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The Fiscal Cliff and 10 Moves Every Investor               Should Consider Making Now                      (...Before It’s...
The Fiscal Cliff and 10 Moves Every                                                                       Investor Should ...
order to capitalize on the current low tax environment and help mitigate      Loss harvesting involves selling securities ...
4. Convert IRA Account Balances to ROTH IRA                                   want to seriously consider reducing their ex...
On the other hand, President Obama’s 2013 budget included                9. Delay Charitable Contributions Until the Start...
are received by a beneficiary income tax free. Investors should beaware that it is possible to take withdrawals from the c...
Carter-Burgess Plaza777 Main Street, Suite 600Fort Worth, Texas 76102855-552-BPWA (2792)
The Fiscal Cliff and 10 Moves Every Investor Should Consider Making Now (...Before It's Too Late!)
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The Fiscal Cliff and 10 Moves Every Investor Should Consider Making Now (...Before It's Too Late!)


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Originally published Oct 2012 -- White Paper regarding moves every investor should consider making in the run-up to December 31, 2012 and the Fical Cliff.

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The Fiscal Cliff and 10 Moves Every Investor Should Consider Making Now (...Before It's Too Late!)

  1. 1. The Fiscal Cliff and 10 Moves Every Investor Should Consider Making Now (...Before It’s Too Late!)
  2. 2. The Fiscal Cliff and 10 Moves Every Investor Should Consider Making Now (...Before It’s Too Late!) “Defer no time, delays have dangerous ends.” -William ShakespeareAs the days of summer draw to a close and we transition into autumn, we In recent months you may have noticed that a new term has workedare reminded once again that time marches forward. What happened its way into the national lexicon. As we approach the end of 2012, youto those great plans for spending more time at the beach this summer? will no doubt start to hear this term more frequently. We’re talking aboutWeren’t we going to plan more weekend barbecues with friends and “fiscal cliff.” This term describes the dramatic slowdown in economicfamily by the pool? For those of us who live in the southern parts of growth that could grip the U.S. economy come the start of the newthe United States, we are offered the opportunity to delay embracing year if Washington does not act to avert a combination of 1) planned,the shorter, cooler days that come with fall, at least for a little while. substantial increases to tax rates brought on by, among other things, theRegardless of the temperature outside, however, the kids are now back expiration of the Bush era tax cuts, and 2) steep, federally mandatedin school, and before you know it the holidays will be upon us. The cuts in government spending that were agreed to by Congress last yearhectic and joyful days of merrymaking that accompany Thanksgiving, as part of the deal to raise the debt ceiling (Budget Control Act of 2011).Hanukkah, and Christmas will be here. In no time we’ll be singing “Auld At midnight on December 31 the Bush tax cuts, enacted in 2001Lang Syne” and ringing in the new year. Where does the time go? and 2003, are set to expire. This would, among other things, boost Many investors look to the end of the calendar year as a time to the top marginal tax rate on ordinary income from 35% to 39.6% andreview portfolio performance. They may tweak their investment plans increase the tax on both dividends and capital gains substantially. Thebased on how markets have behaved over the previous months or how estate tax rate would rise from a current maximum of 35% to 55% whilethey anticipate markets will behave in the year to come. Some use this the exemption amount would fall from more than $5 million per persontime to liquidate positions in an effort to mitigate the size of their tax bill to roughly $1 million. In addition, the temporary payroll tax cut enactedor simply clean things up and raise cash as they head into the new year. in early 2011 and the extended unemployment benefits program are For the remainder of 2012, simple year-end housekeeping might not also set to expire. 2013 will also see the introduction of a new 3.8%adequately prepare an investor for what is set to happen next. Between Medicare surtax on high income earners as part of the Patient Protectionnow and December 31, the stakes are much higher than in years past. and Affordable Care Act (PPACA). Finally, discretionary governmentThe decisions investors make in the last remaining months of 2012 spending will be reduced by approximately $100 billion next year ifcould have long-term implications for the success of their portfolios. Washington fails to come up with a budget agreement that materiallyThose who fail to act in time might just wake up on January 1 to a world reduces the deficit over the next decade.where tax laws and income tax rates have changed dramatically, having The ramifications of going over the “fiscal cliff” are hotly debated.missed out on the opportunity to do anything about it. The purpose of this report is to educate investors about the moves they might want to consider making between now and the end of the year in
  3. 3. order to capitalize on the current low tax environment and help mitigate Loss harvesting involves selling securities at a loss to offset athe burden of future, higher taxes brought on by the formidable tax law realized capital gain in order to reduce the tax burden of that gain.changes that are set to come online in January. Investors are allowed to bank their “excess” losses for use in future years, called loss carryforward. Losses can be used to offset capital1. Sell Your Winners gains and, in addition, up to $3,000 per year of earned income until suchInvestors with taxable investments that have unrealized long-term gains time as a loss has been completely utilized.may want to seriously consider locking in some or all of those gains Selling at a loss now and waiting until 2013 to use that loss toby selling sooner rather than later. For 2012, the maximum personal mitigate gains, or reduce taxable income, creates a tax arbitrageincome tax rate charged on long-term gains (investments held longer opportunity. The investor sells in a low tax environment and then waitsthan 12 months) is 15%. If Congress does not act to extend the Bush to use the loss to reduce their tax burden in years when tax rates areera tax cuts, the maximum rate will rise to 20% starting January 1. higher. When selling at a loss, it is important to avoid the “wash sale” For high income earners over certain threshold amounts ($200,000 rule so as to not negate the benefit of loss harvesting.for individuals and $250,000 for couples) the maximum possible ratewill be even higher due to the implementation of a new 3.8% Medicare 3. Pull Income into 2012surtax. This additional tax is part of the PPACA and it will be levied If Congress does not act, then starting next year ordinary income taxagainst the lesser of net investment income or the amount by which rates will increase to their pre-2001 levels. As mentioned earlier, taxan investor’s modified adjusted gross income, or MAGI, exceeds the payers will also see the addition of a new Medicare surtax in 2013. Thisthreshold amount. Net investment income, or “unearned” income, additional tax will be charged against “unearned” net investment incomeincludes long-term capital gains. Under this scenario, investors above above certain threshold amounts. Net investment income includesthe threshold amounts would pay a maximum tax rate on long-term capital gains, dividends, interest, rental income, royalty payments,capital gains of 23.8%. Even if Congress extends the Bush tax cuts, the taxable portion of payments from non-qualified annuities, passivethe maximum rate charged on long-term capital gains will increase to activity business income, and the value realized from the exercise of18.8% for high income earners starting next year (15% + 3.8% surtax). non-qualified stock options. It is important to note that an investor who sells assets in 2012 in With the addition of the Medicare surtax, the maximum personalorder to lock in gains and take advantage of current tax rates does income tax rate charged on net investment income would be 43.4% nextnot need to wait 30 days before repurchasing the same security or year (39.6% + 3.8% surtax). To the extent possible, investors mightinvestment. Investors may also wish to consider this type of strategy want to consider pulling these types of income into 2012 to avoid thefor any individual bonds they currently hold in their taxable accounts added tax burden. Distributions from qualified retirement accounts suchthat show accrued interest that is set to be paid in 2013 and beyond. as IRAs and 403(b)s will not be subject to the Medicare surtax; however, withdrawals from these types of accounts are included in MAGI.2. Take Advantage of Losses In other words, a distribution from an IRA won’t be hit with theNo one likes to lose money. Investors often hold on to securities that Medicare surtax next year but that distribution might cause an investor toare in the red expecting, or maybe just hoping, that they will come be hit with the surtax on their net investment income. Also, distributionsback in value. Some investors feel that by selling a “loser” they are from IRAs, 403(b)s, etc. are taxed as ordinary income. With tax ratesadmitting defeat. For the remainder of 2012, however, investors set to increase next year, investors may wish to consider acceleratinghave a unique opportunity to take advantage of losses in their taxable planned withdrawals into 2012. Investors should be mindful of howaccounts. Even for the investor who believes that something they additional withdrawals from retirement accounts might affect whichown is a good long-term investment, they might want to consider income tax bracket they fall into for 2012.selling some or all of a position that is under water before year-end to“harvest” the loss.
  4. 4. 4. Convert IRA Account Balances to ROTH IRA want to seriously consider reducing their exposure to dividend payingAll investors, regardless of their income level, have the option to convert instruments, like blue chip stocks, in their taxable accounts prior to thesome or all of their traditional IRA balances to a Roth IRA. Unlike a end of 2012 to avoid this substantial increase to their future tax bill.traditional IRA, a Roth IRA offers tax-free growth, tax-free income,and greater income planning flexibility. (Roth IRAs are not subject to 6. Take Advantage of Current Estate Tax Exemptionrequired minimum distributions starting at age 70½ like traditional IRAs.) Estate tax law seems to change every year. At times it can be hard toThe portion of a traditional IRA that is converted to a Roth is considered keep up. The Tax Relief, Unemployment Insurance Reauthorization,a distribution in the year of conversion and is taxed as ordinary income. and Job Creation Act of 2010, or “TRA 2010”, that President Obama Without Congressional action, most federal income tax rates will be signed into law in December of that same year not only extended thehigher next year. For high income earners, the maximum rate charged Bush era tax cuts for all tax payers for two years, but it also increasedon ordinary income is set to increase to 39.6% from the current maximum the estate tax, gift tax, and generation-skipping transfer tax exemptionof 35%. This will directly impact the cost of converting. Also, beginning limit to $5 million in 2011 and $5.12 million for 2012. (For couples theon January 1, the new Medicare surtax comes online. Distributions exemption limit is $10.24 million in 2012.) The law also set the maximumfrom qualified retirement accounts like IRAs, while not subject to the tax rate charged against estates and gifts beyond these levels at Medicare surtax, are included when calculating modified gross Assuming no Congressional action before the end of the year, theincome. A distribution from an IRA could push the investor over the exemption amount will fall to just $1 million per person in January andthreshold limits ($200,000 for individuals and $250,000 for couples) and the maximum tax rate will increase to 55%. The remaining months oftherefore trigger the 3.8% surtax on other income. 2012 offer investors an unprecedented opportunity to transfer large Given the potentially higher direct and indirect costs of converting sums of wealth to children or other beneficiaries without paying giftnext year, investors may want to consider executing a Roth conversion taxes. In addition, families have the opportunity to complete multi-before the end of 2012. (Prior to conversion, investors should consider generational gifting without the burden of paying generation-skippingwhether or not the amount of the conversion/distribution will bump them transfer taxes. (These lifetime exemptions are in addition to the annualinto a higher tax bracket. Also, for investors who executed a Roth gift tax exclusion that permits investors to give away $13,000 each yearconversion in 2010 and chose to spread the tax burden 50/50 over 2011 to as many recipients as they wish.) The added benefit to investors isand 2012, do not forget to include the remaining “conversion income” that gifting done now removes the post-gift appreciation and any incomethat you have yet to pay tax on in your calculations.) earned on the gifted assets from their estate.5. Reduce Exposure to Investments that Earn Dividends 7. Invest in Tax-exempt Municipal BondsCurrently, the IRS distinguishes between two types of dividends: Existing tax-exempt municipal bond investors and those consideringqualified and non-qualified. For 2012, qualified dividends are those that investing in munis will want to pay close attention to Washington D.C.are taxed at the same rate as long-term capital gains, or a maximum between now and the end of the year. On the one hand, the expiration ofof 15%. Non-qualified dividends are those dividends that are taxed the Bush tax cuts combined with the addition of the new Medicare surtaxas ordinary income, currently as high as 35%. Starting in 2013, the would make the tax-free interest generated by tax-exempt municipalmaximum personal income tax rate charged on qualified dividends will bonds that much more attractive to investors in 2013 and beyond. (Theincrease to 18.8% with the addition of the new Medicare surtax. interest generated by tax-exempt municipal bonds will not be subject to If Congress does not act and the Bush tax cuts expire, the IRS will the new Medicare surtax.) Increased demand for municipalities couldalso cease to differentiate between the two types of dividends. This result in downward pressure on yields for new issues starting in 2013.would mean that starting in 2013 all dividends will be taxed as ordinary Investors may want to consider buying them now in order to lock in theincome. With the addition of the Medicare surtax, this would result in rates currently being offered.a maximum possible tax rate of 43.4% on dividends. Investors may
  5. 5. On the other hand, President Obama’s 2013 budget included 9. Delay Charitable Contributions Until the Start of 2013a proposed cap on tax-exempt interest at 28%. If signed into law, For many families, philanthropy is at the core of their financial behavior.investors in a tax bracket greater than 28% would pay taxes on the For those that are charitably minded, the level of gifting often increasesmunicipal bond income they receive at a rate equal to their personal tax with net worth. Investors need not forgo their planned giving to charity;bracket rate minus 28%. As we have seen, if Congress fails to act, the however, the financial benefit of delaying a gift until after the first of thetop tax bracket will be 39.6% starting next year. An investor in this tax year could be much greater than making that same gift prior to the endbracket would pay a tax of 11.6% (39.6% minus 28% = 11.6%) on the of 2012.income received from their municipal bond holdings. If this proposal We know that unless Congress acts, personal income tax ratesbecomes law, it is reasonable to assume that municipalities will be will be higher in 2013. Increased personal income tax rates plus theforced to increase the yield offered on new issues starting in 2013. This new Medicare surtax will result in a meaningful increase to the value ofcould potentially reduce the value of existing bonds. income tax deductions in 2013 and beyond, including those that come from making gifts to charity and other non-profit organizations.8. Reduce Exposure to Mutual Funds with High Turnover 10. Invest in Life Insurance and AnnuitiesAccording to the Securities and Exchange Commission (SEC), more As taxes on income increase, the ability to invest on a pre-tax basisthan 2.5% of the average stock fund’s total return is lost each year to becomes more valuable. Investors should first consider maximizingtaxes under the current system. This can be significantly more than the contributions to their employer’s qualified retirement plan, like a 401(k)amount lost to fees and expenses. Historically, mutual funds and other or 403(b), as a way of reducing their current taxable income and savingpooled investment accounts that have high turnover have proven to for the future. In addition, investors may also want to look at thebe notoriously tax inefficient. Turnover is measured by how frequently possibility of investing in other pre-tax vehicles, like traditional IRAs, toassets are bought and sold each year. Higher turnover can and often the extent they are eligible to do so.does result in higher capital gains. For those who do not have access to these types of accounts or By law, mutual funds are required to distribute at least 95% of all who have already maxed out their contributions, the next step wouldcapital gains to their investors each year. Unless a fund manager be to consider investment opportunities that offer either tax-free or tax-works to offset a gain by selling another position at a loss, the fund’s deferred growth. This will become especially important starting in 2013investors are made to realize that gain. Investors who hold funds in as the new 3.8% Medicare surtax will add an additional layer of taxationtaxable accounts should pay close attention to the impact that turnover to net investment income for those taxpayers above certain thresholds.can have on their bottom line. As mentioned earlier, municipal bonds might be a good investment for In certain situations, fund investors may find themselves paying certain investors; however, they represent only one asset class.taxes on capital gains even in years when fund performance is zero Investors looking to diversify their holdings and grow their wealth onor negative. (This is not to say that simply because a fund has high a tax advantaged basis may want to consider deferred annuities (fixedturnover that the result will be a substantial tax bill. Some fund managers and variable) and certain types of permanent life insurance. Current taxwork diligently to eliminate the impact that turnover can have on their law allows investors to accrue wealth inside of both annuities and lifeinvestors.) Given that tax rates are set to go up next year, investors may insurance without the burden of taxation. In fact, taxes are not owedwant to consider reducing their exposure to funds with high turnover in on those instruments until such time as the investor chooses to maketheir taxable accounts as a way to help mitigate their future tax burden. withdrawals, and then only to the extent that earnings are withdrawn. This feature can allow investors to “leapfrog” their high income earning years and take withdrawals in the future when either tax rates are lower or they are earning less. Generally speaking, life insurance proceeds
  6. 6. are received by a beneficiary income tax free. Investors should beaware that it is possible to take withdrawals from the cash value ofa properly structured life insurance policy during one’s own lifetimecompletely tax free. In certain states like Texas and Michigan (anda few others) there is the added benefit of unlimited protection fromcreditors for both annuities and life insurance policies. That sound you hear is the clock counting down the final momentsof 2012. Unless Congress acts to avoid the “fiscal cliff”, then comemidnight on December 31, taxes are going up dramatically. Even ifCongress and the President can agree on an extension of the Bushtax cuts, there will still be noticeable change to the investing landscapecome January as the new Medicare surtax comes online. The timefor investors to act is now and the window of opportunity to takeadvantage of current low rates is closing quickly. Investors should heedShakespeare’s warning. Delays can and often do have dangerousends.The information contained in this report is general in nature and is provided for informational purposes only, and should not be construed as legal, tax, or investment advice. BrentonPrivate Wealth Advisors cannot guarantee that such information is accurate, complete, or timely. Laws of a particular state or laws that may be applicable to a particular situation mayhave an impact on the applicability, accuracy, or completeness of such information. Federal and state laws and regulations are complex and are subject to change. Changes in suchlaws and regulations may have a material impact on results. Brenton Private Wealth Advisors does not assume any obligation to inform you of any subsequent changes in tax law orother factors that could affect the information contained herein. Brenton Private Wealth Advisors makes no warranties with regard to such information or results obtained by its use.Brenton Private Wealth Advisors disclaims any liability arising out of the use of, or any tax position taken in reliance on, such information. This report was not intended to be used,and cannot be used, by the recipient for the purpose of avoiding penalties that may be imposed under the Internal Revenue Code or applicable state or local tax law provision. Alwaysconsult an attorney or tax professional regarding your specific legal or tax situation.Securities offered through Cambridge Investment Research, Inc., Broker/Dealer, Member FINRA/SIPC. Investment Advisory Services offered through Cambridge Investment ResearchAdvisors, Inc. a Registered Investment Advisor. Cambridge and Brenton Private Wealth Advisors are not affiliated. V.CIR.1012
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