Here are the economic and market highlights for the week:
- The consumer continued to hold up in June with retail spending holding flat despite expectations for a 0.30% decline. The flat reading comes on the back of a solid May reading that was revised higher to 0.30% relative to the 0.10% initial reading. Excluding the volatile autos and gas segments, consumer spending posted a very solid June, rising 0.80%. That was well above consensus estimates for a 0.20% increase. The control group, a subcomponent measurement which excludes several volatile categories and which factors heavily into the GDP reading, rose 0.90%. Online sales, building material and garden, health and personal care, and apparel saw strong demand, rising 1.90%, 1.40%, 0.90%, and 0.60%, respectively. Spending momentum appears to have followed through into July with consumers racking up $14.2 billion in online purchases during the two-day Amazon Prime Day sales event. That was up 11% from the year ago period. Hot ticket items were back-to-school shopping and electronics as consumers snatched up new tablets, TVs, and Bluetooth speakers in an apparent product refresh cycle. This year’s spending mix marks a shift from last year’s spending composition when inflation-weary shoppers used the Prime Day event to stock up on household essentials like pantry staples and office supplies.
- Housing starts rose to a 1.35 million annual pace in June, up from 1.31 million in May. The move higher was driven by a 22% increase in apartment building which offset a 2.20% decline in single-family construction. Building permits, a sign of future construction, rose 3.40% to a 1.45 million rate. Apartment permits were up 19.20% as demand remains high for apartments amid high home prices and mortgage costs while permits for single-family homes fell by 2.30% month-to-month. With the Fed poised to cut interest rates, single-family building could be in for a rebound in the coming months.
Dow Rallies on Great Rotation out of Tech
It was a roller coaster of a week for investors which saw the Dow Jones Industrial Average swing above the 41K level for the first time ever before falling more than 900+ points total on Thursday and Friday. Despite the volatility, the index still managed to finish higher for the week as the Dow continues to benefit from investors rotating out of tech stocks and into cyclical companies on the prospect that the Fed will soon cut rates. Fed Chair Jerome Powell added to the bullish sentiment this week at the Economic Club of Washington, D.C. where he signaled the central bank will move to cut interest rates when it is confident inflation is moving towards its 2.00% target level. This was a subtle shift in criteria which would allow the Fed to begin cutting rates in anticipation of where inflation is headed rather than waiting for the 2.00% level to be seen. The prospect of lower rates and strong retail spending figures bolstered investor confidence that economic fundamentals remain solid despite separate reports in recent weeks pointing to a broader deceleration in growth.
Earnings and macro fundamentals had less influence on the market’s direction this week than did The Great Rotation, an accelerating trend where by investors dumped tech and Mega cap in favor of cyclical and small caps stocks. Over the last month, the S&P 500 is higher by 0.3% while the S&P 500 Value and Russell 2000 are higher by 2.9% and 8.0%, respectively. Mega cap, and tech in particular, have led the market higher this year, but the combination of looming interest rate cuts and relative valuations have in recent weeks made it appealing for investors to take profits and shift into interest sensitive sectors. Despite the late week volatility, which was compounded by Friday’s cyber outage which was caused by an incompatible software update that froze many Windows based devices, conditions still remain constructive for equities. Consumers, which comprise two-thirds of economic growth, still remain a dominant factor. Easing inflation is boosting discretionary spending and with rate cuts on the horizon, even more relief may soon be on the way for consumers.
The Week Ahead
- Q2 GDP (First Estimate)
- Homes Sales
- PCE Index
IRS Finalizes 10-Year Rule
This week, the IRS issued a final rule on required minimum distributions (RMDs) from retirement accounts. The guidance affects beneficiaries, account owners, and retirement plan participants. Furthermore, the ruling provides clearer guidance for inherited IRA owners by distinguishing between instances in which the original owner began taking RMDs before they died and instances when they died before they started taking RMDs. It also differentiates between eligible designated beneficiaries and ineligible beneficiaries. If this all sounds very confusing, it’s because it is.
RMD Rules for Retirement Accounts
RMDs are congressionally mandated withdrawals from a qualified retirement plan, such as a 401(k), 403(b), and traditional IRA or IRA-based plans such as Simplified Employee Pension (SEP) plans. Workers who set aside part of their earnings in tax-advantaged retirement accounts haven’t paid income tax on those dollars. The taxes are paid when the funds are withdrawn in retirement and are generally taxed as ordinary income for the tax year in which they are taken. Individuals must begin taking RMDs – and pay the taxes – every year once they reach age 72 (age 73 if the account owner reaches age 72 in 2023 or later).
IRS Rules for Inherited IRAs
There has been a lot of confusion in recent years over the RMD rules, particularly for beneficiaries of inherited IRAs. In 2019, Congress passed legislation that removed what was known as the “stretch provision” for RMDs from most inherited IRAs. Prior to the legislative change in 2019, beneficiaries of an inherited IRA could “stretch” distributions from the inherited account over the course of his or her lifetime, thus delaying taxes and benefiting from tax-deferred growth. Someone very young could potentially have a very small RMD.
Under the law passed in 2019 as part of the SECURE (Setting Every Community Up for Retirement Enhancement) Act, certain beneficiaries are required to distribute all the proceeds of a retirement account within a 10-year period. This is known as the “10-year-rule.” In cases where inherited retirement plans are particularly large, the 10-year rule often results in a huge tax bill. The law didn’t specify whether people had to take out money each year, or if they could wait until the final year to take out all of the funds.
The IRS’s final rules issued today confirm that the 10-year rule is mandatory for certain beneficiaries and clarified whether RMDs were to be annual or if the account could be depleted in the tenth year. If the original account owner began taking RMDs, the person who inherited the account must take annual payouts starting the year after the account owner’s death. In the event there are assets remaining at the end of 10 years, the remaining balance will be forced out. If the initial participant had not taken an RMD, then the beneficiary does not need to take RMDs and can choose to simply withdraw the entire balance at the end of 10 years.
Eligible Beneficiaries
The 10-year rule does not apply to “eligible designated beneficiaries” such as a spouse, someone disabled or chronically ill, or another beneficiary “not more than 10 years younger,” such as a younger sibling. If the original participant had not already begun taking RMDs, then an eligible designated beneficiary can either choose to take RMDs consistent with their life expectancy or elect the 10-year rule. If the participant died after taking RMDs, then the beneficiary can take RMDs consistent with the longer of their life expectancy or that of the participant.
Penalties for Missed RMDs
If an individual skips an RMD, there is typically up to a 25% penalty that gets applied to what was supposed to have been distributed. The penalty may be reduced to 10% if the missed RMD is taken within a certain timeframe. Because there has been confusion about the new rules, many people didn’t take distributions in the past several years. The IRS waived the penalty in recent years, including in 2024, as they prepared to issue today’s final, long-term guidance.
IRS Extends Relief
The guidance issued today will not take effect until 2025, so 2024 is the final year that RMDs will be exempted. Beginning in 2025, RMDs will be mandatory per IRS rules. Heirs who inherited accounts before 2020 are still subject to the old rules, which require annual withdrawals over their expected lifetimes.
If you have questions about the tax impact of leaving IRAs and 401(k)s to beneficiaries or about inherited IRAs, please feel free to call our office at (214) 891-8131.