Blog

Week-in-Review: Week ending in 09.03.21

The Bottom Line

● Domestic equities posted another week of gains but lost some momentum after a disappointing payroll release. European equities faltered on political news out of Germany, while Japanese equities rallied around their own political news.
● Treasury yields fell on the shorter-end with the 2-Year falling -1bps, but the longer-end rose slightly with the 10-Year gaining +1bps.
● Economic news for the week painted a blurry picture with the housing market showing signs of cooling, solid manufacturing that is being stifled by labor and parts shortages, and a gigantic miss on payroll numbers.

Is Growth Slowing?

For most of the week, equity markets were able to grind higher, but started to lose their footing after payroll numbers posted a massive disappointment. Despite this falter, domestic equities were all in the green with the S&P up+0.58%, the Nasdaq up +1.55%, and the Russell posting a gain of +0.65% for the week. European equities couldn’t hold onto their gain and fell -0.09% for the week after political turmoil emerged in Germany. Japanese equities rallied after Yoshihide Suga announced he is stepping down from leadership, but his party will remain in control. The Nikkei was up a whopping +5.38% for the week, most of which was achieved on Friday. Economic releases painted a mixed picture going into the long holiday weekend, with manufacturing showing strong output, but constrained from labor and supply chain shortages, housing markets cooled for the second month in a row, and wages grew but didn’t take employment with it. Market participants will be keeping a close eye on growth metrics and will be paying especially close attention to labor markets looking for any signs of trending weakness that could derail the Fed’s targeted plan to start tapering asset purchases at the end of this year.

Digits & Did You Knows

BRAND NEW HOMES — The median sales price of a new home sold in the USA in June 2021 was $390,500, a record high both on a nominal basis and on an inflation-adjusted basis. The old nominal record was $374,400 in April 2021. The old inflation-adjusted record was $345,800 in May 2017, equal to $383,898 in today’s dollars. (source: Census Bureau, BTN Research).
RED TAPE — Congress approved $46.55 billion in rental aid via 2 bills in 12/2020 and 3/2021. As of 08/25/2021, just $5.1 billion has been disbursed to renters or 11% of the total. (source: Emergency Rental Assistance Program, BTN Research).
THE FIRST ONE — The CDC has changed the date of the first US Covid-19 death from 02/06/2020 to as early as 01/11/2020. The CDC now believes 6 Covid-related deaths occurred before 02/06/2020. (source: CDC, BTN Research).

Click here to see the full review.

Source: Bloomberg. Asset‐class performance is presented by using market returns from an exchange‐traded fund (ETF) proxy that best represents its respective broad asset class. Returns shown are net of fund fees for and do not necessarily represent performance of specific mutual funds and/or exchange‐traded funds recommended by the Prime Capital Investment Advisors. The performance of those funds may be substantially different than the performance of the broad asset classes and to proxy ETFs represented here. U.S. Bonds (iShares Core U.S. Aggregate Bond ETF); High‐YieldBond(iShares iBoxx $ High Yield Corporate Bond ETF); Intl Bonds (SPDR® Bloomberg Barclays International Corporate Bond ETF); Large Growth (iShares Russell 1000 Growth ETF); Large Value (iShares Russell 1000 ValueETF);MidGrowth(iSharesRussell Mid‐CapGrowthETF);MidValue (iSharesRussell Mid‐Cap Value ETF); Small Growth (iShares Russell 2000 Growth ETF); Small Value (iShares Russell 2000 Value ETF); Intl Equity (iShares MSCI EAFE ETF); Emg Markets (iShares MSCI Emerging Markets ETF); and Real Estate (iShares U.S. Real Estate ETF). The return displayed as “Allocation” is a weighted average of the ETF proxies shown as represented by: 30% U.S. Bonds, 5% International Bonds, 5% High Yield Bonds, 10% Large Growth, 10% Large Value, 4% Mid Growth, 4%Mid Value, 2% Small Growth, 2% Small Value, 18% International Stock, 7% Emerging Markets, 3% Real Estate.

Advisory services offered through Prime Capital Investment Advisors, LLC. (“PCIA”), a Registered Investment Adviser. PCIA doing business as Prime Capital Wealth Management (“PCWM”) and Qualified Plan Advisors (“QPA”).

© 2021 Prime Capital Investment Advisors, 6201 College Blvd., 7th Floor, Overland Park, KS 66211.

 

Blog Month in Reveiw

Month-in-Review: August 2021

Quick Takes

● Steady ascent. Despite higher COVID cases, rising geopolitical risks, mounting inflation fears, the looming Fed tapering, and waning economic growth, stocks continued their steady ascent with the S&P 500 closing August just below its all-time high.
● Delta damage. With Delta progressively spreading throughout the month, August saw a pullback in consumer activity, with notable declines in visits to Gyms, Grocery Stores, Restaurants, and Retailers. Air passenger traffic also rolled over in August after nearing pre-pandemic levels in June and July.
● Earnings exploding. With less than a handful of companies left to report earnings for the second quarter of 2021, data from FactSet shows the reported year-over-year growth in earnings is 91%–the highest growth since the fourth quarter of 2009.
● Expectations eroding. In the first two quarters of the year, economic results were consistently exceeding expectations. Since the beginning of July, and gaining downside momentum in August, a reversal of this dynamic has resulted in the vast majority of economic data now falling short of expectations.

Asset Class Performance

Returns for most major asset classes were relatively muted in August as U.S. and International Equities were up a bit, while U.S. and International Bonds declined slightly. Bonds are the only asset classes still negative for the year.

Stocks set records despite mixed economics and delta variant

August, traditionally a tepid month for stocks, ended on a high note with the S&P 500 closing at 4,522.68, up from July’s close of 4,395.26 and now the seventh consecutive month of gains. The S&P is now up a healthy +20.41% for 2021. Domestic equities weren’t the only ones to rise during August, European equities rose +1.98% for the month as did Japanese equities, up +2.95% for August. While markets were optimistic, some of the economic releases for the month painted a more mixed picture. On a positive note, CPI metrics came in largely in-line with expectations, which is more consistent with the Fed’s narrative of transitory inflation. Regardless, consumers are beginning to feel the pressures of rising prices and it weighted on Consumer Confidence. The University of Michigan’s Sentiment survey reached its lowest level since 2013 at 70.3. Manufacturing data also retracted, with ISM’s gauge of factory activity falling for a second month in a row, illustrating that supply chain bottlenecks and difficulty hiring labor, especially skilled labor, is still prevalent. Consumers have been hesitant to return to work as the delta variant spread has increased over the summer months, as illustrated in the chart below.

Additionally, the fear of mask mandates and lockdowns returning has curbed consumer spending which fell to +0.3%for the month of July, missing expectations of +0.4%, and well below the prior month’s release of +1.1%. The miss on Consumer Spending came from softer than expected retail goods and automobiles, but service spending increased. If consumer spending continues to soften into the second half of the year, it could lead to stagnating the economic recovery. Despite consumers pessimism, Incomes surged +1.1%, crushing expectations of +0.3%. The advance was due to Child Tax Credit payments, which more than offset a decline in unemployment benefits, which have been tapering off in recent months as the economic recovery progresses. Overall, consumers remain in one of the best financial standpoints in history. Consumers aren’t alone, corporations are posting some of their strongest earnings in history. As earnings season wound down at the end of August, S&P 500 constituents posted a revenue surprise of 4.9% in aggregate, the largest surprise percentage since FactSet began tracking the metric in 2008 and well above the five-year average of 1.46% (dotted line in the chart above). The unprecedented amount of stimulus distributed by the Fed and Congress has been a significant boon to corporations’ top lines. The Q2 sales growth has helped justify stretched valuations, JPMorgan Asset Management reported S&P 500 YTD earnings growth of 19.7% and multiples have compressed down -5.3%. Despite this compression, P/E ratios remain elevated at 21.5x, versus their 5-year average of 16.3x on the S&P 500.

Bottom Line: Equities continue to grind higher despite lofty valuations, temporary setbacks in the economic recovery due to supply chain constraints and labor shortages, the spread of the delta variant, and hesitant consumers. If trends begin to develop in any of these risks, it may stagnant the economic recovery.

Click here to see the full review.

©2021 Prime Capital Investment Advisors, LLC. The views and information contained herein are (1) for informational purposes only, (2) are not to be taken as a recommendation to buy or sell any investment, and (3) should not be construed or acted upon as individualized investment advice. The information contained herein was obtained from sources we believe to be reliable but is not guaranteed as to its accuracy or completeness. Investing involves risk. Investors should be prepared to bear loss, including total loss of principal. Diversification does not guarantee investment returns and does not eliminate the risk of loss. Past performance is no guarantee of comparable future results.

Source: Bloomberg. Asset‐class performance is presented by using market returns from an exchange‐traded fund (ETF) proxy that best represents its respective broad asset class. Returns shown are net of fund fees for and do not necessarily represent performance of specific mutual funds and/or exchange‐traded funds recommended by the Prime Capital Investment Advisors. The performance of those funds may be substantially different than the performance of the broad asset classes and to proxy ETFs represented here. U.S. Bonds (iShares Core U.S. Aggregate Bond ETF); High‐YieldBond(iShares iBoxx $ High Yield Corporate Bond ETF); Intl Bonds (SPDR® Bloomberg Barclays International Corporate Bond ETF); Large Growth (iShares Russell 1000 Growth ETF); Large Value (iShares Russell 1000 ValueETF);MidGrowth(iSharesRussell Mid‐CapGrowthETF);MidValue (iSharesRussell Mid‐Cap Value ETF); Small Growth (iShares Russell 2000 Growth ETF); Small Value (iShares Russell 2000 Value ETF); Intl Equity (iShares MSCI EAFE ETF); Emg Markets (iShares MSCI Emerging Markets ETF); and Real Estate (iShares U.S. Real Estate ETF). The return displayed as “Allocation” is a weighted average of the ETF proxies shown as represented by: 30% U.S. Bonds, 5% International Bonds, 5% High Yield Bonds, 10% Large Growth, 10% Large Value, 4% Mid Growth, 4%Mid Value, 2% Small Growth, 2% Small Value, 18% International Stock, 7% Emerging Markets, 3% Real Estate.

Advisory services offered through Prime Capital Investment Advisors, LLC. (“PCIA”), a
Registered Investment Adviser. PCIA doing business as Prime Capital Wealth Management
(“PCWM”) and Qualified Plan Advisors (“QPA”).
© 2021 Prime Capital Investment Advisors, 6201 College Blvd., 7th Floor, Overland Park, KS 66211.

Blog

Week-in-Review: Week ending in 08.27.21

The Bottom Line

● The S&P and Nasdaq rose to record levels after Fed Chairman Powell’s comments post Jackson Hole Symposium. Small Cap equities were the biggest winner for the week, gaining +5.05% as investors went risk on.
● Treasury yields were volatile leading up to Powell’s comments but settled after his dovish tone. The 2-year yield dropped -1 bps, but the 10-year yield climbed +5 bps higher for the week.
● Economic news for the week illustrated that supply constraints haven’t abated with orders of goods still outpacing shipments and inflation and delta variant spread is still weighing on consumers’ minds.

Powell Soothes Markets

Investors were able to breathe a sigh of relief after Fed Chairman Powell’s dovish comments on Fed policy moving forward. Markets were mainly concerned over the tapering of asset purchases leading directly into a rate hike. Powell quelled these fears by clearly stating that tapering did not mean hiking. Rejuvenated by this reassurance, traders resumed a risk on mode sending the S&P and Nasdaq to record highs, the S&P ended the week up +1.52% and the Nasdaq was up +2.82%. The S&P is now at a healthy +20.06%return for 2021 thus far and the Nasdaq isn’t far behind at + 17.39% YTD. Small Cap equities were the dominant index for the week, up a whopping +5.05% for the week and + 15.31% YTD. Powell’s comments were heard far and wide with international indexes rising as well. The STOXX Europe 600 gained +0.76% for the week and is now up +18.37% for the year. Troubled Japanese equities were able to catch a bid and returned to positive territory for the year, up +2.32% for the week and now up +0.72% YTD. Yields were ripe with speculation over the Fed’s policy and its effect on the economic recovery, but ultimately, the short end of the curve fell -1 bps and the 10-year yield rose +5 bps.

Digits & Did You Knows

MONTHLY BENEFIT — 54 million Americans receive monthly Social Security retirement benefits, including retired workers, dependents of retired workers, and survivors of deceased workers. 42 million Americans receive monthly assistance from the Supplemental Nutrition Assistance Program (SNAP), aka “food stamps”. (source: SNAP, BTN Research).
AFGHANISTAN — The United States spent $2.26 trillion during its 20-year presence in Afghanistan in fighting the Taliban, rebuilding the Afghan government, and training the Afghan military. (source: Brown University, BTN Research).
SKIP THE PUMP — There are 43,600 electric vehicle (EV) charging stations in the USA. The $1.2 trillion infrastructure bill passed by the Senate allocates $7.5 billion for additional charging stations.(source: DOE, BTN Research).

Click here to see the full review.

Source: Bloomberg. Asset‐class performance is presented by using market returns from an exchange‐traded fund (ETF) proxy that best represents its respective broad asset class. Returns shown are net of fund fees for and do not necessarily represent performance of specific mutual funds and/or exchange‐traded funds recommended by the Prime Capital Investment Advisors. The performance of those funds may be substantially different than the performance of the broad asset classes and to proxy ETFs represented here. U.S. Bonds (iShares Core U.S. Aggregate Bond ETF); High‐YieldBond(iShares iBoxx $ High Yield Corporate Bond ETF); Intl Bonds (SPDR® Bloomberg Barclays International Corporate Bond ETF); Large Growth (iShares Russell 1000 Growth ETF); Large Value (iShares Russell 1000 ValueETF);MidGrowth(iSharesRussell Mid‐CapGrowthETF);MidValue (iSharesRussell Mid‐Cap Value ETF); Small Growth (iShares Russell 2000 Growth ETF); Small Value (iShares Russell 2000 Value ETF); Intl Equity (iShares MSCI EAFE ETF); Emg Markets (iShares MSCI Emerging Markets ETF); and Real Estate (iShares U.S. Real Estate ETF). The return displayed as “Allocation” is a weighted average of the ETF proxies shown as represented by: 30% U.S. Bonds, 5% International Bonds, 5% High Yield Bonds, 10% Large Growth, 10% Large Value, 4% Mid Growth, 4%Mid Value, 2% Small Growth, 2% Small Value, 18% International Stock, 7% Emerging Markets, 3% Real Estate.

Advisory services offered through Prime Capital Investment Advisors, LLC. (“PCIA”), a Registered Investment Adviser. PCIA doing business as Prime Capital Wealth Management (“PCWM”) and Qualified Plan Advisors (“QPA”).

© 2021 Prime Capital Investment Advisors, 6201 College Blvd., 7th Floor, Overland Park, KS 66211.

 

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The Three Alternative Investments You Should Research Right Now

There is a current euphoria taking place in the public markets, but if you look forward it seems as though we are borrowing from future returns. Many financial institutions and analysts are projecting lower returns for both U.S. equities and U.S. bonds moving forward, and more broadly across major asset classes. Higher inflation levels are expected in the future as well, and with those higher levels, it’s going to be difficult to find places in the public markets that provide a good return without losing purchasing power.

This is why, for the right investor, alternative investments can really add value to a portfolio today. We look at incorporating alternatives into a person’s portfolio to enhance diversification and improve the risk-reward profile. Said differently, for the same level of risk, alternative investments help us to create portfolios that have a better expected return. But just like most things in life, not all alternative investments are created equally. We like the core, foundational alternatives: private equity, private real estate and private credit. Let’s explore each a little further.

Private Equity

There is tremendous opportunity in private equity. 80 percent of the companies in the United States with sales greater than $100 million are private companies. Now compare that to the shrinking opportunity set in public markets. In the 1990s, there were about 8,000 publicly listed companies in the U.S. but that number is now just under 4,000, meaning the opportunities there have decreased dramatically.

You’ll also see the opportunity in private equity if you look at the overall market cap. The average size of private companies is smaller than public companies, meaning they have more room to grow. And if they have more room to grow, that’s a growth opportunity for the investor.

When you’re looking for returns that are larger than what public markets have offered, private equity offers a huge opportunity partly because of the liquidity premium. Simply put, if you’re going to put your money in something that is difficult to get it out of, you can expect greater returns for that inconvenience.

Now is a great time to explore an investment in private equity because there’s been an amazing evolution in the vehicles and structures that investors now have at their disposal. It used to be that your only option for investing in private equity meant your capital would be locked up for 7-8 years before you’d see a return of your capital. These days, many new investments provide quarterly liquidity opportunities, which provides far greater flexibility for investors.

Private Real Estate

Real estate is a major contributing factor to consumer net worth, which makes these hard assets a great wealth accumulation vehicle. As I look at the current environment, investments in private real estate make even more sense because they serve as a natural inflationary hedge. As interest rates go up, lease rates go up. Landlords are able to pass along rising rates, instead of suffering from them.

Many private real estate investments are also very tax efficient, between the usage of depreciation, taxed deferred growth, and even 1031 exchanges that can allow investors to roll gains from one property or offering forward to another without having to recognize the capital gain at the time of the transaction

Finally, real estate doesn’t necessarily need to be confined to one particular sector. Many people think of retail stores, office buildings, or apartments when they think of this asset class, but other segments such as data centers, industrial warehouses, and even cell phone towers also provide access to secular growth trends in the economy.

Private Credit

For investors who need income ,where can they get it in this current low interest rate environment?

With private credit, you’re also able to extend to other areas of fixed income that you can’t touch in the public markets. For example, collateralized loan obligations or CLOs offer shorter duration fixed income exposure for your portfolio, which helps to limit interest rate risk. If you can get your money returned to you quicker, you face less risk from inflation lessening your purchasing power. Private lending can also offer higher rates of income for the same level of credit risk, again due to the illiquidity premium that is typically associated with these types of products.

Implementation

As we have noted, alternative investments can provide a significant diversification benefit as well as inflationary protection for an investor’s portfolio. But they also help instill better investor behavior. This was evident in March 2020 when the market crashed at the start of the pandemic. Alternative investments are often harder to pull one’s money out of in a hurry, so instead of panic selling, investors stay in and reap the benefits of the recovery.

Today’s environment calls for outside-the-box thinking for investors hoping to achieve healthy returns while maintaining a reasonable level of risk. There is by no means a perfect solution for everyone, and there could be some additional requirements necessary to participate in these types of investments so they must be used carefully, only as a satellite option to complement, rather than replace, a traditional investment portfolio. Because reporting requirements are not as stringent as those for publicly traded securities, a thorough due-diligence process is an absolute necessity before investing, and on an ongoing basis for monitoring purposes. This is where having a research team on your side can be incredibly helpful. If you have questions about alternative investments and how they can best be incorporated into your portfolio, don’t hesitate to reach out to us here at Prime Capital Investment Advisors.

​Advisory products and services offered by Investment Adviser Representatives through Prime Capital Investment Advisors, LLC (“PCIA”), a federally registered investment adviser. PCIA: 6201 College Blvd., 7th Floor, Overland Park, KS 66211. PCIA doing business as Prime Capital Wealth Management (“PCWM”) and Qualified Plan Advisors (“QPA”

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Back-to-School Savings: How Educators can Utilize 403(b) Plans to Save for Retirement

As back-to-school season rapidly approaches, educators may be too busy preparing for the upcoming year to think about their retirement savings. But for educators and employees in other non-profit sectors, you might have access to a great retirement savings vehicle that you may not know about — the 403(b) plan.

In their inception, 403(b) plans were run less like a retirement plan and more like a group of separate IRAs. Because the majority of them were run by one predominant recordkeeper, these plans had problems that affected a participant’s ability to grow their money and properly save for retirement.

First, this meant participants only had access to the investment options that the recordkeeper offered. Participants were not getting what is known as “open architecture”, meaning they did not have the opportunity to access the best large-cap growth funds in the marketplace. They were limited to the recordkeeper’s capabilities.

Second, participants in the early 403(b) plans found themselves in a guaranteed interest contract (GIC), which locks participants’ money in at a crediting rate lower than what would be found in the marketplace. It also would not allow participants to withdraw money faster than a seven to 10 year period, making it a fairly illiquid investment vehicle. At best, this prevented a participant’s account from growing at a reasonable rate. At worst, it also provided for a nasty surprise when a retiring participant was unable to withdraw a significant portion of the account.

When the IRS made some changes to 403(b) plans rules 10-15 years ago, they began to operate much more like 401(k) plans. Now, 403(b) plans are a great resource for educators and other non-profit employees, and the reputation often found around these plans is much less accurate. These plans offer many benefits to employees, such as:

  1. For most employees, 403(b) plans are essentially indistinguishable from 401(k) plans. The plan offers participants a chance to defer some of their paycheck to put away for retirement. This can happen in two ways. Participants can put away pre-tax money now and pay taxes on it when they take distributions later in life. Or, in a Roth option, participants can put away taxed money and let it grow tax-free.
  2. This savings vehicle allows you to expose your savings to the market, which presents the opportunity for it to grow at a much higher rate than if it were put away in a savings account or another bank account. A savings account will not grow your money enough to be ready for retirement.
  3. Investing in a 403(b) plan gives you the opportunity to have a portfolio that will be managed for you and will take into account your age, retirement goals, and risk tolerance to form the strategy right for you. You may even have access to a managed account, which is actively managed and takes into account all aspects of your financial situation.
  4. Some plan sponsors may offer a matching contribution, where they will match a certain percentage of your regular paycheck deferrals to invest in your account. If you aren’t taking advantage of a 403(b) plan with a matching contribution, you’re missing out on that bonus.

If you’re a plan sponsor, you should be ensuring all your employees know about the benefits of the plan. One way to be a competitive employer is to not only offer a good benefits program but to also show that you support your employees in their financial wellness and that you care that they have a good nest egg for retirement.

One way you can do this and be a good employer is to hire a company like ours, Qualified Plan Advisors, to educate your participants about their plan, investment, strategies, and overall financial wellbeing. With our expertise in financial planning, we can truly be a crucial tool for your employees to achieve their retirement goals.

As the school year starts, one thing you should not have to worry about is your retirement savings or financial wellness. For this reason, you should take advantage of your 403(b) plan, and, if available to you, talk to a financial advisor about how to achieve your retirement goals. At Qualified Plan Advisors, we know that working in the education, the medical, and non-profit field comes with a lot of pressure and is crucial to society, so we are here to take the stress out of financial planning.

 

Advisory services offered through Prime Capital Investment Advisors, LLC. (PCIA), a Registered Investment Advisor. Prime Capital Investment Advisors doing business as Qualified Plan Advisors, “QPA.” 6201 College Blvd., 7th Floor, Overland Park, KS 66211

Blog Market Commentary

Week-in-Review: Week ending in 08.13.21

The Bottom Line

● Equities returned to their winning ways after last week’s fall. All major global equity indices posted gains for the week, are now positive for the year–most with double‐digit advances, and are at or near all‐time highs.
● The yield on the U.S. 10‐year Treasury rebounded from its lowest levels since February, to end the week at 1.30%after strong economic data showed the recovery continuing despite the spread of the Delta variant.
● AccordingtoFactSet,withabout90% of S&P500 companies having reported Q2 results, earnings growth is running at a blistering +88.7% pace with a 87% beat rate.

August brings a return to record highs

Global equities posted weekly gains, turning our market snapshot to the right entirely green for the week, and now for the year. The S&P 500 closed the week at another record high, its 44th record closing of 2021, for a +0.9% gain for the week. But Small Cap Value stocks were the best asset class for the week with a +1.1% gain, despite a ‐1.9% drubbing on Wednesday. A better‐than expected July employment report and another week of strong corporate earnings helped investors overcome concerns about rising inflation, the fast‐spreading Delta variant, and a regulatory crackdown on Chinese technology stocks. Earlier in the week data showed better‐than‐expected Factory Orders and an acceleration in the ISM Services Index to a record high. But it was the labor market that really bolstered stocks later in the week with fewer‐than‐expected unemployment claims on Thursday, followed by a stellar July employment report on Friday with upside surprises in new payrolls, a lower unemployment rate, better labor participation rates, as well as higher wages and hours worked. After several weeks of yields falling, the bounty of encouraging economic data helped Treasury yields reverse higher and the Treasury curve steepen.

Digits & Did You Knows

(NOT SO) FRIENDLY SKIES — The Federal Aviation Administration has received 3,715 reports about unruly passengers in 2021 and has initiated 628 investigations, compared with fewer than 150 in 2019. It is now asking airports and law enforcement to help mitigate the poor behavior (source: Federal Aviation Administration, WSJ).
DEBT LIMIT DEBATE — The nation’s debt ceiling limit was reset on Sunday 8/01/21 to our government’s outstanding debt as of that date (approximately $28.5 trillion). Ultimately the government will “run out of cash,” mostly likely in October or November, unless the debt ceiling is raised again (source: CBO, BTN Research).

Click here to see the full review.

Source: Bloomberg. Asset‐class performance is presented by using market returns from an exchange‐traded fund (ETF) proxy that best represents its respective broad asset class. Returns shown are net of fund fees for and do not necessarily represent performance of specific mutual funds and/or exchange‐traded funds recommended by the Prime Capital Investment Advisors. The performance of those funds may be substantially different than the performance of the broad asset classes and to proxy ETFs represented here. U.S. Bonds (iShares Core U.S. Aggregate Bond ETF); High‐YieldBond(iShares iBoxx $ High Yield Corporate Bond ETF); Intl Bonds (SPDR® Bloomberg Barclays International Corporate Bond ETF); Large Growth (iShares Russell 1000 Growth ETF); Large Value (iShares Russell 1000 ValueETF);MidGrowth(iSharesRussell Mid‐CapGrowthETF);MidValue (iSharesRussell Mid‐Cap Value ETF); Small Growth (iShares Russell 2000 Growth ETF); Small Value (iShares Russell 2000 Value ETF); Intl Equity (iShares MSCI EAFE ETF); Emg Markets (iShares MSCI Emerging Markets ETF); and Real Estate (iShares U.S. Real Estate ETF). The return displayed as “Allocation” is a weighted average of the ETF proxies shown as represented by: 30% U.S. Bonds, 5% International Bonds, 5% High Yield Bonds, 10% Large Growth, 10% Large Value, 4% Mid Growth, 4%Mid Value, 2% Small Growth, 2% Small Value, 18% International Stock, 7% Emerging Markets, 3% Real Estate.

Advisory services offered through Prime Capital Investment Advisors, LLC. (“PCIA”), a Registered Investment Adviser. PCIA doing business as Prime Capital Wealth Management (“PCWM”) and Qualified Plan Advisors (“QPA”).

© 2021 Prime Capital Investment Advisors, 6201 College Blvd., 7th Floor, Overland Park, KS 66211.

 

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Qualified Plan Advisors: August Advocate Newsletter

Better Understanding the “Mega Backdoor Roth” Concept: FAQ’s

Retirement plan lingo typically isn’t the most exciting. Terms like “EPCRS”, “ACP”, “ADP”, “QACA”, “EACA”, “402(g) limit”, “415 limit”, etc. don’t make for the best headlines.

Writers and commentators have found a term they like, though, in “Mega Backdoor Roth”. When they throw the term into a headline and introduce a story with the ability to save $58,000 into a 401(k) plan and avoid taxes in the future, we have an intriguing concept on our hands. Yet they frequently overstate its simplicity and fail to address nuances that merit additional attention. Let’s take a look at some FAQs that will help plan sponsors to navigate the processes of considering the necessary plan amendment and communicating with participants.

Q: What steps would be involved in the “Mega Backdoor Roth” possibility?
A: As a starting point, the plan must allow for old-fashioned “after-tax contributions”. These are not Roth contributions; the Tax Code permitted this type of after-tax contributions long before Roth contributions became available.

Next, a participant must elect to convert after-tax contributions to Roth dollars. This could occur through an “in-plan Roth conversion” if the plan’s terms permit such a conversion. In this case, the dollars would remain in the plan. In the alternative, to the extent the plan were to permit an “in-service distribution”, the participant could elect a distribution and rollover the proceeds to an outside Roth IRA.

Following that participant action, the Tax Code would treat the dollars like other Roth amounts, including a later tax-free distribution of the principal amount and earnings (provided that the distribution otherwise met the requirements for a “qualified” distribution).

Q: Could a participant contribute an unlimited amount of after-tax contributions?
A: No. The Tax Code generally limits the total amount that may be contributed to a participant’s 401(k) or 403(b) plan in any given year. For 2021, the limit is $58,000. The following formula answers this question: Annual total contribution limit – sum of all other contributions made to the plan (pre-tax deferrals, Roth contributions, and all employer contributions) = limit on after-tax contributions. (Note that the annual limit increases for participants who make catch-up contributions after maximizing their traditional pre-tax or Roth contributions. In 2021, the limit is $64,500 for those participants.) As discussed below, the limit could be further reduced for a highly compensated employee (HCE) if the plan were to fail the applicable nondiscrimination test.

Q: My CFO read about this in the Wall Street Journal and has asked us to make it possible. Is it really a no-brainer?
A: No. It’s not a no-brainer. It’s also not a slam dunk or a home run. If it works (more on this below), though, it is pretty cool.

Consider the high percentage of employees’ retirement savings that is sitting a pre-tax bucket, awaiting taxation at the time of distribution. The Mega Backdoor Roth structure would provide a pathway toward shifting that percentage lower and permitting more retirement dollars that will be exempt from taxation when distributed. In overly simplistic terms, a Roth 401(k) structure may permit a participant to save around 3x the amount he or she could contribute to a Roth IRA in any given year; a Mega Backdoor Roth structure takes that to an entirely different level, by potentially permitting a participant to save between 2x and 3x the amount that could be contributed under a typical Roth 401(k) structure. In addition, the plan contributions are not subject to the adjusted gross income (AGI) limits that prevent many high earners from directly contributing to a Roth IRA.

The potential advantages make the concept worth exploring. Of course, the potential surprises trigger the need to dive deeper into the details.

Q: What issues should we consider before making Mega Backdoor Roth available?
A: The biggest potential issue relates to the plan’s nondiscrimination testing. An employee’s after-tax contributions are treated as employer contributions for testing purposes and subject to the Average Contribution Percentage (ACP) test. This testing will be required without regard to whether the plan is a safe harbor plan. If only HCEs make after-tax contributions, failure is quite likely – particularly if the plan does not include an employer contribution.

Plan sponsors should also consider whether the after-tax contributions will be subject to a matching contribution. Any plan amendment and participant communication should clearly address the organization’s preferred approach.

Finally, if a plan liberally permits in-service distributions that would be used to accomplish the Mega Backdoor Roth conversion into external Roth IRAs, this could result in significant plan asset outflows. Some employers don’t worry about this. Others take pride in retaining retirement assets in the plan, in part because larger assets provide greater pricing efficiencies for the entire workforce.

Q: Given the combination of potential advantages and disadvantages, what are employers doing to make it work?
A: The most critical test will be to ask the recordkeeper to perform some stress testing in advance of making plan design changes. We recently participated in this exercise with Prudential, which did an incredible job of simulating various potential after-tax contribution usage rates and was able to project the likely outcomes under various scenarios. The stress testing could suggest there will not be testing issues. It also could suggest that potential limits (such as a dollar or percentage ceiling) on after-tax contributions would greatly increase the likelihood of passing the test.

Others are thinking about ways to feature after-tax contributions as an option that participants may appreciate for a variety of purposes. The Mega Backdoor Roth concept most commonly involves HCEs. Yet after-tax contributions are also gaining traction as an attractive emergency savings option, particularly for non-HCEs. QPA’s Rob Massa blogged about this “old idea to solve a modern problem” in July.

These are complex issues. It may make sense to introduce the building blocks over a series of plan amendments. Start with Roth contributions, later add the traditional in-plan Roth conversion option that allows the conversion of pre-tax amounts in the plan, and then follow with the Mega Backdoor Roth concept. If a plan sponsor is not inclined to take that gradual approach, communication is paramount. Depending on the stress test results, a plan sponsor may need to very proactively encourage non-HCEs to use after-tax contributions.

We welcome these conversations. We understand many in human resources or benefits departments face a tough scenario when an executive or otherwise-influential employee presents the Mega Backdoor Roth as a sure thing or, even worse, suggests that the absence of that feature is cause for judging the plan as a poor employee benefit. As is frequently the case in life, the answer is somewhere in the middle. Progressive employers take the time to listen to employee demand, discuss the possibilities with the plan consultant, and explore avenues to bring new features to participants that will be a net positive. The Mega Backdoor Roth could work. Or it could not. We’ll see.

Blog Market Commentary

Week-in-Review: Week ending in 08.06.21

The Bottom Line

● Equities returned to their winning ways after last week’s fall. All major global equity indices posted gains for the week, are now positive for the year–most with double‐digit advances, and are at or near all‐time highs.
● The yield on the U.S. 10‐year Treasury rebounded from its lowest levels since February, to end the week at 1.30%after strong economic data showed the recovery continuing despite the spread of the Delta variant.
● AccordingtoFactSet,withabout90% of S&P500 companies having reported Q2 results, earnings growth is running at a blistering +88.7% pace with a 87% beat rate.

August brings a return to record highs

Global equities posted weekly gains, turning our market snapshot to the right entirely green for the week, and now for the year. The S&P 500 closed the week at another record high, its 44th record closing of 2021, for a +0.9% gain for the week. But Small Cap Value stocks were the best asset class for the week with a +1.1% gain, despite a ‐1.9% drubbing on Wednesday. A better‐than expected July employment report and another week of strong corporate earnings helped investors overcome concerns about rising inflation, the fast‐spreading Delta variant, and a regulatory crackdown on Chinese technology stocks. Earlier in the week data showed better‐than‐expected Factory Orders and an acceleration in the ISM Services Index to a record high. But it was the labor market that really bolstered stocks later in the week with fewer‐than‐expected unemployment claims on Thursday, followed by a stellar July employment report on Friday with upside surprises in new payrolls, a lower unemployment rate, better labor participation rates, as well as higher wages and hours worked. After several weeks of yields falling, the bounty of encouraging economic data helped Treasury yields reverse higher and the Treasury curve steepen.

Digits & Did You Knows

(NOT SO) FRIENDLY SKIES — The Federal Aviation Administration has received 3,715 reports about unruly passengers in 2021 and has initiated 628 investigations, compared with fewer than 150 in 2019. It is now asking airports and law enforcement to help mitigate the poor behavior (source: Federal Aviation Administration, WSJ).
DEBT LIMIT DEBATE — The nation’s debt ceiling limit was reset on Sunday 8/01/21 to our government’s outstanding debt as of that date (approximately $28.5 trillion). Ultimately the government will “run out of cash,” mostly likely in October or November, unless the debt ceiling is raised again (source: CBO, BTN Research).

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Source: Bloomberg. Asset‐class performance is presented by using market returns from an exchange‐traded fund (ETF) proxy that best represents its respective broad asset class. Returns shown are net of fund fees for and do not necessarily represent performance of specific mutual funds and/or exchange‐traded funds recommended by the Prime Capital Investment Advisors. The performance of those funds may be substantially different than the performance of the broad asset classes and to proxy ETFs represented here. U.S. Bonds (iShares Core U.S. Aggregate Bond ETF); High‐YieldBond(iShares iBoxx $ High Yield Corporate Bond ETF); Intl Bonds (SPDR® Bloomberg Barclays International Corporate Bond ETF); Large Growth (iShares Russell 1000 Growth ETF); Large Value (iShares Russell 1000 ValueETF);MidGrowth(iSharesRussell Mid‐CapGrowthETF);MidValue (iSharesRussell Mid‐Cap Value ETF); Small Growth (iShares Russell 2000 Growth ETF); Small Value (iShares Russell 2000 Value ETF); Intl Equity (iShares MSCI EAFE ETF); Emg Markets (iShares MSCI Emerging Markets ETF); and Real Estate (iShares U.S. Real Estate ETF). The return displayed as “Allocation” is a weighted average of the ETF proxies shown as represented by: 30% U.S. Bonds, 5% International Bonds, 5% High Yield Bonds, 10% Large Growth, 10% Large Value, 4% Mid Growth, 4%Mid Value, 2% Small Growth, 2% Small Value, 18% International Stock, 7% Emerging Markets, 3% Real Estate.

Advisory services offered through Prime Capital Investment Advisors, LLC. (“PCIA”), a Registered Investment Adviser. PCIA doing business as Prime Capital Wealth Management (“PCWM”) and Qualified Plan Advisors (“QPA”).

© 2021 Prime Capital Investment Advisors, 6201 College Blvd., 7th Floor, Overland Park, KS 66211.

 

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