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Christine Benz: Biden Tax Plan Is Wake-Up Call to Trim Portfolio Risk

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What You Need to Know

  • Advisors should reassure clients that the proposed tax changes most likely will be altered.
  • With the bull market, many portfolios may have concentrated risk that needs to be trimmed.
  • Charitable donations are a good way to reduce tax liability and portfolio risk.

A reminder from tax and retirement experts: There are many miles to go before any of the tax changes the Biden administration proposed this week become a reality. And even if everything is passed as proposed, which is highly unlikely, many of these changes won’t affect most retirees, they say.

To get some perspective, we caught up with Christine Benz, Morningstar’s director of personal finance, on Thursday. We asked about how retirees may be affected by a rise in the top capital gains rate to 39.6% for those earning $1 million or more a year.

We also wanted to know how retirees could be affected by the proposed change to the step-up in basis, which allows heirs to use the market value of assets — including stocks and bonds — at the time of inheritance instead of the actual purchase price, as the cost basis for capital gains when sold.

Under the plan, only the first $1 million in assets would be eligible for the step-up in basis. (Charitable donations and some family businesses and farms would have certain exemptions).

Benz cautioned that advisors and their clients should not “put the tax cart in front of the horse,” as there may be other issues they need to pay attention to, especially in “this late stage of the bull market,” she said.

“[The tax proposal] is a wake-up call to revisit highly appreciated positions in a portfolio. Even if you wouldn’t be on the hook for higher taxes, people may have big positions in stocks: employer stocks, inherited stocks.

“A lot of these positions are adding risk to the portfolio, so especially given that we find ourselves in a pretty low tax regime for capital gains … [investors] should see if [they] can’t do a little bit of trimming to take some risk out of a portfolio,” she said.

Concentrated positions are a starting point, she said, adding that growth stocks have had a good run and should be repositioned or trimmed. Younger investors may want to get into a globally diversified equity or index fund.

And older investors? “They should look at whether de-risking into lower risk assets makes sense,” she said. These “hiding-in-plain-sight appreciated equity holdings” can be where retirees can pick up some cash flow for a few years or “obviate the need to look for additional income producers.”

Tax Proposals

For the most part, she believes advisors and their clients need to take a wait-and-see approach to the tax proposals as there will be changes with negotiations between the Democrats and Republicans.

That said, she did shed some light on the proposals.

Regarding the elimination of the step-up in basis, Benz said that “it’s interesting because it opens up some opportunities to be artful about which assets fall under that $1 million threshold … but it will create an accounting headache.”

She notes that very wealthy families already have cost basis information “buttoned down with financial advisors or tax advisors.”

However, for less affluent families, it might become a “paper chase” as assets purchased prior to 2010 weren’t tracked, and the onus was put on the investment providers to track cost basis, she said. “In some cases it will be kind of a guesstimate if documents aren’t available, like, ‘oh, I think Dad purchased this in 1967.’”

She also notes the tax proposals were meant to exclude middle-income retirees and families. Further, the large majority of equity and fixed income assets are held in tax-deferred accounts, which when withdrawn are taxed as ordinary income.

Benz says families affected by the step-up in basis proposal can donate assets to charity, which “removes the tax liability associated with highly appreciated assets and it delivers a deduction in the year in which the contribution is made. It also potentially removes risk in the portfolio.”

She adds that annuities, which have tax deferrals built in, as well as some life insurance products, can work to reduce liability. Managing deductions as well as income are strategies that can be used for higher tax risk, she said.