Broker Check


October 10, 2023

In this edition, we discuss the rules associated with distributions from inherited retirement accounts.  This topic has been a source of confusion for some time.  We hope the following provides a helpful framework to support discussions with your tax professional.  We then discuss the economy and the equity and bond markets. 

Inherited IRA RMD?


Prior to the December 2019 SECURE Act, a non-spouse beneficiary of an IRA account was subject to required minimum distribution based upon their age and the account value.  The annual required distribution amount for a 25-year-old would be less than for a 55-year-old, based upon actuarial distance to expected mortality.  Regardless of age, distributions from the inherited IRA could be spread out over the lifetime of the beneficiary.

The SECURE Act (updated in December of 2022 to the SECURE Act 2.0), stipulated that non-eligible designated beneficiaries (adult, non-spouse beneficiaries who are 10 years or more younger than the decedent, and not disabled or chronically ill) must take distributions of the full account by the end of the 10th year following the passing of the original account owner.  This is the government accelerating the collection of taxes, as distributions from an IRA are taxed as income. 

Regulations proposed earlier, in February of 2022, focused on non-eligible designated beneficiaries who inherited the account from original account owners who had already reached their “required beginning date” (the start date for RMD), stipulating that in this case, the beneficiary is subject to both RMD and the 10-year rule.  Beneficiaries who inherited the account from an original owner who had not yet reached the required beginning date are subject to the 10-year rule, but not RMD in the interim. 

RMD was officially cancelled for 2020 due to the COVID pandemic.  In October 2022, the IRS issued a notice waiving penalties associated with not having taken inherited IRA distributions in 2021 and 2022.  In July of 2023, the IRS issued a notice waiving penalties for failure to take RMD in 2023.

The IRS provided relief against penalties for non-eligible designated inherited IRA beneficiaries for failure to take RMD in 2021, 2022 and 2023.  It might be wise to assume two things for 2024 and beyond.  Beneficiaries who inherited a retirement account from an original account owner who was subject to RMD will be subject to both RMD and the 10-year rule.  The IRS is unlikely to provide further relief for failure to take RMD. 

Distribution Strategies

For a non-eligible designated beneficiary who inherited a retirement account from an original account owner who had yet to reach their required beginning date, the account must be fully distributed within ten years.  In this case, the beneficiary may take distributions throughout the ten-year period or distribute the entire account in the 10th year.  Either approach could be advantageous.  Taking distributions throughout the ten-year period may reduce overall tax liability.  However, total account growth may be reduced as distributions lower account value.  Determining which approach is best requires a conversation with a tax professional.    

For a non-eligible designated beneficiary who inherited a retirement account from an original account owner who had reached their required beginning date, initiating RMD in 2024 seems wise, even if the law is not yet finalized.  It may be that RMD does not result in the distribution of the entire account by the tenth year (depending on how the IRS stipulates that RMD is to be calculated), in which case the remaining balance would need to be distributed in year ten.  Therefore, taking distributions of some amount greater than the required minimum may be effective in spreading the tax liability for distributions over the greatest allowable timeframe.  Again, determining the most tax-efficient strategy requires a conversation with a tax professional.  

For non-eligible designated beneficiaries who inherited a Roth IRA, regardless of whether the original account owner had reached their required beginning date, taxes on distributions are generally not a factor, assuming the account is more than 5 years old.  Distributing as little as possible over the ten-year period may be advantageous for growth.  The risk to this strategy would be a bear market in the last year or two.

Closing Thoughts

We at PIM are not tax professionals.  The above is general guidance, that we believe to be accurate, but is not specific tax advice.  Please consult your tax professional for guidance applicable to your situation.

Special thanks to Mr. Bryan G. Mifflin, M.A. (Tax), CPA, for providing specific clarifications on what is clearly a confusing, and seemingly unresolved, issue.


The Futility of Forecasting

They say economists produce forecasts to make astrologists look respectable.  The past nine months have taken some of the humor out of the joke as the consensus forecast for recession has come up empty.  Fed Chairman Powell, hoping to avoid recession while at the same time working with his colleagues to engineer one, and therefore expecting one, stated during remarks at the August Jackson Hole Economic Symposium that the Fed is “…. navigating by the stars under cloudy skies”.

Considerable divergence in the “GDP Now” forecasts from the three Federal Reserve districts below illustrates the level of uncertainty.  GDP, gross domestic product, is a measure of all the services and goods the American economy has produced.  Nowcast models are real time estimates of the final average growth rate for the quarter.  Key variables for the model are employment levels, wages, hours worked, retail sales, exports, home starts, etc.  Federal Reserve districts use the very same data but different statistical methods and assumptions in forecasting.

These readings were taken on September 25th.  The Atlanta Fed was forecasting high growth levels rarely seen in the past 30 years.  The New York Fed saw an economy growing slightly above trend, while the St. Louis Fed projected modest growth similar to the growth rates that followed the 2008 Global Financial Crisis.  Prior to COVID, these models tracked each other closely and did a good job estimating the final GDP number.  Now they look like they’re measuring different countries.

The key takeaway, in our view, is that the economy is still digesting the effects of the COVID period.  The historical market relationships that dominated forecasting for the past 70 years have not applied over the past three.  Deutsche bank, the large German investment bank, published a chart that showed 23 leading indicators that have historically signaled an impending recession.  The chart is too busy for our publication, but the indicators presented suggest that a recession should have started no later than August of this year.

Pillars of Sand?

Some argue that financial economics is a hard science, like physics, where relationships are the same always and everywhere.  If you drop a bowling ball out of a window in Paris, Tokyo, or Seattle, it will fall at the same rate, and at the same rate it would have 200 years ago.  This view is wrong.  Financial economics is a social science, based upon human beings making decisions with imperfect information.  In economics, sometimes the bowling ball falls up before gravity takes hold.

Raising rates from nearly zero to 5.25% over such a short period should be influential in slowing the US economy.  Ditto regarding the yield curve inversion that we’ve been discussing for months.  Yet, the economy is showing far more resilience than expected.  Are the dynamics supportive of a resilient economy, temporarily causing a lag in the negative impact of rising interest rates, or a more permanent condition that will allow the economy to continue growing?

Consumers started 2023 with elevated cash savings accumulated during the COVID years.  Wall Street has been preoccupied with estimating how fast these savings will be depleted.  Consistent consumer spending has so far delayed the Fed’s intended economic slowdown.  According to Federal Reserve research, the bottom 80% of households by income have less in savings today than at the end of 2019, when adjusted for inflation.  Student loan repayments along with rising credit card and auto loan default rates suggest that excess savings are running out.

At the end of the 2nd quarter, Uncle Sam was running an 8.25% deficit.  As a percentage of the overall economy, the government was spending 8.25% more than it collects in revenues.  Deficit spending stimulates the economy by providing demand for goods and services above what the private sector needs.

Typically, 8% budget deficits only occur during a recession, when consumers and businesses increase savings rates leaving the government as the only party willing to spend money.  The US government has been running a deficit since 2002.  But only during the Great Financial Crisis and the COVID period have deficits been as large as in the first half of this year.  The CBO (Congressional Budget Office) estimates that the 2023 US budget deficit will narrow to 5.5%, thus removing another support mechanism from the economy.

Many large US companies refinanced their debt during the pandemic at record low interest rates.  Much like homeowners with low fixed-rate mortgages, these firms are not immediately impacted by the now significantly higher interest rates.  However, depending upon loan terms, this debt will need to be refinanced sooner or later.  If sooner, expect increased cost of capital to eat into corporate profits.  Smaller companies generally use short-term, lower-quality bonds and bank loans to meet ongoing financing needs.  We are seeing elevated bankruptcy rates and charge-offs in these areas.  The default rate of junk bonds has doubled from 2 to 4% since the Fed started raising rates.  Overall levels of distress are modest, but the rate of change is rapid.  Higher cost of capital is problematic for the most vulnerable firms today.  The impact on large, highly creditworthy firms may come into view soon.

The preceding dynamics are admittedly difficult to forecast.  But taken together, the data suggests that the economy is levitating on temporary factors that should give way over the coming months.  We can’t stress enough how historically unprecedented the current economic backdrop really is.  The US has never had a soft landing when inflation peaked above 5% on a year over year basis.  We saw 9% last year. An extended yield curve inversion, like what we have today, has always resulted in a recession.  If the Fed succeeds in slowing inflation to 2% and returning interest rates to “normal” without a significant increase in unemployment (the mythic “soft landing”), then Chairman Powell deserves a Nobel Prize because he will have beaten economic gravity for the first time in history.

US Equity Market

The story with US equities remains the same as it has been nearly all year.  The S&P 500 is up 11% year to date on a cap weighted basis (adjusting for the size of the firm relative to the overall index) but just 0.65% on an equal-weighted basis.  Just seven companies account for nearly all of the index return this year, while the average stock has gone nowhere.  Pulling out a little further, the S&P 500 is up 1.5% (total return) over the past 24 months, while the equal weighted version is -4.15%.

To an extent, the “Magnificent Seven” should be trading higher than the market.  These companies have experienced earnings growth at a time when the overall market is still in an earnings recession.  However, the narrative is getting out of hand.  The technology sector was trading at 26 times expected earnings at the end of the last quarter.  We’re using consensus expected twelve months forward earnings for this example.  For context, the sector was also trading at 26 times expected earnings in the fourth quarter of 2021, when the economy was still feeling the effects of trillions of dollars of COVID stimulus money, zero percent interest rates and $15 billion of quantitative easing each month.

Outside of COVID and the tech bubble, 26 times forwards earnings is not normal, even in the high-flying technology sector.  The story is similar for the S&P 500 overall; current forward valuations have only been this high during COVID and the technology bubble years.

Consensus estimates are for the S&P 500 to be trading at around 5,000 within two years.  To accomplish this, 25% corporate earnings growth from the end of the current year through the end of 2025 will be required (if using a historically reasonable earnings multiple of 18).

How likely is 25% earnings growth over two years?  Outside of recoveries from recessions and massive corporate tax cuts, this is not at all common.  Analysts are calling for profit margins to expand to the highest levels we can find in our database, which goes back to 1992.  Essentially, the market is suggesting that companies will become more efficient in turning sales into profit than ever before.

“Bottom up” analysts, those forecasting the outlook for individual businesses, are bullish.  Sunny skies and smooth sailing ahead.  “Top down” analysts, those who forecast the economy as a whole, see cloudy skies.  Disagreement between the two sides is normal.  What seems unique this time is the level of disagreement.  Pronounced uncertainty should lower valuations in the equity market.  That’s not the case today, which is surprising given that the bond market is now offering a reasonable alternative to equities for the first time in more than a decade.

The Bond Market

For the most part, investors own bonds for income from coupon payments, to get principal back at maturity, and to experience relatively steady market values along the way.  For the past nearly two years, it’s been a different story.

We have discussed in previous commentaries just how historically bad the bond market was in 2022.  This year has been better than the -13% experienced last year, but the US bond market (ticker symbol AGG) is down 1% for the year through September 30th.  In the third quarter, the bond market was down 3.2%.

The language used by investment professionals when discussing the bond market is confusing.  You may hear, or read, that yields are up and that this is something to be celebrated.  After all, bonds are now paying more than before.  Higher yield simply means that the fixed coupon payment of a bond is now higher relative to its current market value.  The amount of the coupon payment hasn’t changed.  For new money coming into the bond market, this is positive.  Bonds are on sale.  But for existing portfolios, it means that the market value of bonds is down.

The all-important 10-year Treasury hit a yield of 4.8% on October 3rd.  Outside of a few quarters in the lead up to the Financial Crisis, the last time the 10-Year Treasury yielded more than 4.8% on a sustained basis was the year 2000.  

The reason for the increases in bond yields over the past few months is mainly tied to the one trillion dollars of new issuance from the US Treasury expected this year.  After being forced to pinch pennies until the debt ceiling drama concluded, the Treasury needed to replenish its coffers by issuing new bonds, increasing market supply.

The main buyers of Treasuries over the past ten years have been the Federal Reserve through quantitative easing programs, banks, pension funds and foreign governments (Japan and China, mainly). Except for some pension funds, the main players are on the sidelines, with no appetite for long-term US Treasury Bonds.

The solution to high bond yields may just be high bond yields.  When Treasury yields spike as they have, so do lending costs for everyone and everything.  From mortgage rates to car loans to corporate borrowing, there is no area immune from higher rates.  Higher borrowing costs means more money spent on debt service and less on goods and services, or not spent at all.  This, in turn, slows the economy which increases demand for the relative safety that bonds have historically provided.  Slowing the economy to bring down inflation is exactly why the Fed started down this path in March of 2022.   

Closing Comments

It is striking how little has really changed over the past nine months. Outside of the top 7, the S&P 500 is flat.  The bond market is close to being unchanged.  The big economic questions remain unsolved. Inflation and growth rates have seemingly moved to readings that disappoint both the bulls and the bears.  We are going sideways.

With the resumption of student loan payments, high borrowing costs, labor disputes, gas prices and whatever Washington DC is doing, pressure is building for the US consumer.  Potential problems are stacking up like cordwood, reflected in the performance of both the stock and bond markets over the past 1-3 months.  Yet, despite the challenges, the labor market remains healthy.  The US consumer will likely remain resilient as long as jobs remain plentiful.  The September jobs report exceeded expectations by a factor of two, exclusively on the back of state and local government hires.

We are hopefully nearing the end of the Fed’s rate-hiking cycle.  We appear to be in a “wait and see” period during which nothing much is happening, and the Fed has paused to observe the delayed impacts of its handiwork.  Inflation will eventually ebb.  The Fed will eventually lower interest rates.  The economy and investment markets will eventually normalize.  We just don’t know exactly when.  All of this is cyclical, but the duration of economic cycles is inconsistent.  With investing, like life, perseverance is rewarded.   In the meantime, portfolio positioning remains conservative.


 We at PIM hope you enjoyed a beautiful summer and that the change of seasons upon us presents a glorious explosion of autumn colors.  Please reach out if you have questions about this communication or anything else.

 Printable Version