As we head into a new year, I always recommend clients take the time to look at their finances and make adjustments where needed.
In this blog, I answer the most common questions I receive this time of year and give my advice as we head into 2025.
- What financial trends do we expect to see in 2025?
Dropping Interest Rates
Easing interest rates will likely continue into 2025. Following a period of high rates, many analysts are predicting that there will be more interest rate cuts in the coming year. The Federal Reserve will meet several times and is expected to implement rate cuts, with the goal of lowering the fund rate to between 3.5% and 3.75% by the end of the year.
What impact will this have on borrowers? Lower interest rates are expected to increase borrower activity, especially in real estate with the expectation that mortgage rates will come down as a result.
Slowing Inflation
In addition to easing interest rates, it’s expected that inflation will also continue to cool, according to analysts. If inflation goes down, we can expect the alleviation of some economic pressures, allowing for more stable consumer spending and investment.
Despite decreasing inflation, consumer debt is at an all-time high, meaning households may continue to struggle with day-to-day expenses. People may feel less confident and spend less money as they run out of built-up savings.
Growth and Volatility
Market volatility could be something to keep an eye on as we head into 2025. Some analysts are optimistic about what the year could bring, but many factors will influence Wall Street’s success. Key influences include a new administration in office, ongoing geopolitical tensions and the pace of economic recovery in major markets outside of the United States.
Certain sectors, particularly technology and healthcare, are expected to drive growth, but they may also face volatility due to rapid changes in consumer demand and regulatory environments. The energy sector could also experience fluctuations as it adapts to increased demand from technology advancements, such as AI.
- How are contribution limits for retirement accounts changing in 2025, and what should people know when choosing between a Roth and a Traditional 401(k)?
To keep up with inflation, contribution limits for employee salary deferrals will increase in 2025, allowing for greater retirement savings. 401(k) plans will rise to $23,500 for individuals under the age of 50 and $31,000 for those 50 and older (including the catch-up contribution).
Individual Retirement Account (IRA) contribution limits are also expected to increase, potentially reaching $7,000 for individuals under 50 and $8,000 for those 50 and older.
When choosing to save in a Roth vs. a 401(k), there are a few considerations to keep in mind. For a traditional 401(k), the contributions you make are made pre-tax, reducing your taxable income in the year you contribute. Taxes are paid upon withdrawal during retirement, which can be beneficial if you expect to be in a lower tax bracket at that time.
In a Roth 401(k), contributions are made after tax, meaning you pay taxes on the income before contributing. Qualified withdrawals in retirement are tax-free, making it advantageous if you expect to be in the same or a higher tax bracket.
The flexibility of withdrawing your money in retirement varies between Traditional 401(k) and Roth 401(k) accounts. With a Traditional 401(k), early withdrawals before age 59½ generally incur a 10% penalty along with income taxes. Required Minimum Distributions (RMDs) begin at age 73, requiring annual withdrawals. Roth 401(k) contributions can be withdrawn tax-free at any time, but earnings require you to wait until age 59½ and meet the five-year rule to avoid taxes or penalties.
When considering market and income factors, your current tax bracket plays a key role. If you're in a lower tax bracket now, a Roth 401(k) might be advantageous as it locks in your current tax rate. However, if you expect higher income in retirement, a Traditional 401(k) could be the better choice.
Additionally, many employers offer matching contributions, which typically go into a Traditional 401(k) account regardless of whether you contribute to a Roth or Traditional option, and these matched funds will be taxable upon withdrawal.
- What should investors consider as we move into the new year?
In anticipation of declining interest rates, investors should be aware of central bank policies. Reduced rates can bolster stock prices but may also signify underlying economic challenges. An improved inflationary environment could lead to a more stable economy, but investors should remain cautious as inflationary pressures could resurface. Ongoing geopolitical tensions and their effects on global markets can also lead to volatility.
Maintaining a diversified portfolio across asset classes including stocks, bonds, real estate, etc., can help mitigate risk during market fluctuations. I recommend diversifying into sectors less correlated with traditional stocks.
No matter what the market brings, it’s important to keep your long-term investment goals in mind. Avoid knee-jerk reactions to short-term market movements and maintain a disciplined approach. Reassess and rebalance your portfolio periodically to align with your risk tolerance and investment objectives to help ensure that you are not overly exposed to any single asset class.
Keeping an eye on international relations and trade policies will also help you stay the course and be informed about how external factors impact the market.
- For retirees or those approaching retirement, what should they know about Required Minimum Distributions (RMDs) and charitable giving?
Required Minimum Distributions (RMDs) are the minimum amounts retirees must withdraw from retirement accounts, whether that’s a traditional IRA or 401(k), starting at age 73. RMDs are considered taxable income, which can increase overall tax liability and potentially push retirees into a higher tax bracket, affecting the taxation of Social Security benefits and other income.
To manage taxes, retirees can utilize Qualified Charitable Distributions (QCDs), allowing individuals aged 70½ or older to transfer up to $105,000 directly from their IRA to a charity without it being counted as taxable income. This strategy reduces taxable income, satisfies RMD requirements, and offers a powerful tool for tax management.
No matter what the new year may bring, it’s important to stay the course and follow your financial plan. At Zephyrus, we plan for our clients first and invest second. That means we work with our clients to create a financial plan before we even talk about any investments. As always, consulting with a financial advisor will provide value, personalized strategies tailored to your financial situation and goals, especially as market conditions change.