Thanks to the cliffhanger in Washington over looming tax changes, financial planners have a tough few months ahead.
The planned year-end expiration of the Bush-era tax cuts has created a bitter partisan divide. The only thing everyone seems to agree on is that the current stalemate will last at least through the November elections.
This has set up a series of tough decisions for investors. Sell appreciated stock to lock in today’s low capital gains tax, even if the rate may stay the same in a last-minute deal in Washington? Is this the last chance to gift more than $1 million to the kids without getting a big tax bill – and is it even affordable?
It’s tempting to take a wait-and-see approach, but advisers should be playing offence, helping clients get their portfolios and estate plans ready for a wide array of scenarios. That way, if and when Congress acts, a client merely needs to pull the trigger and isn’t frantic come year end.
Investment Income Taxes
Unless Congress acts, the top tax rate on capital gains will jump to 20 per cent from a current 15 per cent rate. Dividends, which will be taxed as ordinary income, will face a top rate as high as 39.6 per cent, up from 15 per cent at the maximum. An additional 3.8 per cent Medicare surtax will also be levied on certain investment income for high-earners.
Investors are trying to guess the best time to sell shares and lock in the current low rates. With most people sitting tight for now, there could be a rush of trading toward the end of the year if it looks like Congress won’t stop the increase.
To prepare, advisers should get clients to the point where they’re ready to do an actual trade. Help them create a list of their highly appreciated and dividend-paying assets – even those managed by other advisers.
Ask them to prioritise what they want to offload first. At the top of the list could be stocks they may be emotionally attached to but appear to be fully valued.
Have clients draft and save an e-mail to you specifying the quantities of each holding they want to sell, so they just have to press send when they’re ready, said Bill Fleming, managing director in PricewaterhouseCoopers’ Private Company Services practice.
Talk to clients about the fact that the conventional wisdom of deferring taxes as long as possible may not apply right now.
“We are entering a world that is completely different than all the traditional tax planning we’ve learned,” said Michael Kitces, an adviser and partner at Columbia, Maryland-based Pinnacle Advisory Group.
Lower Gift-Tax Exemption
Wealthy Americans are poised to lose a very nice benefit from Uncle Sam at the end of this year. Currently, taxpayers can give gifts of up to $5.12 million during their lifetime – tax free – with gifts above that amount taxed at 35 per cent. That is set to fall to $1 million, with gifts above that level taxed at 55 per cent, after December 31.
Overall, Democrats support leaving it at $1 million, while Republicans want it abolished.
Advisers should first determine whether clients can afford a gift by running a cash flow analysis to see how long their assets will last. To be safe, go beyond their life expectancy, say, by projecting someone in their 60s will live into their 90s, suggested Jennifer Immel, senior wealth planner at Pittsburgh-based PNC Wealth Management. Assume investment returns that are lower than historical averages and take fees into account, she added.
If the client can afford a gift, tax experts say the smartest way to transfer the assets, be it cash or stock or real estate, is through a trust, which protects the money from creditors and avoids estate taxes from generation to generation.
Even if a client isn’t sure they want to make a gift, get the trust in place early because it might be hard – and expensive – to get an estate planner’s attention come November.
“The fattest cats are going to get the service, and everyone else will pay a premium,” cautioned Mark Haranzo, a New York-based partner focused on the wealth planning issues for the law firm Withers Bergman LLP.
Clients should expect it to take at least a month and to spend about $3,000 to over $10,000 to set up a trust. That is still likely less than the tax hit they could take later, Haranzo said.
Try to educate clients proactively, by setting up seminars led by local estate planners and tax attorneys.
The worst thing you can do: wait for clients to come to you with tax questions. They may blame you if they’re caught off guard at the end of the year.
“Some people could be staring at a Christmas turkey with a sick feeling because they know their clients are panicking,” said Kevin Kimbrough, principal of national sales at Saybrus Partners, a life insurance consultancy to wealth management firms.
(Reporting by Jennifer Hoyt Cummings; Editing by Jennifer Merritt and Dan Grebler; Twitter @jenhoytcummings)