The US federal budget is on an unsustainable path…but not for the reasons that most people think.

Yes, the national debt is $31 trillion, well higher than annual GDP, and only going higher.  Yes, the budget deficit last year was more than a $1 trillion for the third year in a row.  None of this is good.

But the real root of the fiscal problem, and our biggest concern, isn’t the debt or the deficits, it’s government overspending.  If the government had an enormous debt, but spent little, the private sector could produce the country’s way out of the debt problem.  And if the US had little debt, we could still have economic problems from too much government spending.  Ultimately, the government funds itself by borrowing or taxing the wealth produced by private industry.  If spending were high and borrowing low, taxes would have to be prohibitively high.  The bottom line is that excessive spending leads to economic ills.

According to the CBO, spending on entitlements like Social Security, Medicare, Medicaid, and other health care programs will rise from 10.7% of GDP to 15.1% in the next thirty years.  Meanwhile, the net interest on the national debt will almost certainly be higher than it was last year, unless and until we bring the deficit down and slow the growth in debt.

This is why the debt limit debate now going on in Washington, DC is so important.  Don’t fall for the false narrative that one group of politicians wants to push the country into default.  Nor, should anyone want to abolish the debt ceiling altogether.  If there is a way to shine some light on overspending, why shouldn’t it be used?  If debt ceiling politics can focus attention on fiscal issues, it’s done its job.

What we expect is a last-minute budget deal that includes either caps on discretionary spending for future years, some sort of commission or committee that can make proposals to reform entitlements (with expedited procedural rules so the proposals get a congressional vote), or both, as part of a bipartisan deal to raise the debt ceiling.
But let’s go down the highly unlikely path that the debt limit isn’t raised.  The Treasury Department would still have enough cash flow to pay all securitized debt as it came due, as well as entitlements such as Social Security, Medicare, and Medicaid.  It’s true that other programs and agencies would have to take substantial cuts to make sure those higher priority payments get made; and yes, the Biden Administration will not enjoy making that choice.  But it’s still a choice that they alone get to make.
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Ultimately, investors and voters need to realize that not every national debt is the same, even if they’re the same amount.  The US had a debt problem after the Revolutionary War, which was a small price to pay for starting an independent country.  We had a debt problem after World War II, but that was a price we paid to win a crucial war.   Our current debt problem is not like those.  In too many cases, politicians spend to win favor with constituents.  It’s not wrong to use the debt ceiling as a way to focus attention on this problem and the endemic overspending that it creates. That’s a habit this debt limit debate needs to break

I trust everyone had a wonderful holiday season. Whether you reached your personal goals last year or faced challenges, a new year brings new opportunities and a fresh start.

Let’s jump right into this month’s topic. The Setting Every Community Up for Retirement Enhancement Act of 2019, popularly known as the SECURE Act, was signed into law in late 2019.

Now called SECURE Act 1.0, it included provisions that raised the requirement for mandatory distributions from retirement accounts and increased access to retirement accounts.

But it didn’t take long for Congress to enhance the landmark bill that was enacted barely three years ago.

Tucked inside a just-passed 4,155-page, $1.7 trillion spending bill is another overhaul of the nation’s retirement laws.

​Dubbed SECURE Act 2.0, the bill enjoys widespread bipartisan support and builds on SECURE Act 1.0 by strengthening the financial safety net by encouraging Americans to save for retirement.

9 key takeaways on SECURE Act 2.0

1. Changing the age of the required minimum distributions. Three years ago, 1.0 increased the age for taking the required minimum distribution, or RMD, to 72 years from 70½. If you turn 72 this year, the age required for taking your RMD rises to 73 with 2.0.

If you turned 72 in 2022, you’ll remain on the prior schedule. 

If you turn 72 in 2023, you may delay your RMD until 2024, when you turn 73. Or you may push back your first RMD to April 1, 2025. Just be aware that you will be required to take two RMDs in 2025, one no later than April 1 and the second no later than December 31.

Starting in 2033, the age for the RMD will rise to 75.

Employees enrolled in a Roth 401(k) won’t be required to take RMDs from their Roth 401(k). That begins in 2024.

In our view, the SECURE Act 1.0 and 2.0 updates were long overdue. The new rules recognize that Americans are living and working longer.

2. RMD penalty relief. Beginning this year, the penalty for missing an RMD is reduced to 25% from 50%. And 2.0 goes one step further. If the RMD that was missed is taken in a timely manner and the IRA account holder files an updated tax return, the penalty is reduced to 10%.

But let’s be clear, while the penalty has been reduced, you’ll still pay a penalty for missing your RMD.

3. A shot in the arm for employer-sponsored plans. Too many Americans do not have access to employer plans or simply don’t participate.

Starting in 2025, companies that set up new 401(k) or 403(b) plans will be required to automatically enroll employees at a rate between 3% and 10% of their salary. 

The new legislation also allows for automatic portability, which will encourage folks in low-balance plans to transfer their retirement account to a new employer-sponsored account rather than cash out. 

In order to encourage employees to sign up, employers may offer gift cards or small cash payments. Think of it as a signing bonus.

Employees may opt out of the employer-sponsored plan.

4. Increased catchup provisions. In 2025, 2.0 increases the catch-up provision for those between 60 and 63 from $6,500 in 2022 ($7,500 in 2023 if 50 or older) to $10,000, (the greater of $10,000 or 50% more than the regular catch-up amount). The amount is indexed to inflation.

Catch-up dollars are required to be made into a Roth IRA unless your wages are under $145,000.

5. Charitable contributions. Starting in 2023, 2.0 allows a one-time, $50,000 distribution to charities through charitable gift annuities, charitable remainder unitrusts, and charitable remainder annuity trusts. One must be 70½ or older to take advantage of this provision.

The $50,000 limit counts toward the year’s RMD.

It also indexes an annual IRA charitable distribution limit of $100,000, known as a qualified charitable distribution, or QCD, beginning in 2023.

6. Back-door student loan relief. Starting next year, employers are allowed to match student loan payments made by their employees. The employer’s match must be directed into a retirement account, but it is an added incentive to sock away funds for retirement. 

Additional provisions

7. Disaster relief. You may withdraw up to $22,000 penalty-free from an IRA or an employer-sponsored plan for federally declared disasters. Withdrawals can be repaid to the retirement account.

8. Help for survivors. Victims of abuse may need funds for various reasons, including cash to extricate themselves from a difficult situation. 2.0 allows a victim of domestic violence to withdraw the lesser of 50% of an account or $10,000 penalty-free. 

9. Rollover of 529 plans. Starting in 2024 and subject to annual Roth contribution limits, assets in a 529 plan can be rolled into a Roth IRA, with a maximum lifetime limit of $35,000. The rollover must be in the name of the plan’s beneficiary. The 529 plan must be at least 15 years old.

In the past, families may have hesitated in fully funding 529s amid fears the plan could wind up being overfunded and withdrawals would be subject to a penalty. Though there is a $35,000 cap, the provision helps alleviate some of these concerns.

Final thoughts 

I welcome these changes. Many Americans lack adequate savings, and the just-enacted bill helps address some of the challenges many face as they march toward retirement.

What I've provided here is a high-level overview of the SECURE Act 2.0. Keep in mind that it is not all-inclusive. 

I'm always here to assist you, answer your questions, and tailor any advice to your needs. Additionally, feel free to reach out to your tax preparer with any tax-related calculations.

Sources:  Secure Act 2.0 Act of 2022; SECURE 2.0: Rethinking Retirement Savings;  Congress Passes Major Boost to Retirement Savings; The 401(k) and IRA Changes to Consider After Congress Revised Many Retirement Laws

Not long after Friday’s Employment Report multiple analysts and commentators were calling it a “goldilocks” report, by which they meant it showed that the economy was neither “too hot” nor “too cold,” but instead, “just right.”

In turn, the theory goes, the Federal Reserve could stop raising short-term rates earlier and at a lower peak than previously expected, inflation would continue to cool, and the economy could pull-off an elusive “soft landing.”

The biggest headlines from the Employment Report were definitely good news.  Nonfarm payrolls rose 223,000 in December, beating the consensus expected 203,000.  Meanwhile, civilian employment, an alternative (although volatile) measure of jobs that includes small-business start-ups, surged 717,000. Rapid job creation helped push the unemployment rate down to 3.5%, tying the lowest level since Joe Namath was a reigning Super Bowl champion.  (If you’re a Millennial or Gen Z, yes, that’s the same guy in the Medicare commercials.)

But, behind the headlines, the data were not as good.  Temporary help service jobs (temps) fell 35,000 in December, the fifth straight monthly decline, to a level of temp jobs below a year ago.  Why are these jobs important to watch?   Because, when businesses face increased demand, the quickest way to respond is hiring temporary help.  And the same thing happens in the opposite direction.

Meanwhile, the total number of hours worked in the private-sector ticked down 0.1% in December, the second consecutive monthly decline.  Even though payrolls were up, total hours worked data show less work was done.  Putting it all together, this is the equivalent of losing 125,000 jobs in December, not gaining jobs.  Fewer temporary workers and fewer hours worked suggest some weakness in the job market.  What this means is that businesses are still hiring, but their workers have less to do.

Why would businesses do that?  Because finding qualified workers has been unusually difficult during the re-opening from the COVID shutdowns.  In turn, many firms might be willing to keep hiring workers until it’s clear the economy is in a recession.  But this also means that if a recession happens – and we continue to think it will – more workers have to be let go.

The figure that the optimists focused on the most was the wage report, which showed a relatively moderate gain of 0.3% in average hourly earnings in December and a gain of 4.6% versus a year ago. Moderate wage growth, the conventional thinking goes, diffuses the potential for a “wage-price spiral” that keeps inflation high or even pushes it higher.  But this is a basic misunderstanding of inflation dynamics.  As Milton Friedman taught us, it’s loose money that causes inflation to go up.  The fact that wages sometimes go up faster at the same time is also a sign of loose money, but it’s not a sign that wage growth causes inflation.

What analysts, commentators, and the markets should have spent more time chewing over was the ISM Services report, which screamed stagflation.  The overall index came in at 49.6, well below consensus expectations and the first reading in contraction territory since the onset of COVID.  In fact, excluding very early COVID, it was the first sub-50 reading since 2009.  Meanwhile, although the prices paid index declined to 67.6 (versus 70.0 in November), that’s still higher than it ever was between mid-2011 and early-2021.

This week’s CPI report should show tame overall inflation for December itself, but that’ll largely be due to falling energy prices.  The ISM report suggests inflation isn’t going back to the Fed’s 2.0% target anytime soon.

Put it all together and it looks like both the surge in M2 growth in 2020-21 (which created the inflation) and the abrupt slowdown in 2022 (which would cause slower growth) are still wending their way through the economy.  If so, we should see weak economic data, soon.  Further forward, if the Federal Reserve maintains slow M2 growth – an open question given the Fed’s reluctance to focus publicly on the monetary aggregates when setting policy – we could see a major slowdown in inflation in 2024.  Time, and the direction of monetary policy, will tell.

Right now, it looks like Real GDP expanded at a 2.5 – 3.0% rate in the last quarter of 2022.  But how fast it’s growing in the first quarter of 2023 – if at all – is anyone’s guess.    

The housing sector was a huge and early beneficiary of the super-loose monetary policy of 2020-21. But, once the Fed started tightening, housing took the lead downward, as well.  This isn’t a repeat of the 2006-11 housing bust, but it will drag on.  Don’t expect any real recovery in housing until at least late 2023 or early 2024.  Home sales and prices will continue to drag in 2023, particularly in the existing home market.

From May 2020 until June 2022, both the national Case-Shiller price index and the FHFA price index rose more than 40%.  But, since June 2022, Case-Shiller is down 2.4% and the FHFA is down 1.1%.  The biggest declines so far have been out West, in San Francisco, Seattle, Phoenix, San Diego, and Las Vegas.  But every major metropolitan area is down in the past three months, no exceptions.

The drop in home prices should continue.  Prices got too high relative to rents and need to fall more to better reflect rental values.  We expect a total decline, peak-to-bottom in the 5-10% range, nothing like the 25% drop in 2006-11.  Why a smaller drop this time around?  First, compared to the average of the past forty years, home prices are already close to fair value when measured against construction costs.  Second, there is no massive excess inventory of homes, unlike during the prior housing bust. And, unlike during the subprime-era, the vast majority of homeowners with mortgages are locked-in at extremely low fixed rates, which means they will be very reluctant to sell.

The real effect of the change in interest rates is evident in the existing home market.  Sales hit a 6.65 million annual rate in January 2021, the fastest pace since 2006.  But, by November 2022, sales were down to a 4.09 million annual rate, a drop of 38.5% so far.  Meanwhile a decline in pending home sales in November (contracts on existing homes) signals another drop in existing home sales in December.

Existing home buyers have two major problems: first, much higher mortgage rates, which means substantially higher monthly payments.  Assuming a 20% down payment, the rise in mortgage rates and home prices since December 2021 amounts to a 52% increase in monthly payments on a new 30-year mortgage for the median existing home.

Meanwhile, it’s hard to convince a current homeowner with a low fixed-rate mortgage to sell.  If anything, it makes sense for them to ask for even more money if they’d have to take out a new mortgage elsewhere at a much higher rate.  In other words, sellers should now want more for their homes, while buyers want to pay significantly less.  This won’t change soon and so expect existing sales to be even weaker in 2023 than last year.

New home sales are also down substantially since the COVID peak, but should find a bottom sooner. The key is that with a new home, the seller is a contractor.  Also, housing has been underbuilt in the previous decade.  The average price of a new home will likely fall, but we need more of them.  And more houses will be likely be put in rental pools.

What’s important to remember is that this business cycle isn’t normal.  COVID led to a massive surge in government stimulus, both monetary and fiscal, to fight widespread and overly draconian shutdowns. Housing is rarely a bright spot in recession years and this year should be no different.  But don’t expect a catastrophe like the prior bust and, once a recession is over, housing will rebound much more swiftly than after the Great Recession in 2008-09.