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Investors Should Save More, Expect Higher Taxes and Diversify: J.P. Morgan

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What You Need to Know

  • Advisors should speak with pre-retirees about what spending is non-negotiable, says Chief Retirement Strategist Katherine Roy.
  • “Down the road, there will be an increase in interest costs [on government debt] and higher taxes on the wealthy, with higher inflation possible,” notes Chief Global Strategist David Kelly.
  • Based on taxes starting in 2026, Roy suggests investors consider using Roth IRA options over the next five years.

The U.S. savings rate has soared during the COVID-19 pandemic, making it a good time to save more for retirement, a new J.P. Morgan report explains.

The St. Louis Federal Reserve Bank says the savings rate was 20.5% in January, calculated as a percentage of disposable income.

In its latest Guide to Retirement, J.P. Morgan Asset Management says the savings rate was 15% in 2020, when calculated as after-tax income — which includes employee and employer contributions to retirement funds minus personal outlays.

Saving More, Spending Less

That reduction in spending during the pandemic can now help households identify where they can cut spending in order to save more for retirement and, once in retirement, avoid the risk of running out of funds.

Katherine Roy, chief retirement strategist for J.P. Morgan Funds, said in a recent webinar that retirees reduced spending by 2% to 9% during the pandemic, while steady earners have reduced spending by 1% to 6%.

The lesson for advisors:  “Talk to pre-retirees about what spending is non-negotiable and where they can pull back should markets be more volatile in the future,” Roy said.

She noted that retirees can adjust spending dynamically to compensate for portfolios performing poorly or for rising inflation, which increases the cost of products and services.

“Consider adjusting your spending strategy based on market conditions to help make your money last and provide more total spending through your retirement years,” the J.P. Morgan Guide to Retirement advises.

Due to the increase in savings, the latest guide has reduced its assumptions for pre-retirement investment returns from 6% to 5.75%. It also examines what a couple today, in a certain age bracket and at a certain age, need to have saved to maintain their current lifestyle for 30 years of retirement.

Prepare for Higher Taxes

Another topic that advisors should discuss with their pre-retiree clients, according to Roy: higher taxes.

Taxes are already set to rise when the reductions enacted by the 2017 tax cut legislation expire in 2026, and other taxes could increase before then.

The 2017 legislation included lower marginal tax rates and capital gains tax for higher earners, higher income thresholds for AMT exemptions and the doubling of the estate tax exemption for estate taxes.

“If the economy heats up too much, the government will have to raise taxes to deal with that,” said David Kelly, chief global strategist at J.P. Morgan Asset Management, who joined Roy on the webinar.

Higher taxes would help to finance the trillions in fiscal stimulus provided by the government, which Kelly expects lead to a “very fast economic recovery, from an almost 15% jobless rate in April 2020 to 3.5% by April 2023. Along with that recovery will be an increase in debt to GDP, which is slightly over 100% now, to about 110%.

“Down the road there will be an increase in interest costs [on government debt] and higher taxes on the wealthy, with higher inflation possible,” Kelly said.

A Challenging Investment, Tax Environment

Kelly expects investment returns will be challenging going forward, which highlights the need for diversification within a portfolio and a  “more sophisticated approach” to asset allocation and within asset classes.

In the four periods of low but rising inflation since 1988, gold, REITs, emerging market and U.S. equities all yielded double-digit returns, according to Kelly.

Roy recommends, based on taxes rising, starting in 2026, that investors consider using Roth IRA options at some point over the next five years.

She suggests that younger investors primarily use Roths for their retirement accounts, that mid-career investors consider a roughly 30% allocation to Roths, and that retirees who haven’t yet taken their required minimum distribution evaluate potential systematic Roth conversions for their traditional IRA accounts.

(Image: Shutterstock)

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