Broker Check

Happy New Year

January 09, 2023

In This Edition: 1) New RMD age and other annual updates, 2) Tax Loss Harvesting, 3) The Year Ahead

New for 2023

  1. From January 1, 2023, until December 31, 2032, the new age to begin taking RMD is 73. From January 1, 2033, forward, the new age to begin taking RMD is 75.
  2. The maximum employee contribution to a 401(k), 403(b) or 457 plan for 2023 has increased from $20,500 to $22,500.  The maximum that may be contributed by the employee and employer combined is $66,000, up $5,000 over 2022.  The additional “catch-up” contribution that can be made by those age 50 and over also increased from $6,500 to $7,500.
  3. The annual contribution limit to IRA accounts has increased from $6,000 to $6,500.  The additional “catch-up” contribution for those age 50 and older remains unchanged, at $1,000.  There have been slight increases to the income phase-out ranges that determine eligibility to make tax-deductible traditional IRA contributions.  The deductibility of IRA contributions depends, in-part, upon participation in an employer retirement plan.  If married, deductibility considers whether one, both or neither spouse participates in such a plan.
  4. The income phase-out ranges for Roth IRA contributions for 2023 have increased.  For single persons, the phase-out range is $138,000-$153,000.  Below $138k, a full contribution is allowed.  After $153k no contribution is allowed.  Within the boundaries, a partial contribution is allowed. For married filing jointly, the phase-out range is $218,000 to $228,000. 
    1. If you wish to make an IRA contribution for 2022 (Traditional or Roth), you may still do so, if your contribution is deposited or post-marked by Tuesday, April 18th, 2023.
    2. Tax Day customarily falls on April 15th each year. However, in 2023 that date falls on a Saturday and the following Monday is Emancipation Day, which is recognized as a holiday in Washington, D.C. As a result, Tax Day is Tuesday the 18th.
  5. Health Savings Account Contribution Maximums have increased from $3,650 to $3,850 for Single persons and from $7,300 to $7,750 for families of 2 or more. The “catch-up” contribution for those over the age of 55, remains unchanged at $1000.
  6. The annual gift tax exclusion increased from $16k to $17k per year per person.
  7. Social Security Cost-of-Living-Adjustment in 2023: +8.7%
  8. The standard deduction for income tax has increased:
    1. Single: From $12,950 to $13,850
    2. Married Filing Jointly: From $25,900 to $27,700
    3. Head of Household: From $19,400 to $20,800
    4. Married Filing Separately: From $12,950 to $13,850

Tax Loss Harvesting

This commentary may be of general interest to all but is of specific interest to those PIM clients with non-retirement plan investment accounts in our care. 

Tax loss harvesting is the process of selling investments with unrealized losses for the purpose of locking in those losses.  The benefit of realizing investment losses is both immediate and delayed.  To benefit immediately, investments with unrealized gains, to the extent available, are also sold.  Generally, investment losses and gains offset, resulting in no tax on the gains.  Losses beyond those that offset immediate realized gains are carried forward indefinitely and will offset realized gains in future years.  Additionally, in years when realized losses exceed realized gains, an investor may deduct up to $3,000 in realized losses against regular income.  It is important that your tax preparer is aware of tax loss harvesting and uses carried-forward losses in future years.

Though it may not feel this way following a year like 2022, during which all major asset classes delivered negative investment returns, the opportunity to realize investment losses is infrequent and therefore, should be taken when available. 

The Internal Revenue Service is well-aware of the desire of all investors to minimize taxes.  To prevent investors from selling investments specifically to avoid taxes, there exists what is called the “wash sale rule”.  The wash sale rule stipulates that if an investment is sold at a loss, it cannot be repurchased within 30 days before or after this sale, or the tax benefit of the sale is nullified.  Therefore, following tax loss selling, PIM may purchase acceptable substitute securities within a short timeframe to bridge the gap and avoid wash sale penalties, before returning to the original model securities.

This process took place at the end of 2022, resulting in numerous sale transactions on 12/28/22 within client investment accounts to realize losses.  Additional transactions were executed on 1/5/23 to buy substitute securities, and yet more trades will take place in the coming month to return portfolios to their respective model investments.  This is all perfectly normal year-end trading activity.  If you have any questions, please contact your PIM Financial Advisor.

The Year Ahead

With a return of -18.14%, the S&P 500 had its worst year since the financial crisis of 2008.  The U.S. bond market, down 13.06%, suffered its worst year since at least 1976, the inception of the Bloomberg Aggregate bond index.  Will 2023 be any better?

We’ve learned through experience and hard knocks to avoid blindly following the consensus, or any specific strategist.  The future is inherently unpredictable, even for the masters of the universe.  The best course of action is to let the data inform and guide investment decisions.  So, what is the data telling us today?

The Good

Job openings, wage growth, unemployment claims and the overall level of employment suggest nothing other than a strong labor market.  It’s very difficult to square any near-term recession forecast with such labor market conditions.

Related to the labor market, consumer financial health remains strong.  U.S. household net worth is 4.5% off its all-time high, set in March of ‘22, but remains 22% above 2020 levels and 6% above the pre-pandemic trend (Federal Reserve FOF data as of Q3 2022).  Despite inflation, consumers in aggregate remain in a strong financial position with large savings account balances.  It’s hard to envision a recession when the consumer has a solid balance sheet and a well-paying job.

The Neutral

Without going into eye-watering detail, the index of Leading Economic Indicators (LEI) is a popular measure of economic activity made up of ten different signals that tend to move before changes in the overall economy.  These signals range from average hours worked to new orders for consumer and capital goods to residential building permits.  While the overall index has been falling since March, the underlying components suggest a normalization from COVID-era spending patterns.  The index assumes all falling goods orders are a negative for the economic picture, hence the poor readings.  However, it’s a fact that consumers bought a record level of consumer goods during the pandemic.  That level is not sustainable, so orders should be falling as the world returns to normal.  

Same for housing.  During COVID, building permits peaked at 170,000 per quarter.  The average from 2015-2019 was 115,000.  Permits are falling now, but they should be.

Careful examination of the Leading Economic Indicators gauge appears to reveal a slowing economy, yes, but one that is simply normalizing after COVID, rather than moving towards a recession.  This is exactly what the economy needs to bring down inflation and represents the “soft landing” scenario.  However, it’s a fine line between slow-down and recession.

The Bad

The primary reason for concern about the U.S. economy is the yield curve, which is deeply inverted.  Long-term bond yields are much lower than short-term yields.  This typically only happens when the market believes the Federal Reserve is pushing short-term interest rates too high and will be forced to cut them in the future to stimulate the economy and avoid a recession.  The yield curve today is at levels that have only occurred eight times since WWII.  Each time, a recession followed.  

One connection between the shape of the yield curve and the potential for recession is the shift in bank lending standards.  When the yield curve inverts, banks tend to restrict borrowing to only the most credit worthy customers.  The general tightening of lending conditions causes weaker businesses to pull back on business activity, ultimately resulting in job cuts.  Senior Loan officer survey data from the Fed does indicate that lending standards in the banking system are beginning to tighten.  As of 10/31/22, the most current data available, lending standards sit at 2/3 of the level consistent with the previous four recessions.

The Plan

In this environment, the best course of action is to look for “Safe Income at Reasonable Prices” (SIRP). Recession risks remain elevated, but recession is not a foregone conclusion.  After a record sell-off in 2022, the Treasury market looks attractive and can benefit from a slowing economy.  Defensive equities still look attractive relative to alternatives.  

The playbook from 2010-2020 is unlikely to be effective going forward.  This means staying away from high-growth technology stocks and anything else that doesn’t earn a real profit without accounting shenanigans or unrealistic expectations.  We will remain patient and capitalize on high-probability investments until the data points us in a different direction.

Closing Comments

We look forward to 2023 with caution but not quite cautious optimism.  Navigating an economy and capital markets that are in transition, with competing data and a Fed determined to break inflation at any cost requires patience and diligence.  Our approach to investment management, as described above, is to focus on fixed income and value-oriented equities. 

We wish you all a happy and prosperous new year.   

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