Rex discusses how the pandemic has impacted our clients; implications of the election; parallels between betting on sports and investing; and mistakes investors make. The interview is just under 5 minutes. Thanks to 680thefan.com for the air time.
Required Minimum Distributions
IRS Guidance for 2020
The CARES Act eliminates the requirement to take distributions from retirement plans such as IRA’s and 401(k) plans in 2020. Not surprisingly, the legislation and related interpretation by the IRS was very confusing and left many wondering if they could undo an IRA or 401(k) plan distribution made in 2020 prior to the passage of the CARES Act and if so, how. Recently released IRS Notice 2020-51 has provided much needed clarification.
If you took a required minimum distribution from an IRA or 401(k) plan earlier this year you have until August 31st to return the distribution. It is that simple.
Here are answers to some frequently asked questions:
- Must required distributions received prior to August 31st be returned within 60 days of the distribution? No. The funds must be returned by August 31stregardless of when during 2020 the distribution was received. For example, a required distribution received in January of this year may be returned provided it is returned by August 31st.
- May a beneficiary of an inherited IRA return a 2020 required distribution or do these rules only apply to IRA owners? A required distribution from an inherited IRA may be returned by August 31st.
- If required distributions are taken on a monthly basis from an IRA or 401(k) plan may they be returned? Yes, the monthly distributions prior to August 31st can be totaled and returned in whole or in part.
- If a portion of a required distribution prior to August 31st had taxes withheld may the full amount be returned? Yes. Consider the following example: In January, Joe receives a $10,000 distribution from his IRA which at that time he believes is required. $3,000 of the distribution is withheld for Federal taxes and the balance of $7,000 is distributed to Joe. Joe can return $10,000 to the IRA. The $3,000 withheld for Federal taxes will continue to be treated as tax withholding.
- If you turned 70 ½ in 2019 and took your first required distribution by April 1, 2020 may the distribution be returned? Yes, the distribution may be returned by August 31st.
So now that you know that you can return an unneeded required distribution, should you? The answer depends on your unique circumstances. Assuming that you do not need the funds for daily living, then the answer in large part rests on whether the tax rate applicable to the distribution in 2020 would be higher or lower than the tax rate that would apply in the future. Individuals who have suffered a significant loss of income in 2020 because of the economic disruption caused by COVID-19, or for some other reason, should consult with their tax adviser to determine if it is advisable to take a retirement plan distribution in 2020 even though one is not required.
Should you have any questions regarding the recent ruling please contact us.
How to make something from nothing (or even less)
You have two investment options. You can invest in cash which returns 0% each day, and you can invest in a stock which on any given day has a 50% random chance of losing one-half of its value and a 50% chance of doubling. How should you allocate your money between the two? To be clear, over time if you buy and hold the stock, you expect a zero growth because ½* 2 = 1
It may seem that there is no way to make money, but that wouldn’t make for an interesting post. In fact, you could expect to make about 6% per day on average if you could trade without transaction costs.
Put ½ your money in cash and ½ in the stock and rebalance to that proportion every day. You would expect that on half of the days the stock will go down and your portfolio will be worth 0.75 of its previous value. This is because you would have the half that you put in cash plus one-half of the half you put into stocks. On the days the stock goes up, your portfolio will be worth 1.5x as much because you will have the half you invested in cash plus 2x the half you put in stocks.
Thus, every two days we’d expect the portfolio to grow by a factor of 0.75 * 1.5 = ¾ * 3/2 = 9/8. Over n days, the growth factor would be (9/8)^(n/2).
Thus if you started with $1, you’d expect to have $361 over 100 days.
Even if both your investment choices are lousy, there still might be a way to make money. Imagine your investment choices are stocks A and B. On any given day there is a 50% random chance that A will only be worth 10 cents on the dollar – it loses 90% of its value. There is a 50% chance it will double. Thus over time, we’d expect to lose money if we only held that stock. In fact, after two days, we’d expect to have twenty cents on the dollar. That doesn’t sound good. Stock B is exactly the same except when A loses 90%, B will double and when A doubles, B loses 90%. So now we have 2 lousy individual investments (but the good news is they move out of synch). Let’s split our money between the two and see what happens.
Each day our portfolio will grow by a factor of (0.5 * 0.1) + (0.5 * 2) = 1.05. Yes, even though both stocks on average lose money each day, we would make 5% each and every day.
In the absence of transaction costs, one can make money on volatility just by rebalancing. You can even make more than the best performing investment. The tough question is why aren’t we all rich?
While this is not investment advice and is for entertainment / educational purposes, it does suggest the benefit of diversifying and rebalancing.
If you are fascinated by this and you like math, you may want to read the paper “Universal Portfolios” by Thomas Cover.