The Coronavirus Aid, Relief, and Economic Security (CARES) Act was signed into law on March 27, 2020. It offers relief for individuals, businesses, and state and local governments facing financial pressures as a result of the COVID-19 pandemic. With the reach and the complexity of the CARES Act, there are numerous different planning opportunities we’ve explored for the benefit of our clients since this Act was put into place in late March. To demonstrate how our team is proactively applying the recent law change to client situations, we’re sharing an example of how we paired a component of the CARES Act with our in-depth knowledge of TIAA, to improve the investment and tax experience for an actual Carlson Capital Management client. But first, a bit of background.
The CARES Act and RMDs
In early 2020, the stock market suffered a significant correction—the S&P 500 lost 33.9% of its value from February 12 through March 23, 2020. 1 The CARES Act is the government’s response to the stock market correction and economic calamities that have resulted from the COVID-19 pandemic. One key provision of the CARES Act includes a 2020 Required Minimum Distribution (RMD) waiver, an important provision to many investors who have seen their retirement account values dip significantly compared with December 2019, when 2020 RMDs were calculated. Not only can taking distributions during a down stock market result in locking in stock market losses, it can result in missed planning opportunities from an investment, tax, estate, cash flow, and philanthropy perspective if the RMDs are taken without proper consideration from each area.
Rebalancing During Stock Market Volatility
Although CCM portfolios are globally diversified, our clients are not immune to stock market volatility. Through the financial planning process, a personalized target allocation—a mix between equities and fixed income—is determined. For example, many clients have a 60/40 allocation, meaning that 60% of the portfolio is invested in equities, both domestic and international, while 40% is invested in fixed income (“safe” money). When the stock market shifts, CCM proactively rebalances to maintain the client’s chosen asset allocation. During times of intense stock market volatility, the need to rebalance is more pronounced; however, when the portfolio is split between Schwab and outside accounts, fully rebalancing can be challenging in times of stock market volatility.
While the majority of CCM client assets are custodied at Charles Schwab, some of our clients who are working in or have retired from working in the education sector have a portion of their investment assets with TIAA (Teachers Insurance and Annuity Association of America). Given our long history of working with educators at CCM, we’ve developed a great deal of experience and knowledge advising on TIAA accounts. In addition, as a firm, we access and utilize TIAA funds (for clients eligible for TIAA accounts) for their fixed income offerings, mainly the TIAA Traditional annuity, which offers some of the strongest crediting rates in the business. 2 As a result, it’s common for a client who is or was employed in education (and thus likely participates or participated in the TIAA retirement plan options) to continue to utilize TIAA for the fixed income portion of their portfolio while the equities portion is located at Schwab.
A Case Study
In this situation, CCM’s integrated team leveraged the CARES Act to create a customized solution to rebalancing a split portfolio.
Meet Holden, a retired college professor who devoted his career to young physicists.
Like the majority of our clients who are retired college professors, Holden’s portfolio consists of both TIAA for his fixed income and Schwab for his equity exposure. At the start of 2020, Holden’s portfolio was in balance, with 60% of the portfolio in equities at Schwab and 40% in fixed income at TIAA. While Schwab offers fixed income options as well, we’ve intentionally chosen to leave Holden’s fixed income portion at TIAA to take advantage of the superb crediting rates available through the TIAA Traditional 2 product that Holden has owned throughout his time as an educator and into retirement. When the correction occurred in late February and into March, Holden’s portfolio was no longer in balance. His allocation to equities was less than the desired 60%. If all things were equal in the portfolio, rebalancing would have been simple. We would simply sell out of enough fixed income to generate the cash needed to purchase enough equities to get us back to 60%.
For Holden, however, all things aren’t equal. Like all the other retired professors taking advantage of generous credit rates offered by TIAA Traditional, 2 Holden’s investment in the annuity is locked in. We often keep some equities at TIAA as a buffer we can use in this type of situation. For Holden, however, we had used up all of that “buffer” with previous rebalancing efforts, so TIAA Traditional was the only piece left. Unfortunately, TIAA doesn’t allow all of its clients to freely move in and out of the TIAA Traditional fund. In exchange for the high crediting rates, clients who own TIAA Traditional within certain annuity contracts willingly surrender the ability to access the funds on demand. This includes using the funds for rebalancing. Unfortunately, for our efforts to rebalance for Holden, his fixed income at TIAA appeared to be truly fixed.
A Creative Strategy
This is why it’s so important for our team to understand the intricacies and opportunities created by legislation such as the CARES Act. One of the few permitted methods for getting funds out of TIAA Traditional is the RMD. While RMDs aren’t required for 2020 because of the CARES Act, TIAA has continued to allow clients the option to take an RMD upon request. In essence, this provides clients a unique opportunity to access their TIAA Traditional funds. Because the RMD distribution isn’t technically required in 2020, the funds disbursed from the TIAA account in 2020 can be rolled over to Holden’s IRA. This is where the opportunity existed for Holden.
Holden didn’t need the funds from TIAA in 2020. Nevertheless, at our direction, Holden elected to take his RMD from TIAA, so a specified portion of his TIAA Traditional holding was sold and the proceeds were disbursed. Per our plan, this reduced Holden’s fixed income allocation. The proceeds were then directly rolled into Holden’s Schwab IRA account, and our investment team used the funds to increase Holden’s equity exposure to get the portfolio back to a 60/40 allocation.
Why It Matters
Our care for Holden went well beyond portfolio management to utilize the CARES Act. As a holistic planning team, we used our expertise and experience to improve Holden’s tax situation as well. The CARES Act suspension of 2020 RMDs created the opportunity to do a Roth IRA conversion in 2020. Since RMDs are suspended in 2020, clients who are normally subjected to RMD requirements have the rare opportunity to do a Roth IRA conversion with the money from their IRA that would normally go toward an RMD. Without increasing Holden’s taxes from 2019, we converted funds from Holden’s IRA to his Roth IRA. This created additional value since the amount converted grows tax-free and can be passed to Holden’s beneficiaries tax-free. The CARES Act allows individuals over age 72 to take advantage of this proactive tax-planning strategy.
This type of planning doesn’t happen by accident. We are vigilant and opportunistic. It takes the coordination of the investment, tax, and planning teams to develop the optimal solution, and we are happy to provide that to Holden and every other client we serve.
NOTE: Data represents past performance. Past performance is no guarantee of future results. The information provided in this article is intended for clients of Carlson Capital Management. We recommend that individuals consult with a professional advisor familiar with their particular situation for advice concerning specific investment, accounting, tax, and legal matters before taking any action.