How Secure Act 2.0 Changes RMD Rules

Ivanna Hampton: Here’s what’s ahead on this week’s Investing Insights.

Tax and IRA expert Ed Slott talks about some new RMD rules that retirees should know. Plus, what Morningstar considers key for Microsoft’s long-term growth. And, travel’s comeback is still going. Our travel industry analyst will share where investors should look for opportunities.

This is Investing Insights.

Welcome to Investing Insights. I’m your host, Ivanna Hampton.

Let’s get started with a look at the Morningstar headlines.

Our Take on Tech: Microsoft

Microsoft MSFT reported a solid fiscal second quarter as it restructures the company to increase efficiency. However, the outlook for March was once again shy of Morningstar’s below-consensus estimates.

Azure’s growth is decelerating, but the cloud computing platform’s results came in slightly better than expected. Microsoft’s revenue grew 2% year over year to almost $53 billion for the December quarter. The commercial segments of productivity and business processes and intelligent cloud grew compared with the same period last year. Meanwhile, the “more personal computing” segment that includes Windows and gaming declined.

Morningstar is pleased with strong year-over-year growth for the cloud platforms—Azure and Dynamics 365. Both are key pillars to our long-term growth estimates. And we think Microsoft shares are worth $310 each and continue to view the stock as attractive.

Tesla Positioned Well, Says Musk

Electric vehicle maker Tesla TSLA says 2022 was its “best year ever on every level.” And it’s seeing its strongest orders ever in the company’s history so far this year. Morningstar Research Services’ equities strategist Seth Goldstein calls the results “solid.” However, Tesla fell short of Wall Street’s expectations in the fourth quarter. That’s despite the results showing substantial year-over-year gains.

Tesla CEO Elon Musk says the U.S. will quote “probably have a pretty difficult recession this year.” While a recession could affect demand, he says it would also lead to lower input costs and improve margins. Musk says Tesla is in a good position to withstand what could be a “severe” recession because it has little debt. It also has billions in cash on its balance sheet. Musk forecasts the company will produce 1.8 million cars this year based on demand, and possibly more.

Goldstein is maintaining his $220 estimate of what he thinks Tesla’s stock is worth. He considers shares undervalued.

Southwest’s Holiday Hullabaloo Hits Earnings Report

Holiday travel troubles hit Southwest’s LUV fourth quarter.

The airline reported a net loss following its widespread operational failure in December. Southwest canceled more than 16,000 flights. Management says a functional gap was found in its crew scheduling system, and that caused a cascading effect when bad weather hit.

It took an $800 million hit in the fourth quarter due to factors like travel expense reimbursements and a rise in employee compensation. Management says the firm will likely see another net loss during its fiscal first quarter.

Morningstar expects Southwest will begin addressing operational issues this year. Southwest has put short-term solutions in place, hired a consulting firm, and is aiming to update its software. Morningstar has lowered our estimate of what we think the stock is worth to $55, but we still think it’s undervalued.

Travel Makes a Move

Many people are booking trips despite high inflation and talk of a recession. The TSA reports the number of travelers rose from last June to last November, and those figures sat just under prepandemic levels. Morningstar Research Services senior equity analyst Dan Wasiolek covers the travel industry. He’s joined Investing Insights to discuss Morningstar’s travel outlook.

Ivanna Hampton: Dan, the pent-up travel demand is still going strong as the pandemic eases. What’s driving it?

Dan Wasiolek: We think there’s three factors that are really driving this demand. The first is that there is a human-ingrained desire to travel. So, if people have the financial means, and if they’re not restricted by health concerns, they’re going to travel. And that’s what we saw during the pandemic and what we continue to see.

A second reason would be that people are spending more on services and experiences like travel. During the pandemic in 2020 and 2021 when we were more staying in our house, people were spending more on goods. That has now shifted to more consumption towards services, which we think is benefiting travel.

And then the third factor would be that there’s remote work flexibility, which allows for some incremental trips. We learned during the pandemic that you could work remotely and still be productive.

Hampton: So, road trips and leisure travel kicked off the rebound. How’s business travel faring?

Wasiolek: I think we’re now at the stage in the recovery of travel that we’re starting to see more of a pickup in business trips. So, the first stage of recovery in 2020 was one where people wanted to travel, but in order to travel, they had to take road trips and they had to be near their house. And then I think when we got vaccine distribution in 2021, we got an easing of travel restrictions, which then allowed trips to kind of broaden out to more air-based trips and eventually more international trips. And now as people are returning to the office, we’re seeing more of a return to business travel.

We think right now business travel is probably three fourths of the way back to where it was prepandemic, but that’s up from less than half of a recovery a year ago. And we probably think that we’ll get not all the way back to a full recovery, but pretty close. There might be some displacement from video conferencing, but we think 2023 is a year that looks to see continuing recovery in business travel, and that’s supported by commentary from the airline operators and some of the operators in Las Vegas.

Hampton: All right, so let’s shift from work trips to fun ones. Cruise ship passengers tend to book their trips months in advance. Can you talk about how current advance ticket sales compare to those before the pandemic?

Wasiolek: People like to have fun. They’ve been having fun on land and now they’re—also looks like they’re having fun on the sea. And so, the four cruise operators that we follow, they’ve been saying that now their bookings levels are above 2019. We actually got a recent data point from one operator, Carnival Cruise Lines CCL, that for their week ending January 20, that their bookings levels were about 120% above 2019 levels. So the cruise industry is definitely now seeing a strong demand recovery.

Hampton: And that’s impressive since when the pandemic started, they were hit pretty hard.

Wasiolek: They were hit the hardest. I mean, they had their complete operations shut down for several months, where they weren’t allowed to allow any people to be on their cruise ships. So it’s been a pretty dramatic turnaround and one that we think can endure in 2023.

Hampton: So let’s talk about the current economic situation, just the talk that’s happening right now. So why hasn’t inflation and talk of a recession made spending on travel less desirable?

Wasiolek: Travel’s cyclical. It’s not immune to economic slowdowns. And the economic slowdown that we face is a headwind for travel. But in our view, we think that there are tailwinds that can offset that headwind. And we’ve talked about those tailwinds. Again, the human-ingrained desire to travel, people shifting towards more service consumption, and remote work flexibility. And historically, when you look at periods when people are spending on service consumption, typically, travel grows even greater than service consumption, and over a long-term horizon, travel spending is greater than economic growth. Travel is not immune to economic slowdown, but we do think that there are tailwinds that should be considered.

Hampton: Where should investors look for opportunities if they want to play travel’s rebound?

Wasiolek: So, despite the encouraging signs that we continue to see with travel demand recovery and travel broadening out, there’s still opportunities for investors. A couple of names. One would be Expedia, ticker EXPE, which is one of the main online travel agency platforms, and we think would be a general beneficiary of continued travel demand.

A second would be Accor Hotels, ticker AC, which trades on the Paris Exchange. They have a very high exposure to international hotels in Europe and Asia-Pacific, so they stand to benefit from continued overseas travel and the reopening of China.

A third name would be Sabre, ticker SABR, which has airline content. And they’re more exposed than other names to the recovery in business travel. They look like a name that could see outsize growth maybe in 2023 and 2024 in our view.

And then finally, one cruise line operator would be Carnival Cruise Lines, ticker CCL, which as we talked about, should benefit from the return of people going to sea for their leisure travel.

Hampton: All right, Dan. Well thank you for providing Morningstar’s travel outlook today.

Wasiolek: Thanks for having me.

New Rules for IRA Distributions

Christine Benz: Hi, I’m Christine Benz from Morningstar. New retirement legislation has major implications for people who are already retired. Joining me to discuss what Secure 2.0 means for required minimum distributions is tax and retirement planning expert Ed Slott.

Ed, thank you so much for being here.

Ed Slott: Great to be back with you.

Benz: Well, it’s great to have you here. Now, I’m curious. We saw the passage of what’s called Secure 2.0, this piece of retirement-related legislation that passed at the very end of 2022. Were you surprised that this legislation squeaked through as the year wound down?

Slott: I was surprised. It went all the way down to the wire down to Dec. 29, that was the date of enactment, it had to be actually shipped to the president to be signed. About the Secure 2.0 part, remember that was just one part of the big omnibus appropriations bill that ran over 4,000 pages. I wasn’t surprised Secure 2.0 made it through because that had huge bipartisan support. The thing is, would it have been attached to something that would pass? And eventually, that did pass in the midnight hour, so to speak.

Benz: I want to delve into the implications of Secure 2.0 for people who are already in retirement, perhaps they are pulling from their retirement accounts. One of the big changes that was part of Secure 2.0 is that it pushes out the required minimum distribution age. Can you talk about what’s going on there?

Slott: There was a lot of talk about that as landmark legislation. But overall, there was nothing I would call landmark or even earth-shattering or game-changing, nothing transformative like the original Secure Act was, where they eliminated the stretch IRA and the 10-year rule—big changes. This was more fixing up, trimming around the edges. And yes, they increased the age. They pushed it back from 72 to 73. So, some people, again, are going to be confused, “Does this apply to me?”

The best way to figure it out: If you’re born between 1951, because most people know when they were born, so 1951 through 1959, you can use age 73. If you’re already taking RMDs, you must continue. Another way to say it who can use age 73: anybody who turned 72 in ‘23 or later. But go back to the birth years. So, that’s who gets to use 73. Now, there was a lot of misinformation. I don’t know if I’d call it misinformation, but a lot of articles that came out right after the bill was signed. In the headline, they said, the RMD age was raised to 73 and then to 75. Forget 75. That doesn’t happen for 10 years, in 2033. So, put that out; 73 is the age.

Well, it gives you one more year of freedom to do whatever you want before RMDs begin. So, you could do more Roth conversions, for example, another year.

Benz: The rules around missing RMDs also appear to have gotten a little bit more lenient. Can you talk about that?

Slott: Pushing back RMDs sounds good. But remember, the more you push it back, the more that eventually has to come out into a shorter window of time, and that could cost you more money long term. So, while you don’t have to take it till now 73, you might want to start pulling it out earlier, doing Roth conversions. The key is to get as much of your IRA money out when the rates are the lowest, and they are rock-bottom historically low right now in 2023, given the huge inflation increase. They always said inflation is bad. Not when it comes to tax rates; the brackets are expanded. This is the time to hit it. So, I might not look at delaying. I might look at expanding that window, get more of your IRA money out while the rates are low.

Benz: And people’s tax rates may also be low in those early years of retirement, right?

Slott: Yeah.

Benz: I want to talk about missing required minimum distributions. Seems like the penalties are a little bit lighter as a result of Secure 2.0. Can you talk about what’s going on there?

Slott: A lot lighter. The draconian penalty for missing an RMD, as many people know, has been for years, forever, 50%—50% of the amount you should have been taking but didn’t. That is now dropped to 25%, so that’s a big drop, and even lower to 10% if you make up or take the missed RMD within two years. But I’m a little skeptical about this one. Almost nobody, I would say, ever paid the 50%. IRS rarely assessed that because it was such a harsh penalty. I’m wondering if more people may end up paying it now that it’s only 10%. For example, I’d rather pay 50% of nothing than 10% of something. So, the message is, make sure you take your RMDs.

Benz: Well, that’s a good point. I want to talk about the Roth 401(k) part of Secure 2.0. In the past, required minimum distributions were due on those Roth 401(k)s, not to be confused with Roth IRAs. Now, it sounds like those will be lifted. Can you talk about what’s going on there?

Slott: That’s a great move. As you said, Roth IRAs never had lifetime RMDs, not for beneficiaries, but lifetime, your own. But Roth 401(k)s were part of a 401(k) plan, so they always did. This is a great move. Now, starting in 2024, there will be no RMDs for Roth 401(k)s. So, you don’t have to worry about leaving it in the plan. What people were told to do in the past was as you got near your RMD age, roll it out to a Roth IRA. Now you don’t have to do that anymore.

Benz: So, people who like their retirement plan, their company-provided retirement plan and they let them stick around, that might be a good option if they’re in the Roth.

Slott: Yeah, it was a good change.

Benz: So, last question for you, Ed, relates to this qualified charitable distribution, which you and I have talked about on numerous occasions. It’s an attractive opportunity for people who are aged 70.5. Can you talk about the QCD, what it is and also how Secure 2.0 makes a few tweaks to the QCD?

Slott: Well, it’s a great provision if you qualify. It’s only for IRA owners or IRA beneficiaries who are 70.5 or older. Notice Secure or Secure 2.0, neither one changed the age. Even in each of those laws, the RMD age went from 70.5 to 72, then 72 to 73. But for QCDs, it’s still 70.5. So, that’s good. More people can do direct transfers—and that’s what a QCD is, a qualified charitable distribution—a direct transfer from their IRA directly to the charity. Normally, most people now get no tax benefit on the gifts they give to charity. So, this is a great way to get a benefit, an exclusion from income that can actually satisfy an RMD, and you can even do it if you’re charitably inclined, get that money out before RMDs even begin because of the wider gap now, 70.5 to 73.

So, the change now—it was a $100,000 limit. I thought that was enough for most people, but apparently, some in Congress thought it should be higher. So, they’re going to inflation-adjust that in a year or two. Right now, it’s still $100,000. But they also added a provision allowing people to do a one-time $50,000 QCD to split-interest charities. For example, a charitable remainder trust, a charitable gift annuity, they weren’t allowed before, but now they’re allowed. Donor-advised funds are still not allowed, and private foundations are still not allowed. I don’t know how many people are going to take advantage of that. Because the way the rules are written, you’d have to set up a separate entity, a separate charitable remainder trust, for example, just for the $50,000. I don’t know if the cost is worth the benefit in that, but it’s in there.

Benz: Ed, lots of good food for thought for people who are entering retirement or already in retirement. Thank you so much for being here to share your perspective.

Slott: Thanks, Christine.

Benz: Thanks for watching. I’m Christine Benz from Morningstar.

Read About Topics From This Episode

Resilient Azure Helps Microsoft Drive Solid Results; Macro Drives Lower Outlook; FVE Cut to $310

Tesla Posts Solid Earnings, Reports Strong Orders to Start 2023

Southwest Reports Q4 Net Loss Due to December Operational Issue; We See Improving Margins Ahead

New Expense Management Survey From Center Reveals Uptick in Travel Spend Among SMEs Despite Inflation and Recession Concerns

Can the Travel Industry’s Recovery Continue?

3 Notable Changes in Secure Act 2.0 for Advisors