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Rockbridge Institutional – December 2022 Market Review

2022 in the Rear View Mirror
Inflation, the Fed’s response and rising interest rates, a sharp falloff in stock and bond prices, uncertainty of a looming recession and Cryptocurrency implosion were all part of the investment landscape in 2022. Although we don’t know what’s ahead, glad this year is behind us.

Inflation and Interest Rates
Inflation and the Fed’s response dominated the investment environment. 2022 saw the inflationary effects of prior years’ stimulus payments, supply chain disruptions, war in Ukraine, and an accommodative Fed – too much money chasing too few goods. The pattern of inflation, measured by prior year changes in the CPI, is shown in the accompanying chart. Throughout the past year, the Fed worked to bring inflation in check without triggering a recession. While some would argue a little late, the Fed ratcheted up the Federal Funds Target rate continuously from 0.75% to 4.50%. While it is too early to declare victory, a quick look at its recent trajectory shows the pattern of our measure of inflation bending in the right direction.

The rising interest rates in 2022 are seen in changing Yield Curves. (Yield Curves show the pattern of returns for holding various Treasury securities to maturity. Generally short-term yields respond to monetary policy; longer-term yields reflect market expectation for future interest rates.) The upward push in yields moved bond prices and returns lower – an index of long-term bonds was down over 14% in 2022. The December 2022 curve showing an upward slope for shorter intervals, then falling off is especially noteworthy. The short run pattern is consistent with the Fed’s continued tightening. The downward slope beyond a year projects interest rates to fall. Often this shape is explained by an anticipated need for an accommodative monetary policy down the road to spur economic growth in a recessionary environment. A more optimistic reason might be an expected reduction in inflation. We’ll see.

Stocks
Although the recent quarter was positive, 2022 was a down year for stocks, reflecting emerging inflation, increasing economic uncertainty and rising interest rates. A globally diversified stock portfolio finished the year down 18% – a sharp and unsettling change from recent market trajectories.

Stock price reflects the present value of expected future cash flows – as interest rates increase present values (prices) fall. The farther away are the cash flows, the greater the impact of interest rate changes on prices. Consequently, growth stocks lagged value stocks in 2022. Domestic tech stocks were especially hard hit – an equally weighted portfolio of Apple, Microsoft, Amazon, Google and Meta (Facebook) was down nearly 40%.

Inflation and the Fed’s response produced surprises and market volatility in 2022. No doubt we are in store for surprises going forward, some may even be positive.

Cryptocurrency
The Cryptocurrency phenomenon seems to be unwinding. Bitcoin, the most popular of the lot, fell by almost 70%. The Cryptocurrency exchange, FTX, blew up. While it appears the cause of FTX is simple fraud, greed and embezzlement, it prompted a discussion of the Cryptocurrency technology and its expected role going forward. There are two technologies involved – Cryptocurrency as money and “blockchain” to keep track of transactions. It is hard to imagine Bitcoin, or any other Cryptocurrency as money. After 14 years, Bitcoin is nowhere near a meaningful medium of exchange. Its volatility precludes Cryptocurrency as a store of value or unit of account. Blockchain technology was developed to keep track of Cryptocurrency transactions and holdings. While blockchain technology may eventually prove to be useful in certain roles, keeping track of Cryptocurrencies will not be one.

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Secure Act 2.0 – Business Owners

Earlier this week we put out a summary of some of the changes that individual investors should be thinking about as a result of Secure Act 2.0 going into law. This article focuses on the changes that we think will be impactful to business owners going forward:

1) Small Business 401(k) Credits: For businesses with 50 employees or less, the credit for starting a new 401(k) plan has been adjusted from 50% to 100% of plan startup costs, up to $5,000/year for the first three years. There will also be a new tax credit starting in 2023 for employer contributions to employee accounts that earn less than $100,000, up to $1,000/employee. For the first two years of a new planning being established, the credit is 100% of employer contributions. Year three uses 75%, year four uses 50%, and the fifth year uses 25%. After five years of having a plan open, the credit goes to 0%.

2) Auto Enrollment and Escalation: For 401(k) and 403(b) plans established in 2023 or later, new employees must be auto enrolled in the employer’s plan, at a 3% minimum contribution amount. From there, the contribution amount will be increased by 1% per year until it reaches 10%, at which point the employer has discretion to limit contributions to 10% or continue increasing contributions up to a cap of 15% of the employee’s income.

3) Roth Catch-Up Contributions: For employed individuals over age 50, and with wages of $145,000 or more, catch-up contributions to an employer sponsored retirement plan must be made in Roth dollars starting in 2024. While having a Roth component has become a common feature for 401(k) plans over the years, there are still plans out there that haven’t made this change. As an employer/business owner, it will be important to make sure your plan has this feature for highly compensated employees over the age of 50.

4) Solo 401(k) Start Date: For the 2022 tax year and prior, if someone opened a solo 401(k) after the end of the calendar year, but prior to their tax filing deadline- they would still be out of luck for making employee contributions to the plan. Starting with the 2023 tax year, this is no longer the case. As long as your account is open prior to your tax filing deadline, you’ll be able to make your employee contribution for that tax year.

5) Roth Matching Contributions: Prior to Secure Act 2.0, all matching contributions in employer sponsored retirement plans had to be made pre-tax. Going forward, employees can opt to have their matching contributions be made as Roth contributions. Employers making nonelective contributions to their employees can also now do so in Roth dollars. However, these employer contributions can’t be subject to a vesting schedule and will be reported as income to the employee for taxation purposes.

6) Student Loan Matching: Starting in 2024, employers will be able to make matching contributions to their employees on the basis of how much they’re paying in student loans. For example, if a company offers a 100% match on up to 3% of employee contributions- if an employee can prove they’ve contributed 3% of their income to student loans, the employer can still provide the match. However, this provision will not be a requirement by the employer, but it will be subject to nondiscrimination testing to ensure that not only the business owners/highly compensated employees get this benefit.

7) Roth Simples & SEPs: SIMPLE & SEP IRA plans have always been pre-tax savings vehicles for small businesses and self-employed individuals. Starting in 2023, Roth contributions will be allowed in both of these plan types.

8) Simplifying Hardship Withdrawals: Starting in 2023, employees will have the ability to self-certify that their need for taking a distribution falls into one of the approved categories. Formerly, the plan administrator (typically the employer or someone who works at the company) would have had to sign off their approval for the reason. Hardship withdraws can also be taken out of employee AND employer contributions starting in 2024. Prior, only employee contributions have been eligible for these types of distributions.

Again, this isn’t a complete list of all of the changes brought forward by Secure Act 2.0, but a good starting point in terms of things that business owners might need to start thinking about. If you have questions about how any of these provisions might impact you, contact your Rockbridge advisor.

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Secure Act 2.0 – Individuals

Just before the close of 2022, Congress passed a $1.7 trillion government spending bill. Within that 4,000+ page document was Secure Act 2.0, which introduced ~90 new provisions regarding retirement savings. We’re tracking the details of this bill as additional information becomes available, but here are some of the highlights for individual investors:

1) New RMD Age: Starting in 2023, the age for Required Minimum Distributions from retirement accounts will increase to 73. Individuals who have already started taking RMDs, will not be impacted and you will still be required to take your RMD in 2023. For those who turn 72 in 2023, you now have an extra year before you need to start taking your RMDs. An additional provision in the bill is to further increase the RMD age to 75, starting in 2033.

2) Roth Catch-Up Contributions: For employed individuals over age 50, and with wages of $145,000 or more, catch-up contributions to an employer sponsored retirement plan must be made in Roth dollars starting in 2024. This means that your catch-up contribution will be made using after-tax dollars and will no longer be deductible.

3) Employer Plan Catch-Up Amounts: Secure Act 2.0 is also adding a new age group for catch-up contributions starting in 2025. For employees aged 60-63 who participate in a 401(k) plan, you’ll have the ability to contribute the greater of $10,000 or 150% of the “standard” catch-up contribution for 2024. The standard catch-up for 401(k) participants age 50+ in 2023 will be $7,500. Simple IRA plans have a similar provision that will allow for catch-up contributions of $5,000/year for ages 60-63, up from $3,500 for participants aged 50+.

4) IRA Catch-Up Amounts: While catch-up amounts in employer sponsored retirement plans like 401(k)s have been indexed to inflation, increasing steadily over the years, IRA catch-up amounts have remained stagnant at $1,000 for those aged 50+. Starting in 2024, IRA catch-up contribution amounts will also be indexed to inflation.

5) Employer Matching Student Loans: For a lot of young professionals just starting their careers after college, you have the tough choice of deciding between paying down student loans or contributing to your employer retirement plan. Going forward, Secure Act 2.0 will allow your employer to put “matching contributions” into your work retirement plan in the amount in which you’ve paid down your student debt for the year. This is not required, but it might be worth having a conversation with your employer if you fall into this situation.

6) Retirement Savings Lost and Found: Within two years, the Department of Labor will establish an online data base for retirement plan participants and/or their beneficiaries. If you ever have difficulty finding a retirement account from an old employer, or finding a retirement account as a beneficiary, this service will help simplify the process.

7) Auto Enrollment and Escalation: For 401(k) and 403(b) plans established in 2023 or later, new employees must be auto enrolled in the employer’s plan, at a 3% minimum contribution amount. From there, the contribution amount will be increased by 1% per year until it reaches 10%, at which point the employer has discretion to limit contributions to 10% or continue increasing contributions up to a cap of 15% of the employee’s income.

This isn’t an exhaustive list of all of the changes brought forward by Secure Act 2.0, but a summary of the ones that we think will have the largest impact on the individuals we work with. If you have questions about how any of these provisions might impact you, contact your Rockbridge advisor.

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