Managing Your Money

Preparing your finances for the fiscal cliff

J. Christopher Boyd, CFP (Chris) is a leader in the Financial Planning Association of Massachusetts and host of a financial radio show on WXTK 95.1. He will be hosting a live chat on Friday, Dec. 21 at 1 p.m.

With only 17 days until next year, the potential realities of the “fiscal cliff” are coming more clearly into focus. The bottom line, should we actually land in next year with no deal to avert the fiscal cliff, is a jump in taxes for many and reduction in the rate of government spending.

The prospective divergent implications on the US economy are pronounced. If we go over the cliff and there is no subsequent deal, a recession is expected by the Congressional Budget Office and many economists, resulting in an estimated 2% to 3% decline in the economy. If a deal comes out of Washington, many economists expect 1% to 2% economic growth. This has a meaningful impact for jobs, income, growth of wealth, and government revenues.

Given the uncertainty of whether there will be a compromise from Washington within the next couple of weeks, what’s an investor to do?

Cliff Proof Planning:
- First, don’t lose your head about the whole thing. Keep working, keep saving, keep investing. The best way to create wealth over time is to spend less than you earn, and invest for the long-term. Keep contributing to retirement plans or some manner of systematic investment, dollar-cost-averaging monthly and using any potential market declines as a buying opportunity.

- Plan for some short-term uncertainties by maintaining a sufficient amount of cash for emergency spending, and so you won’t need to sell securities at inopportune times. By keeping these reserves, you can allow yourself to ride out the bumps with the rest of your diversified portfolio.

- Revisit your estate plan in 2013 – estate tax rates and thresholds will likely change.

- Year-end Tax Planning this year is turned upside-down. Because of anticipated higher tax rates, realize long-term capital gains this year, rather than next year when there are higher rates. Save capital losses for next year, but if there are many, offset gains with losses and carry forward losses for future use.

- Contribute to a Roth IRA instead of a taking a tax deduction in 2012 for a contribution to a Traditional IRA. This can be done in 2013 prior to tax filing in April.

- Whether to convert an IRA to a Roth IRA is more complex and subject to various considerations. Primary considerations are: do you expect to be paying a lower tax rate now while earning or later in retirement? If the answer is now, then convert to a Roth IRA. Be sure to have cash on hand to pay the taxes caused by the Roth IRA Conversion. Check with a qualified tax advisor for the best tax tips.

- Do charitable giving. Because we don’t know what, if any, limitations to deductions may come with a deal, it seems reasonable to make charitable contributions sooner rather than later, particularly for the wealthy.

- Portfolio design revisions – Consider where you hold which investments. For example, it may make sense to hold income generating assets (dividend paying stocks, corporate bonds, etc.) in your retirement accounts, so that income is not taxed unless withdrawn. Conversely, focus on growth stocks, not dividend stocks, in taxable investment accounts. Tax-free municipal bonds may take on greater appeal for those in higher tax brackets.

- Tax Deferral will become more attractive for those in their peak earning years. Life insurance and annuity products can have higher costs and the potential for long surrender charges, so use of such products should be deliberate and well informed, however, these could be useful tools to postponing or even potentially avoiding some taxation.

Are markets poised for a tumble? It seems likely that uncertainty caused by Washington’s dysfunction may result in a temporary slowdown in the economy, but it is important to keep in mind the long view. Will companies continue to be profitable, and will market prices recognize that profitability? The likely answer is “yes.” Eventually, investors will benefit by taking risk. How long before they are compensated for those risks can vary, but as we look out several years, it certainly seems likely that taking risk will be rewarded, particularly with ownership of equities. It’s okay to be a bit tactical on the edges right now, but don’t just run scared.

With only a couple weeks remaining in the year, there is much to consider with your investments and planning. Take a little time now, the long-term results could pay dividends for years.

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