More On Tax Planningfrom The Advisor's Professional Library
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- Annuities: Estate Tax The value of certain types of annuities may be included in an estate’s value. Understanding the intricacies of these inclusions is a critically important aspect of estate planning.
Affluent investors are likely to face double- and even triple-digit increases in tax rates in 2013, but a new whitepaper offers tips on planning for this eventuality.
Andrew Friedman, a principal in the Washington Update, which focuses on the impact of public policy on the financial services industry, has previously warned that sharp tax hikes are all but certain in less than a year. No matter the political complexion of the next Congress and regardless of whether President Barack Obama is reelected, it is he and the current divided Congress who will preside over the lame-duck post-election legislative session dealing with the expiration of Bush-era tax cuts.
Whether the president feels newly empowered because of his re-election or stands on his previous pledges despite defeat, he is likely to veto any measure renewing tax cuts for affluent Americans; congressional Republicans in the House will face the choice of compromising on a bill that renews the tax cuts for the less affluent or to see the entire measure expire.
At the same time, new taxes enacted with the president’s signature health-care law take effect next year, so that families with incomes above $250,000 will pay an additional 3.8% tax on investment income.
The result of these combined tax increases, according to the whitepaper by Friedman (above), will be a tax rate on dividends rising from 15% to 43.4% for an increase of almost 300%. He calculates the top tax rate on capital gains would rise from 15% to 23.8%–an increase of nearly 60%; the estate tax would rise 55% as the tax rate rises and the old exemption amount is restored; and the top rate on ordinary income will rise from 35% to 43.4%–an increase of almost 25%.
The Washington Update whitepaper details eight strategies investors can employ in this rising tax environment.
The first idea–and one with ominous implications for stock market performance this year–is to sell assets while the tax on capital gains is just 15%. Friedman cites a recent study which found that “if asset values grow by 4% per year and the capital gains rate increases as scheduled from 15% to 23.8%, an investor will have to hold assets for an additional fifteen years to be better off than he would be had he sold the assets initially and paid tax at the lower rate.”
The whitepaper also recommends receiving ordinary income this year rather than next. “For instance, executives could consider exercising non-qualified stock options this year so that the resulting income is taxed at prevailing rates,” Friedman writes.
Conversely, the value of deductible expenses–such as charitable contributions–will rise in the higher-rate environment and should therefore be deferred. Similarly, the attractiveness of municipal bonds will rise since the tax-equivalent yield on the same bond (all else being equal) will be higher in 2013 than in 2012.
Friedman suggests that tax-loss harvesting and buy-and-hold investing both become more compelling strategies in a high-tax environment, as do investments managed to enhance after-tax returns through reduced turnover, deferred gains, hedging techniques and the like.
The whitepaper recommends consideration of life insurance and annuities whose tax-deferral features become more attractive when taxes rise. (Friedman notes that annuity death benefits, unlike life insurance payouts, are subject to income tax, though a beneficiary may “stretch” payments over the course of his life.) Friedman also recommends conversions of traditional IRAs to Roth IRAs and details at length the applicable rules.