Finance 101: August 2024

In August the financial advisors at Ruedi Wealth Management wrote four more columns for The News-Gazette’s Business Extra section. Make sure to look for them every Saturday in the weekend edition of the paper, but in case you missed any in July, all four are below.

What is an ETF?

By Daniel Ruedi, CFP®, RICP®

An Exchange Traded Fund, or “ETF” for short, is an investment fund that can be bought and sold throughout the day, similar to a stock. An ETF is not an investment itself – it is a wrapper that holds many different types of investments, and thus takes on the characteristics of whatever it invests in.   

There are many types of ETFs. Some are simple diversified stock and bond ETFs, while others may cover specific commodities, industries, or currencies. Though the rise of ETF investing coincided with the rise of index investing, not all ETFs passively follow an index.

ETFs can provide investors with the ability to invest in diversified groups of stocks and bonds around the globe at a low cost. Today it is possible to build a diversified global stock portfolio using a single ETF.  Though ETFs can be bought and sold frequently, many ETFs are used as great buy-and-hold investments for long-term investors.

But since ETFs can be bought and sold throughout the day, they can be used for short-term speculation as well. Some ETFs, called leveraged ETFs, attempt to double or triple the performance of the stock market. For example, if the market goes up 1%, leveraged ETFs would go up 2% or 3%.

Another type of ETF called an inverse ETF, attempts to do the opposite of the stock market; if the market goes down 1%, it goes up 1%. These types of ETFs are only designed for short-term speculation and would not make suitable long-term investments.  

ETF shares have a price based on the value of their underlying investments. Similar to the price of a stock, it allows investors to track changes in the value of that particular fund. Unlike a mutual fund, where fractional shares can be purchased, ETF investors must purchase whole shares. Every ETF will have a prospectus that spells out the characteristics of the fund, relevant details about the type of investments the fund owns, and the expenses of the fund.

There are several features of ETFs investors should be aware of. The first is that ETFs charge a fee for operating the fund, which is called an expense ratio. The second is how much the manager is buying and selling the individual holdings within the fund, which is called turnover.

Investors should also pay attention to the number of holdings in an ETF to make sure it is adequately diversified. If you are unsure if ETFs fit into your investment portfolio, or are wondering if a specific ETF is a good investment, you may want to talk to a financial advisor.

Daniel Ruedi is a Certified Financial Planner™ professional with Ruedi Wealth Management in Champaign, Illinois.

No Retirement Savings at 50

Paul R. Ruedi, CFP®

People often like to kick the retirement savings can down the road. The justification is almost always that they will catch up later when their income is higher, when the credit card det debt is paid off, or a multitude of other excuses. But what happens if that period of kicking the can down the road stretches all the way to age 50? I recently came across an online post from a person who was in a panic because she had saved nothing for retirement at age 50. Is her panic justified?

I won’t sugar-coat it, this person is very, very behind. She’s already missed three decades of saving and the large compound growth that results from investing early. She can’t get those back. At the same time, she still has around 13 years until the average retirement age for women in the US, and the potential to work even longer than that. A lot can happen in two decades. But it is a task that will need to be taken seriously. If I was in her shoes, this would be the path I would follow.

First, I’d have to cut spending. Even if you can afford to pay for everything to make your life run, if you aren’t able to save anything for your future you are living beyond your means. Instead of beating myself up for the past, I would use all of that concern and regret to motivate myself to spend more frugally going forward. I’d take a few years living with draconian spending cuts to save as much as possible. Those initial savings could have a couple decades to grow, which can be very powerful.

I would also plan on claiming Social Security at age 70. Your Social Security benefit increases by 8% every year you delay past your Full Retirement Age until age 70. That initial amount is then adjusted for inflation each year. A person with a relatively low level of assets will likely receive a large portion of their retirement spending from Social Security, so it will be important to squeeze as much as possible out of it.

Last but not least, I’d put as much as possible into tax-advantaged retirement accounts and invest in a 100% diversified stock portfolio, at least in the earlier years, to set myself up for maximum growth. I would do all of this as part of a comprehensive retirement plan, so I could have a better understanding of the retirement lifestyle I can expect and what steps will be taken to get there.

Paul R. Ruedi, is a Certified Financial Planner™ professional with Ruedi Wealth Management in Champaign, Illinois.

Estate Tax 101

Paul Ruedi

The estate tax, often dubbed the "death tax," is a topic that frequently sparks debate and concern among Americans. However, the reality is that for the vast majority of us, it's not something we'll ever have to deal with personally. Let's break down the basics of estate taxes and why they're primarily a concern for the ultra-wealthy.

The federal estate tax only applies to estates valued above a certain threshold. For 2024, that exemption amount is a whopping $13.61 million per individual. This means that if you pass away in 2024, your estate can be worth up to $13.61 million before any federal estate taxes kick in. For married couples, this amount is effectively doubled to $27.22 million through a concept called estate tax portability.

While the federal exemption is quite high, it's worth noting that some states have their own estate taxes with lower thresholds. Illinois, for example, begins taxing estates exceeding $4 million. If you live in one of these states check your local rules, as you may need to plan for state estate taxes even if you're well below the federal limit.

For those rare estates that do exceed the federal threshold, the tax rate can be substantial. The portion of the estate above the exemption amount is taxed at a rate of 40%. This is why estate tax planning becomes crucial for high-net-worth individuals and families.

The current estate tax exemption is set to expire at the end of 2025. Without further legislative action, the exemption will revert to pre-2018 levels, adjusted for inflation. Specifically, the estate tax exemption is expected to drop from $13.61 million per individual at the end of 2025 to approximately $7 million in 2026. For married couples, the combined exemption would fall from $27.22 million to around $14 million. This change makes it crucial for high-net-worth individuals to review and potentially adjust their estate plans. But the vast majority of people will still be well below the new exemption amount.

While estate taxes make for interesting political debates, the reality is that they're a non-issue for the vast majority of Americans. Unless your estate is valued in the tens of millions, you can likely focus your financial planning efforts elsewhere. However, it's always wise to stay informed about potential changes in tax laws and consult with a financial professional if you have concerns about your estate plan.

Paul Ruedi is the CEO of Ruedi Wealth Management in Champaign, Illinois.

Inherited IRA Rules

Paul R. Ruedi, CFP®

Inheriting an Individual Retirement Account (IRA) can be a financial windfall, but it also comes with a complex set of rules that can trip up even the savviest beneficiaries. Recent changes in legislation have made these rules even more intricate, leaving many heirs scratching their heads.

First, the rules differ depending on your relationship to the deceased account owner. Spouses have the most flexibility, with the option to treat the inherited IRA as their own or transfer it to an inherited IRA. Non-spouse beneficiaries, however, face more restrictions.

For most non-spouse beneficiaries, the SECURE Act of 2019 eliminated the "stretch IRA" option, which allowed distributions to be spread over the beneficiary's lifetime. Now, these beneficiaries must empty the account within 10 years of the original account owner's death.

This rule applies to IRAs inherited from account owners who died after December 31, 2019. However, there are exceptions to this 10-year rule. Certain "eligible designated beneficiaries" - including minor children of the account owner, disabled or chronically ill individuals, and beneficiaries not more than 10 years younger than the deceased - can still use the life expectancy method for distributions.

Adding to the complexity, the IRS has been adjusting its stance on Required Minimum Distributions (RMDs) for inherited IRAs. In a recent development, the IRS waived 2024 RMDs for certain inherited IRA beneficiaries subject to the 10-year rule. This marks the fourth consecutive year of such waivers, reflecting ongoing efforts to clarify and implement the new rules.

It's crucial to note that while these waivers provide temporary relief, they don't extend the ultimate 10-year deadline for emptying the account. Beneficiaries should carefully consider their long-term tax strategy, as deferring distributions could lead to larger tax bills in the future.

The type of IRA inherited also impacts the rules. For traditional IRAs, beneficiaries must pay income tax on these distributions. Roth IRA beneficiaries, on the other hand, can typically withdraw funds tax-free, provided the account was open for at least five tax years before the owner's death. It is important to note both types of accounts are subject to required minimum distributions.

For those grappling with these rules, seeking professional advice is often wise. The consequences of mishandling an inherited IRA can be severe, potentially resulting in a tax of up to 25% on the amount of a missed required minimum distribution. If you need help navigating inherited IRA withdrawal rules, you may want to talk to a financial advisor.

Paul R. Ruedi, is a Certified Financial Planner™ professional with Ruedi Wealth Management in Champaign, Illinois.

Disclaimer: Past performance is no indication of future results. You should not make any investment decisions without first performing your own due diligence and consulting your financial advisor.