Planning Your Wealth Preservation Options for a Post-Election Economy
The election will be over in few days. The end of this interminable campaign has good and bad components. The good is that we will no longer be subjected to the candidates’ incessant misstatements of fact and making of promises that we know will be broken. The bad is that the media will dedicate even more coverage to the “economic crisis.” This will further reinforce the market-crushing fears in the minds of consumers and investors.
Now is the time for those who base their personal financial decisions on analysis and planning to consider their options for preserving wealth in a post-election economy. More specifically, although no one can accurately predict what will happen post-election, there are steps that can be taken or evaluated now to cover your bases in anticipation of changes that are possible when a new government is established.
These are the wealth-preservation issues and options that Mr. ToughMoneyLove is thinking about:
Personal Income Taxes
Under an Obama administration, the tax increase for the middle class will not be called a “tax increase.” It will be called something else. It will be needed to pay for his healthcare initiatives. For example, Obama will say that he is keeping his promise not to increase income tax rates on the middle class. Instead, he will say he is increasing payroll taxes which are now used for Medicare and Social Security and half of which are paid by the employer.
Either way, unless you are a minimum wage worker or close to it, your net take home pay is headed south. I recommend that you start budgeting and spending now as if you had lost 5% in take home pay. Save the rest. If you are now in the upper income bracket, plan on a reduction in take home pay in the 10-15% range.
If you are self-employed, or a small business owner, or are otherwise in a position to accelerate income this year and taking it from anticipated income next year, I would strongly consider doing it. You will probably save on your total tax bill by taking the income in 2008 rather than in 2009.
Taxes on Capital Gains and Dividends
The favorable rates on taxation of qualified dividends and capital gains are likely to either disappear or to be “means tested.” By this I mean that if you are in a high marginal tax bracket, your tax rate on dividends and capital gains are likely to be proportionately bumped up. Remember, Obama is not a fan of concentrated wealth and is eager to re-distribute it to those who don’t have it. The IRS will become the wealth re-distribution agent, sending “tax rebates” even to those who do not pay income taxes. What should you do? Consider selling at least some of your big market winners (if you have any left) at the end of this year because an Obama-led government is likely to make capital gains tax increases retroactive to January 1, 2009.
The tax free status of most capital gains arising from residential home sales is also in jeopardy. Keep an eye on this issue and while doing so, run some numbers on taxation differences that could develop if you sold your home for a substantial profit. If downsizing or relocating is in your future, in some cases, it could make financial sense to sell before you lose the exemption, thereby saving thousands in income taxes.
Qualified vs. Unqualified Dividends
Regarding taxation of qualified dividends, be alert to the possibility that some of those dividends you receive may end up being non-qualified. This means that you will pay taxes on those dividends at ordinary income rates. Why do I say this? Because for a dividend to be “qualified” and thereby eligible for favorable tax treatment, it must be paid by a corporation out of earnings and profits. If the corporation has not made a profit and is not paying taxes on income it distributes as dividends, it may be ineligible for payment of dividends that are deemed qualified. In this economy, there will a lot more unprofitable companies that will nevertheless struggle to continue to pay dividends so as to keep shareholders happy. There is not much you can do about this now. You can only speculate as to whether the dividends you receive will be paid by a company that turns a profit. But keep the issue in the back of your mind for planning purposes.
Already, some influential Democrats in Congress are calling for a complete revamping of 401(k) plans, including eliminating the ability to exclude employee contributions from income. Even if such a proposal is adopted, it will likely preserve the existing tax treatment for all contributions made prior to the effective date for the new law. For this reason, I would consider front-loading your 401(k) contribution to get as much of it as possible grandfathered under the old law.
Second, you should also consider exploiting as many Roth-type investment options as possible. If you have a Roth-option in your 401(k) plan, I would consider funding it with front-loaded contributions, before income tax rates increase. Along these same lines, do not forget about the Roth IRA conversion window that for now remains open for 2010. This will allow even high earners to convert a conventional IRA to a Roth IRA without regard to income levels. If you are like me and Mrs. ToughMoneyLove, you have been funding a non-deductible IRA these past few years just so you can take advantage of the Roth IRA conversion opportunity in 2010. If not, consider fully funding it now for 2008 and immediately in January for 2009. This may let you escape the higher income tax rates on the money going in while preserving the option to exploit the Roth conversion window in 2010.
This is a tricky area to predict. If Obama is elected with a filibuster proof majority in Congress, big changes in our healthcare system are almost certain to occur. If some form of single payer system is adopted, the need for Health Savings Accounts may disappear. I like my HSA because I treat it as a Roth-type investment vehicle. Thus, if you are now in a healthcare plan that has an HSA feature, consider front-end funding the HSA to the max, so that you have a chance of preserving grandfathered Roth-type tax treatment of those funds.
What other wealth preservation options are you considering in anticipation of a new Congress and Administration taking control?