP loan and the loan is forgiven, the employer is not eligible for this tax relief.

This article is prepared by Pekin Hardy Strauss, Inc. (“Pekin Hardy”, dba Pekin Hardy Strauss Wealth Management) for informational purposes only and is not intended as an offer or solicitation for business. The information and data in this article does not constitute legal, tax, accounting, investment or other professional advice. The views expressed are those of the author(s) as of the date of publication of this report, and are subject to change at any time due to changes in market or economic conditions. Although information has been obtained from and is based upon sources Pekin Hardy believes to be reliable, we do not guarantee its accuracy.

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The Vital Importance of IRAs https://pekinhardy.com/the-vital-importance-of-iras-3/ Fri, 28 Feb 2020 16:51:23 +0000 https://pekinhardy.com/?p=2474 We have published this Navigator at this same time each of the past several years in order to highlight the importance of IRAs and to encourage our clients to make their annual IRA contributions prior to the tax filing deadline.

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the navigator

We have published this Navigator at this same time each of the past four years in order to highlight the importance of IRAs and to encourage our clients to make their annual IRA contributions prior to the tax filing deadline. Given the vital nature of this topic, we will continue to re-publish this Navigator each year with contribution and deductibility rules updated for the new tax year. We hope that you will find this updated letter to be helpful and informative.

Individual Retirement Accounts, or IRAs, are one of the most powerful savings and investment tools currently available to investors. An IRA allows assets to grow unencumbered by the drag of taxes, and IRA contributions may be tax-deductible in some cases. This article discusses the key role that an IRA should play in most investors’ savings and investing strategies and examines the primary characteristics pertaining to each of the four most common types of IRAs.


The Vital Importance of IRAs


Unless you have unusually dutiful and wealthy children who intend to take care of you when you retire, it would be remiss of you not to take advantage of investing in an individual retirement account (IRA), regardless of your income level. By maximizing contributions to an IRA, these accounts help to reduce potential tax liabilities today and allow the assets to grow tax-deferred for many years. Uncle Sam only allows investors to contribute a limited amount to an IRA each year, and there is no “doubling down” the following year if an opportunity to contribute is missed. The tax code allows older savers to make additional “catch-up” contributions, but even this provision only allows for an incremental $1,000 per year after age 50.

As the maxim goes, “time in the market is more important than timing the market,” thanks to the powerful impact of compound returns. To illustrate the power of compounding over time, let us provide an example. An investor contributes the maximum allowed ($6,000 for tax year 2019) in an IRA this year; assuming a 7% annual return compounded over 25 years, the original $6,000 contribution would grow to $32,564. After 30 years, the original contribution would have grown to $45,673. The investor would earn an additional $13,109 (or more than twice the original investment!) just by investing for an incremental five years.

Better yet, assuming the investor were to save $6,000 in a retirement account every year for the next 25 years, starting this year (and again assuming a 7% annual return), the retirement account would increase to $379,494 at the end of that period. After 30 years, the retirement account would increase to $566,765. That represents a nearly 50% difference due entirely to having saved for an additional five years! Furthermore, for an investor in the highest federal income tax bracket and who lives in the state of Illinois, for example (Illinois residents are currently subject to a 4.95% state income tax rate), the value of an IRA after 30 years could be more than 30% greater than a taxable account utilizing the same saving and investing strategy. The chart below provides a graphical representation of how an IRA and a taxable account might grow over time for such an investor, assuming a 7% annual rate of return and annual contributions of $6,000. For the sake of simplicity, we have not adjusted these numbers for inflation, but they nonetheless provide a clear illustration of the power of “time in the market,” as well as the potential benefits of investing in a tax-deferred investment vehicle.

Because investment gains in IRA accounts are tax-deferred or tax-exempt, IRAs can provide investors with the flexibility to change investments whenever necessary without creating a taxable gain. There are four main variants of IRAs that are available to investors, and each type has its advantages and drawbacks, depending on an investor’s age, income-tax bracket, distribution needs, etc. The balance of this article will focus on the reasons that a person might utilize one type of IRA over another, as well as the rules and regulations governing each type. Of course, the ultimate decision of which IRA is the appropriate vehicle for you to use should be made in consultation with your portfolio manager.


 Traditional IRA


An investor is eligible to invest in a traditional IRA regardless of income level. The primary benefit of a traditional IRA account is that there are no income taxes on investment earnings until withdrawals are made. Investors are allowed to start withdrawing money from a traditional IRA at age 59½ without a penalty, though ordinary income tax rates apply to any distributions. The age at which withdrawals become mandatory has recently changed as part of the SECURE Act, from age 70½ to age 72, except for individuals who reached age 70½ prior to January 1, 2020. IRA owners who reached age 70½ in 2019 must adhere to the previous rules and receive required distributions from their IRAs. If money is withdrawn prior to age 59½, a 10% Federal penalty tax will be applied to the withdrawal in addition to regular income taxes, which will apply to all earnings and any amounts that were originally contributed on a tax-deductible basis. Mandatory withdrawals, called Required Minimum Distributions, or RMDs, are calculated according to the investor’s life expectancy and account size and grow over time as a percentage of the portfolio.

A traditional IRA lets you put away as much as $6,000 annually, as of tax year 2019, or $7,000 if you are age 50 or older (these limits remain unchanged for tax year 2020). The tax deductibility of contributions is dependent on your income and whether or not you have an employer-sponsored retirement plan, such as a 401(k). Anyone who has earned income, regardless of age, can make a traditional IRA contribution.1 To deduct a traditional IRA contribution from taxable income, an investor’s Modified Adjusted Gross Income, or MAGI, must be less than IRS income limits; these limits are set by the IRS each year and depend upon a taxpayer’s filing status. Investors whose incomes exceed these limits may still be eligible for a partial deduction, but these deductions are phased out as income approaches an upper limit set by the IRS. The table below outlines the contribution and deduction limits for traditional IRAs for tax year 2019 (these limits will increase for tax year 2020).

Please note that even if you do not qualify for a tax deduction, it may still make sense for you to contribute to an IRA because of the attractive tax shield that an IRA creates for a portion of your investment income.


 Roth IRA


While traditional IRA earnings compound on a tax-deferred basis, Roth IRA earnings compound on a tax-exempt basis. Unlike a traditional IRA, there are no taxes on Roth IRA withdrawals when you withdraw money during retirement. There are also no age limits on eligibility for a Roth IRA, and, unless the laws change, there are no Required Minimum Distributions. However, investors who wish to open and/or contribute to a Roth IRA must meet certain income requirements, which depend on tax filing status. Because of the tax treatment differential, a Roth IRA typically is a better retirement vehicle than a traditional IRA, assuming that an investor meets the requirements to contribute to a Roth IRA.

Contribution limits for Roth IRAs are the same as for traditional IRAs (currently $6,000 with a $1,000 incremental catch-up for people older than 50; these limits remain the same for tax year 2020), and investors can contribute the maximum amount to a Roth IRA, regardless of whether or not they participate in employer-sponsored retirement plans. As with a traditional IRA, withdrawals can be made from a Roth IRA without penalty after age 59½, provided that the account has been open for more than five years. Failing to meet these requirements may result in a penalty tax, ordinary income tax, or both being applied to the withdrawal. Tax year 2019 contribution limits for Roth IRAs are shown in the table set forth below.

While the Roth IRA contribution limits listed above prevent high income earners from making direct contributions to a Roth IRA account, anyone can convert a traditional IRA into a Roth IRA, regardless of income level. Some higher income investors rely on this conversion option every year, by making an annual contribution to their traditional IRA and then converting those traditional IRA assets to Roth IRA assets (often referred to as a “Backdoor Roth IRA Contribution”). It should be noted that some Roth IRA conversions may be taxable events if the assets being converted have not yet been taxed as ordinary income.

 


 SEP IRA


A Simplified Employee Pension (SEP IRA) may be the best retirement account option for sole proprietors and small businesses with up to 100 employees. Employers can contribute as much as 20% of self-employment income each year, and this limit rises to 25% if the company is incorporated. Contributions are capped at $56,000 for tax year 2019 and will increase to $57,000 in 2020 (assuming this falls below the 20% and 25% limits). As with most other non-Roth retirement accounts, investment returns grow tax-deferred until money is withdrawn.

Contributions to SEP IRA accounts can be made by both the employer and by the employee. Contributions made by the employer on an employee’s behalf must be the same percentage for each employee annually. These contributions are tax-deductible as a business expense and are not mandatory every year. However, employers must decide each year whether or not to fund their accounts, and if they make contributions for themselves, they must also make contributions for all eligible employees.

In general, any employee who has worked for the same employer in at least three of the past five years should be allowed to participate in a SEP IRA, provided that he or she is at least 21 years of age and earns at least $600 annually. SEP IRAs carry the same rules as traditional IRAs when it comes to employee contributions. Employees can contribute up to $6,000 or $7,000 if they are age 50 or older for tax year 2019 (these limits remain unchanged for tax year 2020). Sole proprietors are subject to the (higher) employer limits rather than the employee limits.

Any withdrawals that are made from a SEP IRA prior to age 59½ are subject to ordinary income tax, as well as a 10% penalty. Like Traditional IRAs, withdrawals from SEP IRAs become mandatory after age 72, at which point all withdrawals are taxed at ordinary income tax rates.2


 Simple IRA


A Savings Incentive Match Plan for Employees (SIMPLE IRA) is an alternative to 401(k) plans for businesses with 100 or fewer employees. These plans are a win-win for employers and employees. Employers can either match employee contributions or simply contribute 2% of employee salaries up to the statutory contribution limits. Employers who match employee contributions may match up to the lesser of 3% of each employee’s salary or $13,000 for tax year 2019 ($16,000 if the employee is 50 years old or more). These limits will increase to $13,500 and $16,500 for tax year 2020. The employer receives a tax deduction on the contributions while employees receive extra compensation via contributions to their retirement accounts. Like other IRA plans, SIMPLE IRAs grow tax-deferred until withdrawals are made.

There are no age limits on participation in a SIMPLE IRA plan. However, withdrawals made before age 59½ may incur a steep 25% penalty if the withdrawal is made within the first two years of joining the plan, and there may still be a 10% penalty for withdrawals taken after the first two years. Money in SIMPLE IRAs is locked into the accounts, so an employee who moves to another employer within two years of joining a plan must wait until the two years have passed before moving the money to another plan in order to avoid the penalty.


 Closing Thoughts


As noted above, IRAs are powerful savings tools that should generally be maximized each year. Given the real possibility of increasing tax rates in the future, investors would be wise to consider every tax-sheltering opportunity afforded to them. IRAs provide one important such opportunity. We would urge anyone who is eligible (and able) to consider making the maximum contribution to his or her IRA each and every year. If you are already contributing the maximum amount to a 401(k) plan, then you have taken an important step in preparing for retirement. However, although contributions to an IRA may not be tax-deductible for you, we would still encourage you to consider making IRA contributions in addition to your 401(k) contributions in order to take full advantage of all of the tax-sheltering options that have been made available to you.

If you do not yet have an IRA, do not delay talking to your portfolio manager to discuss whether opening and contributing to one makes sense for you. For those who already have an IRA, we encourage you to make contributing to your account every year a high priority. As the examples we discussed showed, even one year of delay can make a major difference over time, due to the power of compounding. And, as always, we are more than happy to help you to understand how best to take advantage of IRAs.

1 Prior to the passing of the SECURE Act, those who had reached age 70½ could no longer contribute to an IRA, but the new legislation allows older savers who are still working to continue contributing to their IRAs as long as they are earning income.

2 This does not apply to SEP IRA owners who reached age 70½ prior to January 1, 2020. These individuals must adhere to the previous rules and receive required distributions from their SEP IRAs.

This article is prepared by Pekin Hardy Strauss, Inc. (“Pekin Hardy”, dba Pekin Hardy Strauss Wealth Management) for informational purposes only. The information and data in this article does not constitute legal, tax, accounting, investment or other professional advice. The views expressed are those of the author(s) as of the date of publication of this report, and are subject to change at any time due to changes in market or economic conditions. Pekin Hardy cannot assure that the strategies discussed herein will outperform any other investment strategy in the future, there are no assurances that any predicted results will actually occur.

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The SECURE Act https://pekinhardy.com/the-secure-act/ Fri, 14 Feb 2020 19:51:38 +0000 https://pekinhardy.com/?p=4331 The SECURE Act, which was signed into law at the beginning of the year, introduces new provisions intended to make retirement more secure for people across the country. Investors should be cognizant of the fact that the Act makes significant changes to IRAs, employer-sponsored retirement plans, and some aspects of the tax code, and will likely play a role in retirement planning.

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the navigator

The SECURE Act, which was signed into law at the beginning of the year, introduces new provisions intended to make retirement more secure for people across the country. Investors should be cognizant of the fact that the Act makes significant changes to IRAs, employer-sponsored retirement plans, and some aspects of the tax code, and will likely play a role in retirement planning.


The SECURE Act


At the beginning of 2020, President Trump signed into law the SECURE Act, which stands for “Setting Every Community Up for Retirement Enhancement.” The Act is intended to help both savers and current retirees by updating the laws to make retirement saving easier, more accessible to more of the populace, and more secure. As a result, the legislation will affect nearly everyone in or saving for retirement, but to differing extents.

In this Navigator, we will review some of the most significant changes made by the SECURE Act that may affect your retirement or retirement savings.


 New Rules for IRAs


  • The stretch provision for heirs was eliminated:
    Inherited IRAs and retirement accounts now must be distributed within 10 years, instead of distributed over the beneficiary’s life expectancy. There are no requirements for how the account is distributed during those 10 years, however, so beneficiaries will be able to choose the timing of their distributions. Despite the timing flexibility, this is likely to increase the taxes paid by heirs overall, especially those who will have to withdraw from IRAs during their peak earning years.This rule is only applicable to those accounts of decedents who pass away after December 31, 2019. Some beneficiaries, including spouses, disabled or chronically ill people, individuals who are less than 10 years younger than the decedent, and some minor children, are exempt from the rule.     
  • Required minimum distributions (RMDs) now begin later:
    For those who reach age 70 ½ in 2020 or later, the age at which RMDs begin has increased from 70  ½ to 72 years old. First year RMDs can now be delayed from December 31st of the year the individual turns 72 to April 1st of the following year.
     
     
  • Traditional IRA contributions can be made later:
    Starting in 2020, an individual can contribute to an IRA as long as they have earned income. Previously, contributions were not allowed past age 70 ½. This does not affect RMDs, however, so a 73-year-old with earned income could potentially both contribute to and withdraw from an IRA in the same year.

 New Rules for Employer-Sponsored Retirement Plans


  • Annuities are now allowed in 401(k) plans:
    While previously only available to 403(b) participants, 401(k) plans can now contain annuity and lifetime income options. Before the changes, employers had fiduciary responsibility to make sure that different products were appropriate for employees’ portfolios, but under the new law, insurance companies – which sell annuities – are expected to ensure plan options are appropriate. This is perhaps the most controversial aspect of the SECURE Act, with critics arguing that it is primarily a win for the insurance industry that lobbied for the bill and not necessarily a win for savers.If you have an employer-sponsored retirement plan, we would caution you to carefully assess any forthcoming annuity options before putting any contributions into one. Generally speaking, there is little reason for annuity contributions in an already tax-deferred plan like a 401(k). We have written extensively on fixed annuities and variable annuities in previous Navigators if you would like more information, and we invite you to contact your portfolio manager if you have any questions about annuity options in your own 401(k).
  • Tax credits have increased for small business retirement plans:
    For business owners with 100 or fewer employees, the tax credit for new retirement plans has increased from $500 to $5,000.
  • Benefits for automatic enrollment in 401(k) plans have increased:
    Auto-enrollment retirement plans have been shown to increase employee participation, and the Act includes several provisions to encourage the use of these plans. Employers who have established or choose to set up automatic plan enrollment for eligible employees will receive a tax credit of $500 to offset the setup cost of the plan. Additionally, the maximum contribution for automatic enrollment has increased from 10% to 15%.
  • Some part-time workers will have access to retirement benefits:
    Beginning in 2021, part-time employees who work more than 500 hours in three consecutive years will be able to participate in their employer’s retirement plan. Today, an employee must work more than 1,000 hours per year to participate.

 Other Significant Changes


  • 529 funds can now be used to cover student loan payments and tuition for apprenticeship programs, which were not approved uses of funds before this year.
     
  • Changes made to the ‘Kiddie Tax’ by the 2017 Tax Cuts and Jobs Act (TCJA) were repealed. Prior to TCJA, children with unearned income received $1,100 tax-free, were taxed at the child’s rate on the next $1,100, and were taxed at the parent’s rate on earnings over $2,200. Under TCJA, income over $2,200 was instead taxed at the trust and estate rates, which could be significantly higher than the parent’s rate. The SECURE Act reverts back to the parent’s tax rate beginning after 2019, and parents can use the new rates for 2019 taxes as well as to amend their 2018 taxes.
       
  • Qualified Disaster Distributions from retirement accounts have increased to $100,000.
     
  • Qualified Birth or Adoption Distributions up to $5,000 will be distributed from retirement accounts without penalty.
      
  • It is now easier for small businesses to pool together in multiple employer plans to offer retirement benefits to employees.

If you have any questions about how the SECURE Act will affect you and your family, please reach out to your Pekin Hardy Strauss advisor.


This article is prepared by Pekin Hardy Strauss,Inc. (dba Pekin Hardy Strauss Wealth Management, “Pekin Hardy”) for informational purposes only and is not intended as an offer or solicitation for business.  The information and data in this article does not constitute legal, tax, accounting, investment or other professional advice.  The views expressed are those of the author(s) as of the date of publication of this report, and are subject to change at any time due to changes in market or economic conditions. Pekin Hardy cannot assure that the strategies discussed herein will outperform any other investment strategy in the future, there are no assurances that any predicted results will actually occur.

 

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10 Predictions for the Next 10 Years https://pekinhardy.com/10-predictions-for-the-next-10-years/ Thu, 16 Jan 2020 16:30:21 +0000 https://pekinhardy.com/?p=4175 The 2010s represented the longest-ever period of sustained, uninterrupted economic growth and associated market gains. With shrinking unemployment, growing average household wealth, and increasing income disparity – driven by the most activist Federal Reserve in history – the stock market climbed to historic highs and the housing market was resuscitated, as bond yields declined to all-time lows.  The economy has experienced 110 months of sequential job gains thus far, and unemployment has reached a 50-year low.

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The future ain’t what it used to be.”

Yogi Berra, Baseball Hall of Fame Catcher & Manager

The 2010s represented the longest-ever period of sustained, uninterrupted economic growth and associated market gains. With shrinking unemployment, growing average household wealth, and increasing income disparity – driven by the most activist Federal Reserve in history – the stock market climbed to historic highs and the housing market was resuscitated, as bond yields declined to all-time lows.  The economy has experienced 110 months of sequential job gains thus far, and unemployment has reached a 50-year low.

Over this decade of immense change, the United States experienced many fascinating investing phenomena:

The United States lost its AAA credit rating.
Until 2011, the Federal government had always raised the debt ceiling in a collegial, bipartisan manner, so that the Federal government would continue to operate without a hitch.  In 2011, the Republican-controlled House of Representatives required spending concessions from President Obama before it would agree to raise the debt ceiling.  Although a last-minute deal was eventually reached, the capital markets reacted violently to the negotiations.  Accordingly, Standard & Poor’s downgraded the U.S. credit rating for the first time in history, dropping it two notches from AAA to AA+.

“Too Big to Fail” got a whole lot bigger.
During the Financial Crisis, 982 U.S. banks, insurers, and finance companies were deemed to be “Too Big to Fail,” thus justifying unprecedented, massive taxpayer cash bailouts, and an extended period of zero percent interest rates.   Despite the risks looming from these large-scale enterprises, the biggest banks have become far larger over the past decade.  Today, Citigroup, Bank of America, JPMorgan Chase, and Wells Fargo each have more than $2 trillion in total assets.[1]  Beyond that, the notional amount of derivatives on the balance sheets of the Too Big To Fail banks, now measured in the hundreds of trillions of dollars, should warrant, in our view, considerably more concern from investors and regulators.

Zero percent and negative interest rates played a critical role in driving asset prices north.
Central banks across the globe ventured into uncharted territory in the past decade by cutting interest rates to zero percent and, in certain countries, below zero percent.  The European Central Bank, as well as the central banks of Japan, Sweden, Denmark, and Switzerland cut their respective interest rates into negative territory.  For the first time in 5,000 recorded years of economic history, government bonds traded with a negative rate of return.  In 2019, Germany issued a 30-year bond with a zero percent yield for the first time.  Roughly one-third of non-U.S. bonds now sport a negative rate of return.[2]

Quantitative Easing (QE) played a significant role in stimulating financial asset prices.
In addition to zero percent and negative interest rates, the Federal Reserve and other central banks across the globe purchased trillions of dollars of government bonds, mortgage-backed securities, and, in certain cases, equity ETFs, reducing borrowing costs for governments, corporations, and households alike.  U.S. companies issued record levels of corporate debt and used much of the proceeds to repurchase stock.  From 2008 to 2015, the Federal Reserve expanded its balance sheet from $800 billion to $4.5 trillion.

The 2010s represented an uninterrupted bull market.
The decade began and ended in one extended bull market, with record-low interest rates, record-high profit margins, tax cuts, and unconventional monetary policies like quantitative easing pushing the stock prices upward with seemingly no pause in pace.  The S&P 500 Index trumped all other global markets this past decade in terms of investment performance with a 270% total return, as demonstrated in the chart below.

Big tech monopolies formed and outperformed.
Investment performance for the FAANG technology companies (Facebook, Amazon, Apple, Netflix, and Alphabet / Google) dominated the performance of the S&P 500 and the Nasdaq Composite; the best performing stock in the 2010s amongst the FAANG stocks was Netflix with a 4,111% total return, and the “worst” performing stock of these six companies was Alphabet with a 432% total return.  Notably, the U.S. Department of Justice has not brought an antitrust lawsuit against a technology company since 1999.

Unicorns became rampant.
In financial jargon, a “unicorn” is a privately held startup with a valuation of over $1 billion.  Although unicorns are supposed to be creatures only found in fairy tales, there were as many as nearly 300 financial unicorns in 2018.[3]  The proliferation of unicorns has been driven by 1) venture capitalists intensely pushing the “get big fast” strategy, 2) richly-priced acquisitions by large corporations who have easy access to cheap money, and 3) the considerable increase in the amount of private capital invested in startups.

Shale oil transforms the U.S. energy industry.
Extracted from oil shale rock fragments, shale oil is now being produced unconventionally in many locations in the United States and elsewhere.  While technological advancements increased the amount of unconventional oil and gas reserves in the United States during the 2010s, the costs of extracting shale oil, both in terms of dollars spent and environmental risks, are much higher than the costs of conventional oil production.  The lifetime of shale oil wells is also much shorter than that of conventional wells.  Nevertheless, this drilling innovation contributed significantly to GDP growth during the 2010s and transformed the United States from a net oil importer to a net oil exporter.

Cryptocurrencies became a new asset class.
While bitcoin was launched in 2008, most Americans were not aware of bitcoin and other digital currencies until 2017 when cryptocurrency prices hit the stratosphere.  In fact, bitcoin was the top performing asset class of the 2010s with a whopping price increase of 719,260%.  Many investors and technology entrepreneurs remain excited about the long-term potential of cryptocurrencies to revolutionize money, payment systems, and banking.

Globalization began to reverse.
Reversing a decades-long trend, international trade began to decline in 2018.  President Trump took aim at the trading policies of the European Union, South Korea, Japan, and, most importantly, China.  Since then, billions of dollars of new tariffs have been established, causing increased economic uncertainty.  With China alone, the United States has imposed tariffs on $550 billion in Chinese goods, which were countered by $185 billion in tariffs on U.S. exports to China.

An extraordinary decade for the capital markets has just drawn to a close. In the last several weeks, many investment firms and financial media outlets have been making predictions about the year 2020. Instead, we would like to take a stab at making some predictions about the next decade, while knowing definitively that a number of astounding, unforeseen events will unfold.

The capital markets are generally very skilled at making fools of people who make broad, sweeping predictions that turn out to be dead wrong. While acknowledging that some of our predictions will prove to be incorrect, we present our Ten Predictions for the 2020s:

  1. The dollar-centric international monetary system becomes a multi-polar monetary system.
    The U.S. dollar share of foreign central bank holdings continue to decline, as the dollar is used less in international trade.  Conversely, the Chinese Yuan, the Euro, the Japanese Yen, and gold will play an increasingly important role in foreign central bank holdings.  With lower international demand for dollars, the U.S. dollar exchange rate declines, benefiting U.S. producers with increased export competitiveness while harming U.S. consumers with higher import prices.  With dollar weakness, U.S. manufacturing resurges, inflation accelerates, and Federal debt levels eventually becomes more manageable.
  2. Without reform, the Federal Reserve’s monetary role increases, and interest rates remain low.
    With foreign central banks backing away from U.S. Treasuries and a ballooning budget deficit, the Federal Reserve becomes the last resort buyer of U.S. Treasuries in a significant and noticeable way.  These Treasury purchases fund the government’s defense spending, entitlement obligations, and interest payments, while also capping interest rates on U.S. Treasuries at low levels.  With interest rates capped by the Federal Reserve, U.S. fixed income investments generate rates of return that do not exceed the inflation rate.
  3. A resurgent U.S. Department of Justice pursues antitrust actions against monopolistic corporations.
    Several large, near-monopolistic technology companies face new regulations and/or are broken up as the U.S. government attempts to curtail their power and foster increased competition.  As part of this breakup, many of the free or heavily discounted services provided by these companies dissipate.  The U.S. government also places size limitations on commercial and investment banks, causing the largest banks to break up into smaller pieces.
  4. The S&P 500 disappoints.
    After one of the longest bull markets in history, the stock market disappoints in the 2020s.  Weaker S&P 500 investment returns are driven by the following:

     

    • Stock valuations in the United States are sky-high at the beginning of the decade and come down to more reasonable levels by 2030. Accelerating inflation reduces the present value of companies’ future cash flows, resulting in a stock market P/E ratio at the end of the decade that is well lower than the start of the decade.
    • Corporate share buybacks cease. Because buybacks had been the predominant buyer of stocks throughout the post-Financial Crisis period, the lack of buybacks has a considerable impact on demand for equities, negatively affecting share prices.
    • Corporate profit margins, which began the decade at record high levels, decline over the next ten years due in large part to higher wages, increased import prices, and efforts taken by the Federal government to prosecute antitrust cases.
    • To fund living expenses during retirement, aging baby boomers sell their housing, stock, and bond holdings at discounted prices to a smaller population of Generation Xers and Millennials.
  5. Value stocks meaningfully outperform growth stocks.
    As investors start to pay attention to business fundamentals, earnings, and cash flows, investors rotate out of expensive tech companies and into relatively inexpensive value stocks.  The cheapest part of the stock market at the beginning of the decade considerably outperforms the most expensive stocks in the stock market, similar to what transpired during the 2000s as the dot-com bubble ended.
  6. International stocks outperform U.S. stocks, led by emerging market stocks.
    As the dollar weakens, foreign stock markets as denominated in U.S. dollars outperform the U.S. market.  In many of these international markets, cyclically-adjusted price/earnings (CAPE) ratios are currently undemanding, and particularly so in emerging markets, which means that the valuations of foreign stocks are likely to rise during the next ten years.  Some of the big winners include now out-of-favor stock markets like China, Italy, Russia, Brazil, and South Korea, all of which trade at CAPE ratios well below that of the S&P 500.
  7. Gold shines.
    With 10-year bond yields below the rate of inflation, investors increasingly rely less on fixed income investments as a foundational store of value within investment portfolios.  Conversely, with interest rates low and inflation accelerating, gold’s investment attractiveness improves, as gold becomes an essential part of many investors’ strategic asset allocations.  At the same time, central banks continue to increase their purchases of gold as a neutral reserve asset to settle accounts with other countries.  As a result of increased demand by central banks and private investors alike, the gold price more than triples by the end of the decade.
  8. Blockchain-based cryptocurrencies like bitcoin become the biggest loser of the decade.
    Digital currencies continue to grow, but bitcoin and other blockchain-based cryptocurrencies lose their luster. Private cryptocurrencies become one of the worst-performing asset classes of the decade as it becomes evident that cryptocurrencies will never be embraced by the international monetary system as alternative currencies. Concurrently, a group of central banks collaborates to issue and administer a new and revolutionary digital currency system, which allows for far greater transparency, efficiency, safety, reliability, and government control than the current non-digital currency system.  This new digital currency system enables a myriad of new monetary tools that could not be applied today.
  9. Underfunded public pension plans receive a Federal bailout.
    With increasing liabilities and unreasonable assumed investment rates of returns, underfunded public pension plans create a financial crisis.  Municipal bond markets freeze up, and social unrest grows as retired teachers, police officers, and firefighters across the country demand assistance from the Federal government.  Congress bails out insolvent pension plans in return for structural reforms that prevent the problem from recurring.  The pension bailout causes further weakness in the U.S. dollar exchange rate as foreign investors worry further about the weakening fiscal discipline of the United States.
  10. The explosion in student debt forces dramatic changes in higher education.
    As college unaffordability worsens further, scores of Tier Two and Tier Three private universities declare bankruptcy and liquidate.  New startups that focus entirely on vocational training proliferate and take significant market share from traditional educational institutions.  Responding to these changes, large companies in the United States stop insisting on a college degree as a hiring prerequisite for many white-collar jobs.

A decade is a long time, and we expect significant trends to develop that we are not even contemplating, nor for that matter, is anyone else contemplating.  One thing we expect will not change is our approach towards investing.  We will be looking for value, we will be wary of risk, and we will continue to invest our clients’ long-term capital commitments like we do our own capital, with prudence and discipline.  We wish you and your families a happy, healthy, and prosperous decade, and we look forward to working hard on your behalf in the coming years with regards to your prosperity.

At the end of 2019, the former President of Pekin Hardy Strauss Wealth Management, Ron Strauss, unexpectedly passed away at the age of 80.  Ron played a larger-than-life role for those of us who were lucky enough to work with him.  His role as mentor, partner, friend, and father figure was invaluable to all of us.  He taught us by example: working hard, putting clients first, caring about the good of the firm’s associates, using ethics as a guide stone, and being committed to prudent, disciplined value investing.  Ron positively influenced all of us at Pekin Hardy Strauss Wealth Management; we will miss him terribly, and we appreciate the many notes of condolence that we have received during the past few weeks.

Farewell, our friend and mentor.

Pekin Hardy Strauss Wealth Management

[1] To provide a sense of scale, 2018 U.S. GDP was only $20.5 trillion.

[2] Source:  Deutsche Bank.

[3] Source:  TechCrunch.

This commentary is prepared by Pekin Hardy Strauss, Inc. (dba Pekin Hardy Strauss Wealth Management, “Pekin Hardy”) for informational purposes only and is not intended as an offer or solicitation for the purchase or sale of any security. The information contained herein is neither investment advice nor a legal opinion. The views expressed are those of the authors as of the date of publication of this report, and are subject to change at any time due to changes in market or economic conditions. Although information has been obtained from and is based upon sources Pekin Hardy believes to be reliable, we do not guarantee its accuracy. There are no assurances that any predicted results will actually occur. Past performance is no guarantee of future results. The S&P 500 Index includes a representative sample of 500 hundred companies in leading industries of the U.S. economy, focusing on the large-cap segment of the market.  The Consumer Price Index (CPI) is an unmanaged index representing the rate of the inflation of U.S. consumer prices as determined by the U.S. Department of Labor Statistics.

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Qualified Retirement Plans: Big Benefits for Small Businesses https://pekinhardy.com/qualified-retirement-plans-big-benefits-for-small-businesses/ Mon, 11 Nov 2019 19:43:50 +0000 https://pekinhardy.com/?p=3973 In this Navigator, we examine the most common types of small business retirement plans and discuss their suitability for various types of businesses. Not participating in some sort of a qualified retirement plan is generally a mistake, in our estimation, as business owners can use retirement plans to cut tax liabilities and improve after-tax investment returns.

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Qualified retirement plans are powerful savings tools that can help small business owners and their employees set aside assets for retirement in a tax-advantaged manner. There are many different types of retirement plans available to small businesses, and determining the most suitable type for any business should depend upon its size, its profitability, its ownership structure, and other factors. In this Navigator, we examine the most common types of small business retirement plans and discuss their suitability for various types of businesses. Not participating in some sort of a qualified retirement plan is generally a mistake, in our estimation, as business owners can use retirement plans to cut tax liabilities and improve after-tax investment returns.


Qualified Retirement Plans: Big Benefits for Small Businesses


Small business owners have a lot on their plates. They must make personnel decisions, marketing decisions, purchasing decisions, and the list goes on. One very important decision that may not get the attention it deserves is the type of retirement plan(s) to implement. Employer-sponsored qualified (i.e., tax-advantaged) retirement plans are highly effective savings tools, and they also play a key role in employee benefits packages. Selecting a suitable retirement plan structure is a decision that should not be taken lightly by business owners, as it could have far-reaching consequences for both owners and employees.

Before delving into specific plan types and structures, it is worth taking a moment to think about why a small business owner would want to offer his or her employees access to a qualified retirement plan. Businesses are not required to provide such benefits to their employees, and retirement plans are not without costs. However, from the perspective of the business owner, the benefits of offering a retirement plan usually outweigh the associated costs.

  • Research clearly shows that offering a retirement plan improves employee recruitment and retention.1
  • Offering retirement plan benefits allows business owners to accumulate sizable tax-advantaged savings for their own retirements.
  • Retirement plan expenses help to minimize business income taxes.

For many businesses, establishing and maintaining a qualified retirement plan is truly a win-win for both owners and employees.

With this strong case for offering retirement plans as a backdrop, let’s now examine some of the specific types of retirement plans that small businesses may choose to implement.

Small businesses can choose from several different types of qualified retirement plans. The most appropriate plan type for a specific business depends on several factors, but the size of the business is a key determinant in selecting an appropriate retirement plan type. Some plan types are more appropriate for smaller businesses or sole proprietorships, while others are more versatile and can be implemented in businesses of widely varying sizes. The table below shows the appropriateness of some popular retirement plan types for businesses of varying size.


 SEP IRA


 Appropriate for: sole proprietorships, businesses with fewer than 100 employees

A Simplified Employee Pension Individual Retirement Arrangement (“SEP IRA”) is a defined-contribution pension plan designed to provide sole proprietors and small businesses with a low-cost, efficient retirement savings vehicle. SEP IRAs are easy to administer, and they allow for tax-deferred growth before money is withdrawn. Employers and sole proprietors may contribute up to 20% of taxable income to a SEP IRA each year, and the contribution limit rises to 25% if the business is incorporated. Contributions are capped at $56,000 for 2019. SEP IRAs do not require an annual IRS Form 5500 filing, which can help to keep plan administration costs down. 2

Both employers and employees can make retirement contributions to SEP IRA accounts. Contributions made by the employer on an employee’s behalf must be the same percentage for each employee annually. These contributions are treated as a business expense and are not mandatory every year. However, employers must decide each year whether or not to fund their SEP IRA accounts, and, if they make contributions for themselves, they must also make contributions for all eligible employees.

Any employee who has worked for the same employer in at least three of the past five years is generally allowed to participate in a SEP IRA, provided that he or she is at least 21 years of age and earns at least $600 annually. SEP IRAs carry the same rules as traditional IRAs when it comes to employee contributions: employees can contribute up to $6,000 each year or $7,000 if they are age 50 or older for tax year 2019. Sole proprietors are subject to the (higher) employer limits rather than the employee limits.

Similar to traditional IRAs and 401(k) plans, any SEP IRA withdrawals that occur before age 59½ are subject to ordinary income tax as well as a 10% penalty. Withdrawals become mandatory after age 70½. All withdrawals from a SEP IRA are taxed at ordinary income tax rates at the Federal level, regardless of the age at which distribution happens.
SEP IRA assets, like other IRA assets (Roth, Traditional, etc.), can typically be invested in a vast array of investments, limited only by restrictions imposed on the part of the custodian of the plan. In most cases, SEP IRA assets can be invested in stocks, bonds, mutual funds, and ETFs at the account owner’s discretion.


 SIMPLE IRA


Appropriate for: businesses with fewer than 100 employees

A Savings Incentive Match Plan for Employees Individual Retirement Arrangement (“SIMPLE IRA”) is an alternative to 401(k) plans for businesses with 100 or fewer employees. Like SEP IRAs, SIMPLE IRAs are defined-contribution plans, and employers can either match employee contributions or simply contribute 2% of employee salaries up to the statutory contribution limits. Employers who match employee contributions may match up to the lesser of 3% of each employee’s salary or $13,000 for tax year 2019 ($16,000 if the employee is 50 years old or more). Taxable corporate income is reduced by the amount of the contributions, while employees and the business owner receive extra tax-deferred compensation via contributions to their retirement accounts. Like SEP IRAs, SIMPLE IRAs do not require an IRS Form 5500 filing.

There are no age limits on participation in a SIMPLE IRA plan. However, withdrawals made before age 59½ will incur a steep 25% penalty if the withdrawal occurs within the first two years of joining the plan and a 10% penalty thereafter, unless a qualifying exemption applies. SIMPLE IRA assets may not be rolled out of a plan (to another employer plan or another IRA) within the first two years of a plan’s existence.

Assets in a SIMPLE IRA, like those in a SEP IRA, can be invested in any securities to which the plan’s custodian has access, including stocks, bonds, mutual funds, and ETFs.

 


 401(K) 


Appropriate for: businesses of all sizes

Named for the subsection of the Internal Revenue Code in which they are defined, 401(k) plans are defined-contribution pension accounts that allow employees and employers to set aside tax-advantaged funds for retirement. 401(k) plans are extremely common in the United States, as approximately 79% of Americans work for an employer that sponsors a 401(k)-style retirement plan.3 401(k) plans may be appropriate for businesses of all sizes, from sole proprietorships to very large enterprises with thousands of employees, as plans can be tailored to fit the specific needs of the sponsoring business.

While 401(k) plans are highly customizable, nearly all 401(k) plans share certain characteristics. 401(k) plans allow employees to contribute pre-tax income into a retirement account which can be invested on a tax-deferred basis in a range of pre-determined investment options.4 Taxes are eventually paid at ordinary income rates when distributions take place during retirement. Employers may also contribute to employee accounts, and such contributions reduce taxable income at the corporate level. In a given tax year, an employee may contribute up to $19,000 to a 401(k) plan. Employees over the age of 50 may contribute an additional $6,000 each year as a so-called “catch-up” contribution. Combined employee and employer contributions to an individual’s 401(k) account cannot exceed $56,000 per year ($62,000 for those over 50).

The IRS wants to ensure that 401(k) plans are benefiting all employees, not just the highest-paid employees or owners of companies. For this reason, the IRS requires that 401(k) plans pass annual discrimination testing. These tests seek to determine if key employees/firm owners are benefiting significantly more from the plan than other employees. Plans that do not pass these tests each year can be penalized and may be forced to give contributions back to key employees/owners who must then pay taxes on the returned contributions.

One of the best ways to avoid running afoul of IRS discrimination rules is to implement a Safe Harbor provision, in which employers commit to making mandatory contributions to employee accounts. Employers may choose from three types of mandatory contributions:

  1. Non-elective Safe Harbor: The employer contributes 3% of each eligible employee’s salary to the plan, regardless of whether or not the employee contributes to the plan.
  2. Basic Safe Harbor Match: The employer matches 100% of the employee’s contribution up to 3%, then matches 50% of the next 2%. For employees to receive the employer match, they must contribute to the plan.
  3. Enhanced Safe Harbor Match: The employer matches 100% of the employee’s contribution up to 4%. Employees must contribute to the plan in order to receive the match.

Employers who include Safe Harbor provisions in their 401(k) plans can generally avoid the IRS’s discrimination testing. Such provisions are also popular with employees, as they amount to an effective pay raise, making Safe Harbor 401(k) plans a win-win for businesses.

A 401(k) plan sponsor may also choose to implement a Profit Sharing provision, which allows an employer to make discretionary contributions to employee accounts above and beyond any mandatory Safe Harbor contributions. While Profit Sharing contributions are not capped per se, total annual contributions, including both employee deferrals and any employer contributions, may not exceed $56,000 in 2019 (or $62,000 if the employee is age 50 or above).

 


 OTHER 401(K) VARIATIONS


Businesses can choose from several 401(k) variations, including Solo 401(k) plans and SIMPLE 401(k) plans.

— SOLO 401(K) —

Appropriate for: sole proprietorships

Solo 401(k) plans are 401(k) plans that cover businesses without non-owner employees. Because they only cover owners and their spouses, Solo 401(k) plans are not subject to IRS discrimination testing. However, a Form 5500 filing is still typically required.

Contribution limits for Solo 401(k) plans are the same as for Traditional 401(k) plans ($19,000 or $25,000 for employee deferrals and $56,000 or $62,000 for total contributions). However, because the employer and employee are one and the same, a special calculation determines how much an employer may contribute. Employer contributions are limited to 25% of net income, which is defined as gross income less half of self-employment taxes and all employee deferrals. An example may help to illustrate this calculation:

John is a 45-year-old sole proprietor and earns $150,000 in gross income from his business. He elects to defer $19,000 of his income to his Solo 401(k). His self-employment taxes amount to $20,829.60 (15.3% of the first $132,900 of income plus 2.9% of income above $132,900). Therefore, John can make an employer contribution of $30,146.30 to his Solo 401(k).

25% * ($150,000 – $19,000 – 0.5 * $20,829.60) = $30,146.30

— SIMPLE 401(K) —

Appropriate for: businesses with fewer than 100 employees

Like SIMPLE IRAs, SIMPLE 401(k) plans are useful for small businesses with 100 or fewer employees. Like Traditional 401(k) plans, they allow for employee deferrals (up to $13,000 in 2019 or $16,000 if the employee is age 50 or older). However, unlike other 401(k) plans, SIMPLE 401(k) plans require employers to contribute to each eligible employee’s account according to one of the two following methodologies.

1. A matching contribution up to 3% of each participating employee’s pay

2. A non-elective contribution of 2% of each eligible employee’s pay, regardless of participation.  No employer contributions are required beyond those listed above, and employees are fully vested at any contribution level. SIMPLE 401(k) plans are not subject to IRS discrimination testing, but a Form 5500 filing is required.

SIMPLE 401(k) plans are very similar to SIMPLE IRA plans, with one primary exception: SIMPLE IRAs do not allow participants to take loans from their accounts, while SIMPLE 401(k) plans do. A business owner who wants the option of taking loans from his or her account or who wants to offer such an option to employees without having to deal with IRS discrimination testing may find it attractive to implement a SIMPLE 401(k) plan.


 CASH BALANCE PLAN


Appropriate for: businesses of all sizes with highly predictable cash flows

A cash balance plan is a defined benefit plan that allows individuals in predictably profitable businesses to set aside substantial amounts of retirement money each year on a pre-tax basis. Such amounts are typically made in addition to contributions made to a 401(k) plan and/or a profit-sharing plan. Cash balance plans differ from other defined benefit plans (i.e., traditional pension plans) in that they define promised benefits in terms of an account balance, rather than a monthly or annual payment. Unlike defined contribution plans, investment risks related to a cash balance plan are borne by the employer, not the employee. Given this structure, one might think of a cash balance plan as a sort of “hybrid” retirement plan that incorporates characteristics of both defined benefit plans as well as defined contribution plans.

Cash balance plans offer significant benefits to participants, chief among them being the ability to make large tax-deductible contributions each year, well in excess of those allowed by traditional 401(k)/profit sharing plans ($56,000 or $62,000). Technically, cash balance plans do not have an annual limitation on contributions. Instead, cash balance plans have a maximum lump sum amount that can accumulate for any one participant, meaning that the annual contribution amount allowed is a function of the interest credit rate and the participant’s age.5 Younger participants have lower annual contributions because they have more years to accumulate the maximum lump sum amount.

While cash balance plans can be implemented by businesses of all sizes and are typically highly beneficial for participants, they are also relatively complex and typically require professional assistance in plan design and maintenance. For this reason, cash balance plans may only be appropriate for a small subset of businesses.


 CLOSING THOUGHTS


Our discussion of small business retirement plans has not been exhaustive, as there are countless variations and iterations of the various plan types outlined above. Many plan types can be customized to fit the specific needs of the sponsoring business. The most important takeaway here is that all small businesses can find a retirement plan that works for them, and business owners should do whatever they can to participate to the maximum extent possible in that retirement plan.

If you are considering implementing a qualified retirement plan for your small business or you are considering making changes to your existing retirement plan, please reach out to us to discuss potential solutions.


  1. https://business.betterment.com/wp-content/uploads/2018/08/2018-08-22-B4B-Customer-Survey-Report.pdf
  2. IRS Form 5500 is an annual report filed with U.S. Department of Labor (DOL) that contains information about a qualified retirement plan’s financial condition. Filing of a Form 5500 typically requires the involvement of a tax professional.
  3. U.S. Census Bureau.
  4. Some 401(k) plans allow participants to make after-tax Roth contributions as well.
  5. A plan’s interest credit rate is a guaranteed rate of return as specified by the plan document. It is typically tied to long-term Treasury yields or is stated as a low, fixed rate (e.g., 3% per annum).

This article is prepared by Pekin Hardy Strauss, Inc. (“Pekin Hardy”, dba Pekin Hardy Strauss Wealth Management) for informational purposes only. The information and data in this article does not constitute legal, tax, accounting, investment or other professional advice. The views expressed are those of the author(s) as of the date of publication of this report, and are subject to change at any time due to changes in market or economic conditions.

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Investing in Uncertain Times https://pekinhardy.com/investing-in-uncertain-times/ Fri, 25 Oct 2019 16:17:29 +0000 https://pekinhardy.com/?p=3940 Slowly but surely, the world has been moving from compromise and coordination to name-calling and tribalism. We read news of impeachment inquiries, trade wars, mass demonstrations, accusations of treason, worsening geopolitical tensions, conspiracy theories, fake news, and Twitter curses, sometimes all in the same day. The current period will likely be studied closely by historians trying to make sense of the many seemingly irreconcilable conflicts that have surfaced.

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“Things fall apart; the centre cannot hold;
Mere anarchy is loosed upon the world,
The blood-dimmed tide is loosed, and everywhere
The ceremony of innocence is drowned;
The best lack all conviction, while the worst
Are full of passionate intensity.

W.B. Yeats, “The Second Coming”

Slowly but surely, the world has been moving from compromise and coordination to name-calling and tribalism. We read news of impeachment inquiries, trade wars, mass demonstrations, accusations of treason, worsening geopolitical tensions, conspiracy theories, fake news, and Twitter curses, sometimes all in the same day. The current period will likely be studied closely by historians trying to make sense of the many seemingly irreconcilable conflicts that have surfaced.

Rising areas of contention include, but are not limited to: the United States vs. China, the rich vs. the poor, the old vs. the young, capitalists vs. socialists, Democrats vs. Republicans, and globalists vs. nationalists. Many of these conflicts seem irreconcilable, which means that a risk exists that some conflicts could be fought until won or lost rather than negotiated through compromise. The ongoing news about these conflicts creates uncertainty and stress for all concerned citizens.

As investors, we do not yet know how these conflicts will get resolved. Just as it would have been impossible to predict the drone attack that took place in September against Saudi Arabia, crippling approximately 50% of its oil processing capacity, it would be folly for us to make concrete predictions about political outcomes. Nevertheless, we have no choice but to express an opinion about probable outcomes through the investment decisions we make on behalf of our clients.

In this regard, we thought it would be useful to focus on a few areas of particular friction and discuss their likely economic and financial implications.

Global Geopolitical Uncertainty
Two phenomena have driven the increased friction between the United States and China. First, as China’s economic and military strength has grown, China is increasingly able to challenge the global hegemony of the United States from economic, military, cultural, and monetary standpoints. Second, ever since China joined the World Trade Organization in 2002, U.S. manufacturing job losses accelerated as U.S. companies built new production capacity in China while closing down domestic manufacturing facilities, which has exacerbated rising economic inequality within the United States.

While President Trump and Chairman Xi negotiate the terms of the U.S./China bilateral relationship, the uncertainty is unsettling for financial markets. President Trump often tries to buoy the stock market with hopeful tweets about trade discussions, except for when he scares the stock market with defiant tweets that stoke geopolitical tensions. As time passes, it grows more likely that the United States and China could enter a new cold war. In a worst-case scenario, we would expect to see a bifurcation of supply chains, payment systems, technology infrastructure, financial markets, and even the Internet. In a best-case scenario, we would expect a bilateral agreement between the United States and China that allows for limited trade and places additional restrictions on currency manipulation.

With regard to the Middle East, the United States is trying to withdraw from its role as a regional peacekeeper. As we write this letter, President Trump has announced his intent to withdraw from Syria. The drone attack on Saudi Arabia’s processing facilities probably took advantage of the Trump administration’s communicated lack of appetite for engaging in new regional conflicts in the Middle East. With less interest and ability to project power in the region, the U.S. will allow other countries like Russia, China, and Iran to fill the void.

The international monetary system, too, is in the middle of a transition as a unipolar monetary system centered around the U.S. dollar becomes increasingly multipolar. Since the Financial Crisis, perhaps in anticipation of current geopolitical shifts, foreign central banks have been turning away from the U.S. dollar as a hard currency reserve and turning towards gold. The United States has attempted to combat these efforts through economic sanctions, but sanctions are causing many countries to become even more eager to reduce their reliance on a U.S. dollar-centric monetary system.

With the United States withdrawing or reducing its military presence in the Middle East, the role of the U.S. dollar as the currency of choice in oil markets will inevitably diminish. China, which has become the largest importer of Middle East oil, should find it increasingly easier to buy oil without using U.S. dollars to do so. For example, in September, Petroleum Economist reported the terms of a strategic partnership between China and Iran whereby China would provide Iran with $400 billion of direct investment and 5,000 Chinese security personnel in return for Iran’s agreement to accept non-dollar currencies for its oil, including the Chinese renminbi. This development, and others like it, will inevitably reduce long-term global demand for U.S. dollars.

As the world shifts from a unipolar one with the United States as the world’s policeman and reserve currency issuer to a multipolar one, it should inevitably mean higher trade barriers, less globalization, less foreign hoarding of U.S. dollars, more support for gold as an international reserve, and fewer military commitments overseas for the United States.

Domestic Political Uncertainty
Over the past 30 years, with increased globalization, low inflation, and declining interest rates, U.S. investors have benefited greatly from increasing corporate profit margins and strong financial returns. At the same time, while wage gains have been robust for the upper 10% of the income distribution and especially for the upper 1% and above, wages for the bottom 90% of the income distribution have remained stagnant. As a result, income and wealth inequality has reached extreme levels not seen since the early 1930s, resulting in social discontent, class conflict, and the rise of populist politicians like Donald Trump on the Republican side and Bernie Sanders, Elizabeth Warren, and Andrew Yang on the Democrat side.

When considering the theme of economic inequality, we are reminded of historian Will Durant’s warning that an “unstable equilibrium generates a critical situation, which history has diversely met by legislation redistributing wealth or by revolution distributing poverty.” Current prescriptions that propose to address economic inequality vary. Some propose devaluing the dollar (e.g., Warren, Trump), thereby reducing the real value of debt obligations. Others propose wiping away debts, such as college loans (e.g., Warren, Sanders). Meanwhile, several want to use tax and fiscal policy to redistribute wealth explicitly (e.g., Yang, Sanders, Warren).

Regardless of the outcome of the 2020 election, whoever becomes president will likely face a starkly divided nation, enjoying wild popularity among one-half the electorate while being despised by the other half.

For investors, however, it may be the similarities between President Trump’s plans and various Democrat plans that are worth noting. President Trump has made it abundantly clear that he has no intention to lower the Federal deficit. If anything, he would be eager to sign a bill that increases spending to invest in infrastructure or further reduce tax rates. While Democratic candidates are calling for increased taxes, the taxes planned would hardly pay for proposed new spending. The top presidential candidates seem to all agree that keeping the Federal deficit under control is no longer a policy priority.

During the three consecutive years between 2016 and 2018, the budget deficit has expanded without a recession for the first time in U.S. history and is currently running at approximately 4% of GDP (see chart below). Based on current Congressional Budget Office projections, it is difficult to see anything that would get in the way of growing deficits during the next several decades, even without any policy changes. The policy proposals of President Trump and most Democratic presidential candidates would worsen an already poor budget outlook.

An increasing deficit is concerning enough, but the situation is made worse by the fact that the U.S. Treasury is starting to have increasing difficulties in financing these deficits. Since 2014, U.S. private investors, especially U.S. primary dealers such as JPMorgan Chase, have absorbed most of the additional supply of U.S. Treasuries (see chart below). However, these primary dealers have little room to expand their balance sheet further to buy U.S. Treasuries, which is why the Federal Reserve will have to become an increasingly significant source of government funding.

Indeed, in recent weeks, the Federal Reserve has begun to increase the size of its balance sheet again by purchasing U.S. Treasury bills to ensure that the Federal government remains funded (see chart below). While denying any kinship to the quantitative easing measures that took place earlier this decade, the Federal Reserve has resumed these purchases while the only visible difference is that its purchases are restricted to short-term Treasuries.

We expect that the Federal Reserve will continue to “inject liquidity” and buy U.S. Treasury bonds as necessary with that liquidity, with no end in sight. Our confidence level is supported by the large supply of Treasury bonds that already has become too large for private investors to absorb and  should only increase in the future.

Investment Implications
The ongoing, centrifugal transition towards a multipolar geopolitical environment and a more populist but divided political environment should have important repercussions on the economy and financial markets. For the United States, a less globalized economy and increasing fiscal deficits monetized by the Federal Reserve are likely to result in higher wages, lower corporate profit margins due to increased labor costs, accelerating cost-push inflation, reduced capital inflows, a lower exchange rate for the U.S. dollar, and a renewed policy focus on domestic manufacturing production.

Inflation’s acceleration has already begun, albeit quietly, due to a combination of increased tariffs, reduced immigration, and minimum wage increases, despite the dollar remaining strong up until this point. The consumer price index (CPI) is currently at a ten-year high. Further acceleration of inflation, while harmful to consumers and especially so to retirees, would make it easier for the U.S. government to reduce the real debt burdens of the Federal government, U.S. corporations, and U.S. households alike.

With a weakening dollar, we would expect foreign stock markets, commodities, and gold to outperform. On the other hand, those companies which have benefited greatly from globalization trends, such as Apple and Boeing, will probably have a difficult time maintaining current profit margins. Stocks that are expensive and trade at elevated P/E ratios should also have a difficult time performing well, as P/E ratios tend to contract when inflation expectations increase. We are still buying selected U.S. stocks for clients, but they are generally not the stocks of companies that have benefited so much from the globalization trend of the past 30 years, and they are generally stocks that already have low P/E ratios.

Despite inflation accelerating, we would expect interest rates to remain low, thanks to U.S. Treasury purchases by the Federal Reserve that would cap interest rates and provide funding for increasing budget deficits. This has happened before, in the years following World War II, when the United States also had a large debt load relative to GDP  (see chart below). Because inflation could very well remain at a level above that of long-term interest rates, long-term bonds remain unattractive investments.

In periods of history where it sometimes feels like everything might be falling apart, such as the one we are all currently living through, trust comes at a premium. Our primary goal is to act as a trusted steward for our clients in managing their assets, during good times and especially during challenging times. We thank you once again for your ongoing trust.

Please do not hesitate to reach out to us with any questions.

Sincerely,

Pekin Hardy Strauss Wealth Management

This commentary is prepared by Pekin Hardy Strauss, Inc. (dba Pekin Hardy Strauss Wealth Management, “Pekin Hardy”) for informational purposes only and is not intended as an offer or solicitation for the purchase or sale of any security. The information contained herein is neither investment advice nor a legal opinion. The views expressed are those of the authors as of the date of publication of this report, and are subject to change at any time due to changes in market or economic conditions. Although information has been obtained from and is based upon sources Pekin Hardy believes to be reliable, we do not guarantee its accuracy. There are no assurances that any predicted results will actually occur. Past performance is no guarantee of future results. The Consumer Price Index (CPI) is an unmanaged index representing the rate of the inflation of U.S. consumer prices as determined by the U.S. Department of Labor Statistics.

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FSA or HSA: Choosing a Medical Savings Account https://pekinhardy.com/fsa-or-hsa-choosing-a-medical-savings-account/ Tue, 01 Oct 2019 17:46:19 +0000 https://pekinhardy.com/?p=2077 Flexible spending accounts (FSAs) and health savings accounts (HSAs) are both tax-advantaged accounts that allow you to pay for qualified medical expenses using pretax dollars. During open enrollment season for employment benefits,you may have the opportunity to choose between an FSA and an HSA. Understanding the advantages and disadvantages of each type of account is essential when it comes to making the right decision for you and your family.

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the navigator

Flexible spending accounts (FSAs) and health savings accounts (HSAs) are both tax-advantaged accounts that allow you to pay for qualified medical expenses using pretax dollars. During open enrollment season for employment benefits,you may have the opportunity to choose between an FSA and an HSA. Understanding the advantages and disadvantages of each type of account is essential when it comes to making the right decision for you and your family.


FSA or HSA: Choosing a Medical Savings Account


Open enrollment season for health care benefits is coming for many workplaces, and you may soon find yourself trying to determine which selection of benefits is best for you and your family. You may need to choose between a flexible spending account (FSA) and a health savings account (HSA), both of which are tax-advantaged accounts that allow you to cover qualified medical expenses with pretax dollars. Both types of accounts can provide significant advantages, but it can be difficult to determine which is right for you. This Navigator discusses the difference between the two types of accounts and important considerations in choosing between them.


Flexible Spending Accounts


FSAs are the most common savings vehicles offered as part of employee benefit packages. FSAs have no eligibility requirements, but you can only participate in an FSA if your employer offers it as an option. With an FSA, you can set aside up to $2,750 in 2020 (projected) from your income to pay for qualified medical expenses.1  Contributions to FSAs are made from pre-tax income, and you do not pay taxes on FSA withdrawals if they are used for qualified medical expenses.

You choose how much to contribute to the account for the entire year during open enrollment and can only change your contribution level in the case of marriage, divorce, or other major life events. You can withdraw money immediately, even before there is any money in the account, provided you don’t exceed the amount you have chosen to contribute in a year. However, any unused funds remaining at the end of the year are generally forfeited, though some employers will offer a short grace period or small rollover for unused funds. FSAs work well for recurring expenses like eyeglasses, contact lenses, or prescriptions, but you run the risk of needing additional funds for unexpected medical treatment and not having the necessary amount in your FSA. In most cases, you will also leave money in your FSA if you change employers mid-year and you have not spent your entire year-to-date amount.


Health Savings Accounts


HSAs allow more flexibility both in terms of contribution amounts and when you make qualified medical expenditures. You are eligible for an HSA if you have a high-deductible health plan, which is defined as a plan with a deductible of at least $1,400 for an individual or $2,800 for a family in 2020. In order to qualify for an HSA, the high-deductible plan must be your only health insurance and you cannot be eligible for Medicare. Unlike with an FSA, you can use an HSA if you are self-employed or using an Affordable Care Act plan, as the accounts are not dependent on your employer.

Through an HSA, you can save up to $3,550 annually for an individual or $7,100 for a family in 2020, and you can contribute any amount up to the maximum at any time. Many employers also contribute to employee HSA plans, although the amount can vary. Unlike in an FSA, money in an HSA rolls over indefinitely and always belongs to you, regardless of employment status; you can even use it to cover health care expenses after you retire. Additionally, money in an HSA account is invested, so it can grow over time.

Using an HSA can provide significant tax benefits: contributions to HSAs come from pretax income, earnings on the HSA account are not taxed, and you will not pay taxes on withdrawals if they are used for qualified medical expenses. If you withdraw money from an HSA for another purpose before age 65, you would have to pay taxes plus a 20% penalty, but after age 65, you would only pay taxes.

Some people use HSAs as another retirement account: they contribute to the HSA but continue to pay for their medical expenses out-of-pocket, essentially building a fund for medical expenses in retirement. If you choose not to pay for medical expenses through your HSA at the time they are incurred, you can actually withdraw money to cover those expenses years later. As long as you keep the receipts, you could withdraw money in 2019 to offset an unclaimed medical expense in 2016, provided your HSA was open at the time of the expense.


Which is Right for You?


Both FSAs and HSAs have significant benefits for users. In general, you should opt for the HSA if you qualify because it offers a higher limit and allows you to carry your contributions from year to year. However, an HSA might not be right for you if any of the following is true:

  • You are unable to take on the extra expenses that come with a high-deductible plan.  While you will likely have a lower premium with a high- deductible plan, copayments, coinsurance, and out-of-pocket expenses will likely all be significantly higher than under other insurance plans. If you are uncomfortable with or unable to take on higher exposure to healthcare costs, the HSA is not the right option for you.
  • You do not have room in your budget for additional savings into an HSA.  HSAs only provide a benefit if you are able to save into the account to offset the higher out-of-pocket costs of the high-deductible plan. If you choose a high- deductible plan and do not take advantage of the savings opportunity, you will be considerably worse off than you would in a more standard insurance plan.
  • You are able to accurately predict your annual medical expenditures in advance.  If you can reliably plan for medical expenses in a given year, an FSA may be a better option for you.

In most cases, you cannot have both an FSA and an HSA, so it is important to make a well-researched choice of savings vehicle. Both FSAs and HSAs offer significant benefits when used correctly, and both should be considered during your open enrollment elections.


1 Medical expenses are defined as the costs of diagnosis, cure, mitigation, treatment, or prevention of disease. The IRS has complete guidance on what constitutes a qualified medical expense.

This Navigator was originally published in November 2018. It has been updated to reflect new contribution limits for 2020.

This article is prepared by Pekin Hardy Strauss Wealth Management (“Pekin Hardy”) for informational purposes only and is not intended as an offer or solicitation for business.  The  information  and  data  in  this  article  does not constitute legal, tax, accounting, investment or other professional advice. The views expressed are those of the author(s) as of the date of publication of this report, and are subject to change at any time due to changes in market or  economic  conditions. Pekin  Hardy  cannot  assure  that the strategies discussed herein will outperform any other investment strategy in the future, there are no assurances that any predicted results will actually occur.

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Pekin Hardy Strauss Recognized as a 2019 Best For The World Nominee https://pekinhardy.com/pekin-hardy-strauss-recognized-as-a-2019-best-for-the-world-nominee/ Thu, 05 Sep 2019 14:31:46 +0000 https://pekinhardy.com/?p=3771 CHICAGO, Illinois: Pekin Hardy Strauss Wealth Management, a Chicago-based independent investment adviser, has been recognized by B Lab as a 2019 Best For The World Honoree in the categories of Changemaker and Customers. Pekin Hardy Strauss ranked in the top 10 percent of all B Corps for its positive impact on its customers and its […]

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CHICAGO, Illinois: Pekin Hardy Strauss Wealth Management, a Chicago-based independent investment adviser, has been recognized by B Lab as a 2019 Best For The World Honoree in the categories of Changemaker and Customers. Pekin Hardy Strauss ranked in the top 10 percent of all B Corps for its positive impact on its customers and its significant improvement in its overall impact on its workers, customers, community, the environment, and governance.

Best For The World recognition is administered by B Lab, the global nonprofit that certifies and supports Certified B Corporations, which are for-profit companies dedicated to using business as a force for good. Today there are 3,000 Certified B Corporations across 64 countries and 150 industries.

Adam Strauss, Co-CEO of Pekin Hardy Strauss, said the firm is proud to be included on B Lab’s Best For The World list.

“Pekin Hardy Strauss is proud to be a part of the global B Corp™ community, and being designated a Best For The World honoree is a reflection of our commitment to our clients, employees, and community,” he said.

B Corps meet the highest standards of verified social and environmental performance, public transparency, and legal accountability to balance profit and purpose. B Corp Certification doesn’t just evaluate a product or service, it assesses the overall positive impact of the company that stands behind it—like Pekin Hardy Strauss. Using the B Impact Assessment, B Lab evaluates how a company’s operations and business model impact its workers, community, environment, and customers. To achieve the B Corp Certification, a company must achieve a score of at least 80 out of 200 points on the assessment.

“We’re incredibly proud of this year’s Best For The World honorees,” says Anthea Kelsick, Chief Marketing Officer of B Lab. “These inspiring companies represent the kinds of business models and impact-driven business strategies that are building a new economy—one that is inclusive, regenerative, and delivers value to all stakeholders, not just shareholders.”

1,000 B Corps from 44 countries were named to the 2019 Best For The World lists, including Patagonia, Beautycounter, Dr. Bronner’s, TOMS, Seventh Generation, and Greyston Bakery. The 2019 Best For The World honorees are determined based on the verified B Impact Assessments of Certified B Corporations. The full list is available at https://bcorporation.net/.

About B Lab and the Selection Process

The 2019 Best For The World Lists are selected based on verified responses to the B Impact Assessment, a platform that measures a company’s impact on its workers, community, customers, and environment. Prospective B Corps complete the Impact Assessment as a part of the initial B Corp Certification process, and then must update the assessment every three years to ensure they still qualify. Best For The World honorees scored in the top 10th percentile of all Certified B Corporations in the respective impact area on the B Impact Assessment. Of the 3000 B Corps, 1000 were named to the 2019 Best For the World.

Pekin Hardy Strauss is not affiliated with B Lab and the firm has not made any payment for participation in this survey.  Honors of this kind are only one of many factors relevant in determining whether to retain an investment adviser. Please contact Financial Advisor for more information on the methodology of the survey.

B Lab is a nonprofit that serves a global movement of people using business as a force for good. B Lab’s initiatives include B Corp Certification, administration of the B Impact Management programs and software, and advocacy for governance structures like the benefit corporation. B Lab’s vision is of an inclusive and sustainable economy that creates a shared prosperity for all. To date, there are 3,000 Certified B Corps in over 150 industries and 64 countries, and over 50,000 companies use the B Impact Assessment. For more information, visit https://bcorporation.net/

About Pekin Hardy Strauss Wealth Management

Founded in 1990, Pekin Hardy Strauss, Inc. (dba Pekin Hardy Strauss Wealth Management) is a leading independent investment adviser that offers wealth management services and serves as the adviser to a socially responsible value-oriented mutual fund. The firm provides its high-net-worth clients with thoughtful financial advice, comprehensive financial plans and custom investment portfolios. Pekin Hardy Strauss Wealth Management strives to deliver positive risk-adjusted returns by pursuing a disciplined value investing approach that minimizes investment risk with investors’ capital.

The employee-owned, Chicago-based firm is committed to maintaining the highest standards of ethics and objectivity. Pekin Hardy Strauss has been a Certified B Corporation® since 2015, when it became the first investment advisor in Chicago to be certified. Learn more at pekinhardy.com.

B Lab Contact: Hannah Munger; Manager, PR & Communications; hmunger@bcorporation.net; +1 212-608-4150

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