This month Federal Reserve Chairman Ben Bernanke spoke before a House panel about the current state of the economy. He pledged the central bank stands ready to act and do what is necessary to work towards reducing unemployment and keeping the economy moving. Mr. Bernanke also detailed the steps the central bank has taken so far to keep our economy from falling off a cliff. Yet, investors need to pay attention to what Bernanke said on his second day of testimony, “The way the current law is set up, we are going to have a very, very sharp contraction in the fiscal situation, increased taxes and cuts [in] spending that are very dramatic and that occur almost simultaneously on January 1 of 2013.” This is the “Fiscal Cliff” that Investors need to be prepared for.
• The 2% point tax reduction on payroll tax goes away. This will impact roughly 160 million works.
(http://abcnews.go.com/Politics/OTUS/tax-hikes-loom-congress-act/story?id=16034065)
• Federal extended unemployment benefits end. Job growth has already started to slow.
(http://economywatch.msnbc.msn.com/_news/2012/05/04/11536808-job-creation-slows-again-in-april-jobless-rate-dips?lite)
• The debt ceiling limit will be hit again. We are already at $16,000,000,000,000 and growing fast. (www.usdebtclock.org)
• The tax cuts under former President Bush in 2001 and 2003 then extended by President Obama are scheduled to expire.
• Federal Budget cuts that were part of the agreement reached during the 2011 Debt Ceiling agreement are set to take effect.
This combination of higher taxes and less spending could put our economy over the “Fiscal Cliff” as Mr. Bernanke pointed out. Stephen Fuller, from George Mason University, said “The unemployment rate will climb above 9%, pushing the economy towards recession and reducing projected growth in 2013 by two-thirds.”
The debates will only continue to heat up this year. Yet, in our opinion we are unlikely to see any real action taken until after the election. That will give our politicians less than two months to implement solutions. We can’t control what they get done, but here are three action items you can control.
#1. Income Tax Planning For Retirement Accounts:
A traditional retirement account grows tax-deferred and then the account owner pays income taxes in the future when withdrawals are made. If you think your individual tax rates will be higher in the future, you should have a Roth Conversion Triple Split Analysis done right now. This could allow an investor to potentially pay lower income tax rates now, and in the future. To qualify for the tax-free and penalty-free withdrawal of earnings, a Roth IRA must be in place for at least five tax years, and the distribution must take place after age 59 ½ or due to death, disability, or a first-time home purchase ($10,000 lifetime maximum). Depending on state law, Roth IRA distributions may be subject to state taxes. As a backup plan, if tax rates do not change or the strategy does not work as planned, the Roth recharacterization rules allow an investor to undo the conversion next year.
#2. Income Tax Planning for Regular Investment Accounts:
The stock market has significantly increased in price over the past four years. If the current Bush Era tax cuts expire, capital gain rates would increase from 15% up to 20%. Investors who own stock in a taxable account should consider locking in gains while capital gains rates are at historic lows. Next, investors receive dividends could be in for a shock next year. If the current dividend rate expires, rates would change from 15% to ordinary income rates. Thus an investor in the 25% tax bracket would see a 40% reduction in income due to higher taxes. To avoid a major reduction in income, retiree’s and investors should consider having Plan B in place.
#3. The new estate tax:
Remember that company stock that Dad and Mom have held onto all these years? Currently if they pass that stock on to you as a beneficiary all profits are forgiven in what is known as “stepped up basis.” If this law expires, it makes heirs extremely vulnerable to capital gains taxes on what could be highly appreciated stock. Plus, does anyone know what Mom or Dad paid for that stock years ago? Thus, the new rules would make record keeping a big nightmare. A solution is to help Mom or Dad take an inventory of their assets and get cost basis information as soon as possible.
A year from now, the focus may shift on the problems overseas to the problems right here at home. The “fiscal cliff” could turn out to a financial disaster here in the United States. Or maybe at the end of the year after the election results are in, our politicians can come together and quickly implement solutions to avoid the U.S. going back into a major recession. The “fiscal cliff” may turn out to be as much as a hoax as Y2K was. If an investor develops a plan this year on the three ways to be prepared for the “fiscal cliff” the bottom line is they will have a plan in place no matter what happens.
For more information about The Retirement Guys, tune in every Saturday at 1 PM on 1370 WSPD or visit www.retirementguysnetwork.com. Securities and Investment Advisory Services are offered through NEXT Financial Group Inc., Member FINRA / SIPC. NEXT Financial Group, Inc. does not provide tax or legal advice. The Retirement Guys are not an affiliate of NEXT Financial Group. The office is at 1700 Woodlands Drive, Suite 100, Maumee, OH 43537. 419-842-0550
