Bob’s Journal for 11/11/2021

Last Chance for ‘Mega Qualified Charitable Distribution’

Traditional IRA owners of any age have until December 31, 2021, to use what many advisors call the “Mega Qualified Charitable Distribution.”

The strategy takes advantage of a law put in place during the early days of the COVID-19 pandemic that increased to 100% of adjusted gross income (AGI) the limit on deductions for cash charitable contributions to public charities.

Normally, total deductions of charitable contributions of cash to public charities can’t exceed 60% of adjusted gross income (AGI). But deductions for such contributions made through the end of 2021 can equal 100% of AGI.

The law allows you to take a large distribution from a traditional IRA or 401(k), make charitable contributions with it and owe no taxes on the distribution.

Though many advisors call this the Mega Qualified Charitable Distribution (QCD), it really isn’t a QCD.

A QCD can be made only after age 70½ and is limited to $100,000 per year. In a QCD, you direct the custodian of a traditional IRA to make a distribution directly to a charity or give you a check payable to the charity. You don’t include the distribution in your gross income and don’t take a deduction for it. But it counts toward your required minimum distribution for the year, if you are required to take one.

In the Mega QCD, a taxpayer of any age takes a large distribution from a traditional IRA or 401(k) plan. The distribution is included in gross income for the year.

The taxpayer then makes one or more cash contributions to public charities (not donor-advised funds, private foundations or similar tax-exempt entities).

If the taxpayer itemizes expenses on his or her tax return, the full amount of the charitable contributions is deductible up to 100% of AGI. Any excess contributions can be deductible in future years if the taxpayer itemizes expenses.

A charitably minded taxpayer with a large IRA can reduce the value of the IRA without owing any income taxes on the distributions. That reduces future required minimum distributions and future income taxes.

The strategy isn’t for everyone. But it is a good idea for someone with a large traditional IRA who is looking for ways to reduce future required minimum distributions at little or no tax cost and help charities today. But the strategy expires at the end of 2021.

The Limits of Algorithms

Many businesses tout their use of algorithms to improve their profits and customer service. Investment and financial firms often say they use algorithms to make investments and other financial decisions.

But algorithms have their limits. A recent case in point involves Zillow Group, the real estate firm with a website that many people use to estimate the values of their homes or look for homes for sale.

One of Zillow’s businesses was to buy homes, renovate them and sell them, a practice known as home-flipping.

Zillow expected to be able to make a profit on the transactions. It used its own algorithm of home price estimates to determine which houses to buy and how much to pay for them. The algorithm estimated how much of a profit could be made from flipping a home.

Last week, however, Zillow announced that it was shutting down its home-flipping business and laying off 25% of its workforce.

Zillow has been losing money on the business since its start and the losses recently increased. The company said that it was far more difficult to forecast home prices than it anticipated.

The company said it lost $381 million on home-flipping in the latest quarter. It owns 9,800 homes for sale across the United States and has contracts on another 8,200. It expects to lose up to 7% on these homes as it winds down the business over several quarters.

The problem isn’t necessarily with algorithms in general but with Zillow’s algorithms. Researchers quoted in The Wall Street Journal said Zillow routinely paid more for homes than competitors and didn’t make improvements and adjustments in its process that competitors did.

They also pointed out that it should have been difficult to lose money buying and selling homes during the last few years when house prices increased steadily.

The case doesn’t show that there’s something inherently wrong with algorithms. But an algorithm isn’t magic. Algorithms are built and maintained by people, and what the people do and the data that go into the algorithm determine its usefulness.

New Rules on Rollover Advice Delayed

The Department of Labor (DOL) announced that it would delay until 2022 new rules on financial advisors related to rollovers and retirement plan advice.

The DOL has been concerned for years that retirement account owners have been steered into expensive financial products and other choices that aren’t in their best interests.

Detailed rules were issued during the Obama administration. But they later were invalidated by a court. The Trump administration rewrote the rule, and the Biden administration let the rewritten rule go into effect. The DOL said it plans to issue an expansion of the rule in the future.

More recently, the DOL announced new rules that require investment advice fiduciaries to demonstrate that rollover advice is in the customers’ best interest, if the advisors want to receive compensation such as commissions, 12b-1 fees, revenue sharing, along with markups and markdowns.

Detailed rules explain what an advisor has to do to demonstrate that a recommendation is in a customer’s best interest. The DOL rule is supposed to be consistent with the Securities and Exchange Commission’s Regulation Best Interest, though there are differences in the two rules.

The DOL rules went into effect in February 2021, but DOL suspended enforcement through Dec. 20. Now, enforcement is suspended for part of the rules through February 1, 2022, and until June 30 for the rest of the rules.

There’s concern in the financial industry that some small and even mid-size firms won’t be able to comply with the rules. The DOL requires a substantial amount of data for an advisor to show that a recommendation is in the customer’s best interests compared to alternatives in the marketplace. A few financial advisors have said they won’t give advice on rollovers because of the new rules.

The Data

The Consumer Price Index (CPI) increased 0.9% in October and 6.2% over 12 months. The 12-month increase is the highest since December 1990.

Excluding food and energy, the CPI increased 0.6% in October and 4.6% over 12 months. The 12-month gain is the highest since November 1990.

In October, prices rose the most for energy, housing and vehicles. The CPI increases more than offset any wage hikes that most workers have been receiving, giving workers a real reduction in the purchasing power of their income despite hefty gains in wages.

The increase in the CPI also means the real interest rate (the nominal rate minus inflation) continues to decline. The real interest rate on the 10-year Treasury bond now is negative 1.1%.

Wholesale prices also continue to increase. The Producer Price Index (PPI) rose 0.6% in October and 8.6% over 12 months.

Excluding food and energy, the PPI increased 0.4% in October and 6.8% over 12 months.

The Small Business Optimism Index from the National Federation of Independent Business (NFIB) declined in October to 98.2 from 99.1 in September. Seven of the index’s 10 components declined and one held steady.

Business owners continue to say uncertainty is high, identifying their biggest problems as the lack of workers and inventory shortages. The percentage of business owners expecting better business conditions over the next six months declined to its lowest level since November 2012.

A net 44% of business owners reported raising compensation, which is at a 48-year high.

The Employment Situation reports issued last Friday said payrolls increased by 531,000 in October. Also, September’s payroll increase was revised higher to 312,000 from the 194,000 reported initially.

Private payrolls increased by 604,000 and government payrolls decreased by 73,000. Manufacturing jobs increased by 60,000.

The most jobs were created in the leisure and hospitality sector, a total of 164,000.

The unemployment rate hit a new pandemic low of 4.6%.

Average hourly earnings increased by 0.4% in October and 4.9% over 12 months.

New unemployment claims declined each of the last two weeks to another pandemic low of 267,000.

The pre-pandemic level of new claims in mid-March 2020 hit 256,000.

Continuing unemployment claims increased a little in the latest week, rising just above the pandemic low reported the previous week.

Productivity declined by 5.0% in the third quarter, though the second quarter’s productivity was revised higher to a 2.4% increase.

Unit labor costs increased 8.3% in the third quarter, following a 1.1% increase in the second quarter.

Consumer credit outstanding increased at an annualized 8.3% in September and 5.6% in the third quarter, according to the Federal Reserve.

Revolving credit, which is mostly credit card usage, increased at an 11.8% annualized rate in September while vehicle and student loans combined increased at a 7.2% annual rate.

The Markets

The S&P 500 rose 1.19% for the week ended with Tuesday’s close. The Dow Jones Industrial Average gained 0.75%. The Russell 2000 increased 2.86%. The All-Country World Index (excluding U.S. stocks) added 0.70%. Emerging market equities are 0.65% higher.

Long-term Treasuries rose 2.63% for the week. Investment-grade bonds increased 1.04%. Treasury Inflation-Protected Securities (TIPS) added 1.80%. High-yield bonds gained 0.80%.

Meanwhile, the U.S. dollar declined 0.12%.

Energy-based commodities fell 0.61%. Broader-based commodities lost 1.65% but gold rose 2.47%.

Bob’s News & Updates

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