As we watch to see when and how the economy will recover from the COVID-19 pandemic, there has been much talk about the shape of the recovery. Which letter will the economic graph resemble, and which one should we want to to resemble? Here's a quick guide:
V-shapedA sharp period of decline is followed by a sharp period of recovery. This is the sort of recovery that most people seem to be talking about (and hoping for) right now. The very encouraging May employment report, which said that the country added more than 2 million jobs in that month, put forth some hope that we be in for a V-shaped recovery. But it's not actually the most optimistic scenario. That would be:
Z-shapedThe economy suffers a downturn, but then bounces back up strongly enough to go above the level it would have been if it had followed a pre-pandemic baseline, as pent-up demand creates a temporary boom. This scenario relies on the supposition that a good part of the consumer spending that didn't happens during lockdowns—vacations, big-ticket home improvement items, recreational spending at bars and restaurants—was simply delayed, and is made up once the risk from the pandemic passes.
U-shapedThis is sort of the poor cousin to the V-shaped recovery. You have a sudden decline followed by a period of stagnation, before a strong period of recovery begins to take hold.
Square root-shapedThis one is a little convoluted to imagine, because it describes a rather convoluted recovery. It’s actually an inverted square root sign, where the economy drops down to the bottom, stay there a while, then settle into a prolonged period of subpar growth — a lasting slowdown.
Nike Swoosh-shapedThis would be a hard, fast drop followed by a long, slow climb back to economic stability. The biggest difference between this and the square root scenario is that with the swoosh, the recovery is long but makes consistent progress.
W-shapedIn this scenario, there’s a downturn, and then signs point to recovery, as if we're in a V-shaped recovery. But then another downturn happens, before things actually start to recover for good. We saw this in the early 1980s: There was a recession in 1980, then almost a full year of recovery before a second recession took hold in 1981.
L-shapedThis the most pessimistic outlook, a result in which the pandemic has a long-term effect on lowering our nation's GDP. Lost investment during the crisis, slowing productivity growth, and disruptions to the global economy would cause the trajectory of GDP to be lower than it looked before the pandemic. This is basically what the recovery from the Great Recession looked like: It took six years for per capita GDP to return to 2007 levels.
Which one are we headed for? It’s too soon to say, but the good news is that there is a lot of pent-up economic demand out there, and we may see consumer spending snap back to something resembling normal over the summer. If that returns in a robust way, a V-shaped recovery isn’t out of the question. If COVID-19 returns in the fall, as some fear, that may drive us back to a W.
For the moment, what we know is that the recession officially began, according to a report from the National Bureau of Economic Research, in February. The big question now is, when – and how – does it end? We’ll be watching.
Retirement planning is not exactly known for having hot new ideas, but one of the hottest to bubble up in recent years is the notion that you should aim to be paying zero taxes in retirement. There are a couple of reasons that make this a worthy goal. It’s not just that your income and your ability to save are both dwindling or nonexistent once you stop working. You’ll also have fewer deductions at that point in your life, since your children will have grown up and your house will likely be paid off.
This is part of a strategy developed by an author and advisor named David McKnight, who has a book and podcast out called The Power of Zero, each of which expand on the concept. He’s also an affiliate of Echelon Wealth Strategies.
One of McKnight’s theories is that taxes are now historically low, and have nowhere to go up. No matter what happens in the upcoming elections, we will eventually have to deal with the fact that our debt is 108 percent of our GDP, after averaging 62 percent from 1940 until 2017. The federal deficit has reached a trillion dollars. After taxes have dropped in recent years, it is very likely that you’re going to have to pay higher tax rates in the future.
One way to deal with these realities begins with thinking of your retirement funds as going into one of three different buckets: taxable, tax-deferred, and tax-free.
This final bucket becomes the key if you are trying to achieve zero taxes in retirement. Contributing to this tax-free bucket gives you control over how much you need to retire comfortably. You can plan your own future.
That’s not necessarily the case with the other buckets. Remember how we said we are likely to be in a higher-tax environment in the future? No matter how much money you have saved up in tax-deferred plans, you are at the mercy of wherever tax rates have landed when you reach retirement. You can plan all you want, but you still don’t know exactly how much of those funds you will be able to draw down if you don’t know how much tax you will owe on them.
Of course, there’s value in contributing to the tax-free bucket as well. These could well be your highest income-earning years, so there’s a benefit to being able to claim a deduction to reduce your current taxable income. But if you think that tax rates will increase, it may make sense to invest more in the tax-free bucket during your earning years.
Getting to zero is a tricky balance to maintain, but we at Echelon Wealth Strategies can help you find the retirement plan that suits you best. If you’d like to discuss how the ideas in this article pertain to your individual situation, give me a call at 615-505-3838.
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