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Ukraine War Means Yet More Inflation: Andy Friedman

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What You Need to Know

  • Higher inflation will take hold in the U.S. due to the Russia-Ukraine war, Friedman says.
  • He predicts some of the tax increases in Biden's Build Back Better plan will be enacted, taking effect in 2023.

Higher inflation due to the Russia-Ukraine war along with likely tax hikes are on tap for the United States, according to Andy Friedman, founder and principal of The Washington Update. Meanwhile, tax hikes are likely to be passed before the midterm elections in November, he says.

In a webcast held Thursday by American Century Investments, the political analyst and former tax attorney discussed the financial impact of the war and offered planning strategies advisors can use to help clients prepare for potential tax increases.

The Russia-Ukraine war will cause a spike in oil and food prices in the United States resulting in “increased inflation on top of the inflation we already have,” Friedman said on the webcast.

More inflation presents “a conundrum” for the Federal Reserve Board: it “will want on the one hand to increase interest rates to tame inflation but on the other hand it will want to keep rates low to spur an economy that is likely to slow down as a result of the inflation and the effects on the world markets. And all of that is going to lead to increased market uncertainty.”

Congress, Friedman added in a separate email to ThinkAdvisor on Monday, “has a lot on its plate now: government funding (by March 11); COMPETES Act (supporting domestic chip manufacture); [Electoral] Count Act (formalizing the electoral count process); the Supreme Court nomination; and a possible gas tax holiday.”

President Joe Biden’s Build Back Better plan, he said, “has fallen lower in priority.”

The gas tax is 18.4 cents per gallon. There’s “talk about relieving that tax through the end of 2022,” according to Friedman.

As for potential tax increases, Friedman opined that some parts of the Build Back Better legislation will pass.

“I continue to think that the Democratic leadership wants to pass at least some items in BBB before the [midterm] election,” he said in the email. “The bill likely will include items Sen. [Joe] Manchin once indicated that he might support, such as universal pre-K, expanding health insurance coverage, clean energy, and drug pricing. The bill will incorporate tax increases so that there is no revenue loss. The tax portion of the bill might also include other policy items, such as limits on IRA holdings.”

“First thing that probably hits us the most is an increases in tax rates,” he said.

Manchin, D-W.Va., supports an increase in the individual tax rate from 37% to 39.6%, the capital gains rate from 20% to 28%, and the corporate tax rate from 21% to 25%, as well a 15% minimum tax on corporations, Friedman said.

Others in Congress, particularly Sen. Kyrsten Sinema, D-Ariz., are looking at surtaxes on very high income families.

“So there would be a 5% surtax for families with income over $10 million and an additional 3% surtax, for a total of 8%, on families [with] over $25 million” in income.

Keep in mind, Friedman continued, “that income will include capital gains, and so for those of you who have large unrealized built-in gains in assets, when you sell them if we see a surtax system you could see additional tax on that sale.”

Friedman sees these tax changes as likely to be enacted “to pay for a stripped down” Build Back Better bill, taking effect at the beginning of next year.

Freidman explained that advisors can help clients prepare for potential tax hikes via the following planning strategies.

1. To prepare for a potential income tax hike, consider Roth conversions. ”If you convert at a lower tax rate then you don’t have to pay tax on your withdrawals from your IRA account when tax rates go up,” he says. “It’s a great idea if you believe tax rates are going up to consider converting now.”

2. Take advantage of the backdoor Roth IRA strategy this year.

3. Consider tax-managed solutions and active management in mutual funds. It’s “very helpful” to have “someone who can keep an eye on and be aware of” tax changes, he says.

4. Life insurance can provide tax-free income in retirement — whether through loans or withdrawals. “It can be very beneficial if tax rates are high,” he says.

5. Annuities can help investors defer taxes.

6. “It may be reasonable if we see this [tax] legislation moving and enacted to consider realizing [capital] gains in some of your assets with substantial unrealized gains,” Friedman says.

7. Donating appreciated property is a “great way to avoid tax on the appreciated property.”

8. If aggregate retirement account balances are high, consider taking money from these accounts first to reduce future RMDs. “Now that’s the opposite of what we usually do; usually if you’re in retirement you’re obliged to take distributions from nonqualified assets so you don’t have to pay tax after pulling assets out of your retirement plan,” he says. “But if you have substantial assets in your retirement plans, that may be a time to [be] getting those plans lower so you don’t have to distribute funds later.”

9. A qualified charitable distribution allows individuals over 70 ½ to donate up to $100,000 per year from IRAs directly to charity, tax-free. This can qualify as an RMD.