It has been an eventful year, both here at home as well as in the wider world. With the election just concluded, Congress now faces the consequential task of addressing the expiration of the Bush tax cuts as well as automatic spending cuts. In the first article below, we take a look at the details of what the press is breathlessly hyping as the “fiscal cliff”, as well as what the associated changes in the tax code might mean for you.
The question of the month stems from a recent call from a client who had received notice of a sharp increase in a long term care premium. Unfortunately, this is becoming more common as carriers seek to avoid losses on long term care, and in the column below, we provide a process to follow to determine your best option in addressing a premium increase.
Finally, with Thanksgiving just a day away, we’d like to thank our clients for your support, friendship and trust. It really does mean a great deal to us.
Micah Porter, CFA, CFP®
The “Fiscal Cliff” and What it Means for You
Micah Porter, CFA, CFP®
I’ve often said that what passes for “news” these days in the media is nothing more than an attempt at driving ratings. The recent election was a great example of this phenomenon, as the media hewed to the narrative of a toss-up even as poll aggregators consistently showed that Obama had a narrow but electorally significant advantage. However, breathlessly reporting a toss-up is presumably better for ratings than covering a likely win for one candidate, so a toss-up it was according to the media.
The media appears to be taking the same approach to what is being called the “fiscal cliff”. The “cliff” is actually a combination of expiration of the Bush tax cuts and the simultaneous implementation of spending cuts. While a halting recovery isn’t the best time for these events to take place, most reporting on the subject is likely a bit too dramatic for the following reasons:
Congress is likely to reach a compromise, averting across the board tax increases and across-the-board spending cuts. The compromise may not come until early next year, however, as Congress can then claim to have voted for tax cuts since the rates would automatically increase at the end of 2012.
As others have pointed out, January 1st is not a point of no return. Spending cuts are not immediately implemented at that point, and Congress can vote to lower taxes in 2013. Having said that, if Congress can reach agreement sooner rather than later, they can reduce uncertainty that could reduce corporate spending and roil the markets.
Should no compromise be reached, according to CBO estimates, it would lead to a sharp recession in 2013, but we would return to growth in 2014 with the U.S. budget in better shape moving forward.
Given that compromise appears to be the most likely path moving forward, here are the areas that will be impacted:
Income tax rates – if no compromise is reached, rates will go up across the board. At this point, the most likely compromise would appear to be an increase in the top tax rate for those earning above $250,000 ($200,000 for single filers) from 36% to 39.6%.
Tax rates of qualified dividends and long-term capital gains – the maximum rate on long term capital gains would increase from 15% to 20%. Additionally, the rate on qualified dividends would increase from 15% to an individual’s marginal tax rate. There is less clarity on where we’ll end up on these rates post-negotiation.
Estate tax rates – currently, estates with a value of $5.12 million are not taxed, and amounts above that value are taxed at rates that start at 35%. Our best guess is that the estate tax exclusion will be established somewhere around $3.5 million with a starting rate between 35 and 45%.
AMT patch – when the AMT, or alternative minimum tax, was formulated, the income thresholds established were not indexed to inflation. To remedy this, every year Congress has to agree to a patch to raise the income amounts at which AMT becomes operative. It’s likely that they’ll do this as part of addressing the fiscal cliff, or a broad swath of taxpayers will see their taxes increase due to the AMT.
Payroll tax – as part of the stimulus passed in 2009, FICA tax was reduced by 2% across the board. To this point, there has been little talk of extending the payroll tax cut, though if negotiations are passed to the new Congress, that could change given the new composition of the Senate.
Given that change is coming regardless of whether compromise is reached, there are a couple of steps you can take as follows:
If you’re a high income earner and you’ve got the ability to pull income from 2013 into 2012, ask your accountant if it might make sense to do so.
In the short term, look at your taxable holdings and see if there might be gains to take this year as opposed to next year.
Over the longer term, if the rate on qualified dividends increases, reconfirm that the holdings you have that pay qualified dividends should remain in your portfolio. Additionally, assess the impact of moving those holdings to non-taxable accounts.
When the dust settles on the estate tax, if you have a sizable estate, check in with your attorney to ensure no changes are needed to your estate documents.
We’ll be following negotiations on the “fiscal cliff” closely and will proactively contact our retainer clients about the above issues as needed.
Client Question of the Month
Micah Porter, CFA, CFP®
My long term care rates have increased substantially. Should I continue to maintain coverage?
Long term care insurers have always had the right to raise premiums on policyholders, but until recent years insurers have avoided doing so. Unfortunately, poor underwriting by the insurers coupled with rapidly rising care costs have led many insurers to exit the long term care market altogether, while those that remained raised premiums on policies, frequently by double-digit amounts. So if you have a policy on which the insurer is proposing a sharp increase, what should you do?
The first step to take is to understand what your options might be. Often, insurers will allow you to change some aspect of the policy in exchange for a lesser increase in premium or no increase at all. If the change would still provide long term care insurance that would cover your risk adequately, then that might well be your best path.
If the insurer offers no option other than paying the increased premium, or if the options offered leave you with insurance that isn’t adequate for your needs, then you need to determine whether or not you can afford the new premium. To put it another way, does the increased premium still allow you a budget that you can afford given your long-term plan?
If you’re unsure of whether you can afford the increased premium, or whether you are willing to pay the increased premium, examine the impact on your plan. More specifically, take a look at how your plan would be impacted by two things:
1) The increased amount (if any) you’d need to take from your portfolio to cover the increased premium, and
2) The impact on your overall plan if you decided to discontinue the policy and funded the cost of care yourself
By following the process outlined above, we’re able to help clients identify their options if and when they are faced with premium increases.