“As a new administration shifts into high gear, many people think about how Biden’s tax reform proposals will affect them. People nearing retirement age and attempting to play “catch-up” with their savings are especially concerned about imminent tax increases’ impact on their retirement planning.”- Jerry Yu.
For as long as taxes have been around, they have been problematic. For one thing, tax law is notoriously difficult to understand. Each year brings even more regulations and changes on both the federal and state levels.
President Biden promises his own broad and impactful changes to the tax code. The first significant federal tax increase since 1993 is a crucial component of Biden’s reforms. These revisions could potentially roil the market and hamper post-pandemic economic recovery.
Compounding matters, nearly every state and municipality are also considering tax increases to make up for shortfalls created by the COVID-19 pandemic.
Gimme Shelter: Tax blues for the middle class?
Americans earning over $400,000 are particularly vulnerable, especially as they face inflation-induced loss of purchasing power and historically low-interest rates. Individuals earning between $400,000-$1 million are likely to experience pain in the form of higher personal income taxes, along with additional social security tax that will add 15 percentage points to their marginal rates.
What will higher taxes mean if you are within a few years of retirement?
It is always tempting to think that tax changes won’t affect you because you don’t fall into the high net worth category. However, regardless of your current financial situation, it’s a good idea to plan for a worst-case scenario. Here are a few things I believe might happen as higher taxes become a reality.
There will be an increased need for tax-efficient portfolio management strategies. Proposals that are most likely to affect retirees’ portfolios are those for higher marginal taxes and capital gains taxing at the marginal rate. Those negative effects could be threatening retirement prosperity. Retirees and pre-retirees may want to use tax-efficient portfolio management strategies to enhance investment returns, such as “tax-loss harvesting” and tax deferral.
Raising the top tax bracket for individuals might make municipal bonds more attractive. Since most states don’t tax muni bond income as long as the bonds were issued in the state of residence, many people will find muni bonds more appealing.
Don’t panic! There may NOT be a massive market sell-off.
For now, Biden’s changes apply to a much smaller pool of individuals than reforms of the past. 75% of the stock market is owned by retirement accounts, pension funds, and foreign investors and is not subject to a capital gains tax. Also, the amount of shares currently owned by individual taxable investors is presently less than 25%. Talk with an investment advisor before you make any radical changes to your portfolio.
The bottom line.
Tax increases are bound to occur over the next few years as federal, state, and local governments scramble to make up shortfalls created during the COVID-19 pandemic. Wise retirees and those within 7-10 years of retirement must make tax planning a core component of their retirement blueprints. It’s a great time to partner with your trusted advisor, CPA, or tax attorney to protect your wealth from potential adverse consequences. Most of all, don’t rush to change your investment matrix until you’ve discussed the consequences with your financial planner.