Last week one lucky winner purchased a Powerball ticket worth over 2 billion dollars. It is highly unlikely that person is reading this (but if you are, please call us right away as there are some urgent matters to discuss). For people planning their retirement, winning the Powerball is not a viable option as the odds are extremely low. It is up to each of us to save for retirement and then have a plan for spending wisely. There are some things left to chance in retirement, such as hoping the stock market provides positive returns, but the odds of success are much greater.
Equities were higher last week, more than erasing the prior week’s declines. The markets sold-off sharply on Wednesday following the results of the mid-term elections. But this was followed by an outsized rally on Thursday in the wake of a softer-than-expected Consumer Price Index (CPI) report. Growth was a big outperformer of value, most notably technology companies, with megacap tech enjoying an especially strong week. Treasury bonds rallied and interest rates, especially longer term, fell significantly after the report.
The CPI report was seen as an affirmation of the peak-inflation thesis and seems to provide evidence of a long-expected slowdown in price growth. This report may alter the trajectory of future action by the Federal Reserve and it is now thought the Fed will pause interest rate hikes in the not-to-distant future and the terminal rate may not be far away. The ensuing stock market rally is confirmation that the largest factors affecting stocks right now are interest rates and monetary policy from the Fed.
Expectations for a rate hike at the December Fed meeting are now at 50 basis points, or one-half of one percent. Indications are the Fed will step down the pace of rate hikes, but they plan to continue a path of raising interest rates. CPI remains elevated and at levels similar to what we saw in the spring, which at the time were the highest levels seen in 40 years. It will take a few months to confirm if inflation has indeed peaked. At the pace it is dropping, it will still take years to return to the Fed’s annual inflation target of 2%.
The intent of this weekly update is to discuss the markets, but we feel it worthwhile to pause and touch on the Powerball drawing as it can be a lesson for anyone saving money. The person who won last week’s drawing probably will not have to worry about replacing lost income or having enough money to live off for the remainder of their lives, assuming they seek the help of a knowledgeable team of advisors. But will they walk away with over $2 billion and join the elite club of ultra-wealthy billionaires? The answer is no. They will be offered either a lump sum of just under one billion dollars or they can take 30 equal payments of about $67 million per year. Federal and state taxes will take about half of all payments. Unless the winner happens to live in a state without an income tax, in which case the federal government will still take nearly 40%. If the winner elects the lump sum, they will receive less than $500 million of the stated prize of $2 billion; still plenty of money to live quite comfortably. Retirees face a similar predicament, albeit with much smaller numbers. You do not get to keep all that you win, save, or earn. Uncle Sam and the IRS will want their share.
Let’s assume you have saved $1 million dollars in an IRA for retirement and your plan is to withdraw 4% per year to fund your annual income needs. Federal and state income taxes are likely to be around 20% of any withdrawal from a qualified plan (IRA, 401K, etc.) so you will have to withdraw 5% to fund your 4% income need and have enough to pay taxes on the distributions. If you were to take out the entire account balance at one time, you would be subject to federal and state income taxes of about 50%, essentially making the one million dollars saved for retirement worth five-hundred thousand dollars. That nest egg you have saved for retirement may not be worth as much as you think it is. Many people subject themselves to a large tax burden that could have been avoided with some proactive planning. Also remember there may be future changes in the tax code and there is likely to be the need to take out larger amounts to keep up with inflation.
We should soon receive further clarity around the balance of power in the House of Representatives as final votes are tallied. Earnings are winding down with only a handful of names still reporting. This coming week does bring another inflation report, the Producer Price Index (PPI), as well as retail sales. The latter could receive larger than usual attention given that consumer sentiment came in weaker than expected last week. Catalysts for the market may be somewhat limited over the next few weeks, especially with the Thanksgiving holiday. Another inflation number, Personal Consumption Expenditures (PCE), which happens to be the Fed’s preferred gauge of inflation, is released at the end of the month. Markets remain dependent upon action from the Fed and there are still numerous data points before their next meeting in December.
Don’t chance your retirement on something with a very low probability of success, such as the lottery. Planning for retirement should not be left to chance at all. Be sure to have a solid plan for saving and, perhaps more importantly, withdrawing your money while limiting taxes. Contact us if you feel the odds are not in your favor and we will help guide you toward the path of winning.
Have a wonderful week!
Nathan Zeller, CFA, CFP®
Chief Investment Strategist
Please contact us if you would like to review your individual financial plan or learn how the TaxSmart™ Retirement Program can help you.
Office phone # 952-460-3260