There’s a lot of news swirling about the potential for tax hikes. While we’re still far from any proposals becoming law, here are some things to consider if you’re concerned about what this could mean for your portfolio.
What’s Been Proposed?
President Joe Biden has introduced three plans under his Build Back Better agenda, which are intended to boost the economy through trillions of dollars in government spending. Paying for it would come in large part from changes in the tax code for corporations and upper-income individuals.
The White House’s plans:
1. American Rescue Plan – Enacted
Provided funding for COVID-19 relief activities, including money for businesses through the Paycheck Protection Program, recovery checks and tax credits to households meeting income requirements and an extension in unemployment benefits.
2. American Jobs Plan – Proposed
Suggests funding for infrastructure, manufacturing, job training, schools, child care, the country’s electrical grid and more.
3. American Families Plan – Proposed
Seeks investments in education and child care, tax relief for lower-income families, a reduction in child poverty and more.
Read up on three tax proposals from the American Families Plan to keep an eye on.
Will Taxes Affect Markets?
Corporate taxes translate directly to corporate profits, and any changes in corporate tax rates tend to quickly show up in stock prices as investors anticipate outcomes. During the last round of tax code reform, the Tax Cut and Jobs Act of 2017, the impact of corporate tax cuts on profits and returns was swift.
Although the spending side of the Build Back Better agenda could benefit select industries and businesses—such as those involved in roads, bridges and green technology—the proposed corporate tax hikes are likely to have a much bigger effect on asset prices overall.
But remember, there’s no specific legislation yet—we’re still in the early stages of negotiations. In fact, President Biden has already reduced his original infrastructure plans, and Senate Republicans have their own proposal with no corporate tax increase.
While you may feel a need to prepare for the possibility of higher taxes, nothing will happen overnight.
Proposed Taxes Leaving You Unsettled?
Is it wise to address taxes before we have all the facts? It depends on your circumstances.
For those earning over $400,000, the proposed taxes may be a good reason to talk to a financial or tax advisor. If you make more than $1 million, you also may consider strategies for managing capital gains taxes.¹ And if you expect to pass on a large amount of assets to heirs, you can review your estate plan.
You should take into account that taxes and your own situation could look very different in the future—meaning the current proposals may or may not impact you much over the long run.
What You Can Do Now
Even in the absence of a new, detailed tax law, it’s important to review your specific situation and long-term goals. Here we outline some ideas (and some cautions) to consider:
Convert Traditional to Roth IRAs?
A traditional IRA lets you make pretax contributions, which likely give you an income tax break, but your withdrawals are taxed. With Roth IRAs you make after-tax contributions, but qualified withdrawals (such as after age 59½) are tax free.
While the conversion process may be right for some people, you still need to look at your own circumstances—not just today, but also whether you expect to be in a higher or lower tax bracket in retirement. Many people’s tax bracket in retirement may be lower than it is today. A question to ask is whether paying the tax bill now will be worth it.
Taxes are due on the amount you convert. For example, if you want to convert $100,000 to a Roth IRA and your tax rate is 25%, you will owe $25,000 in taxes. As you can see, it can result in a hefty tax bill. If you expect to be in a lower tax bracket in retirement, you might want to hold off.
Note: It’s often recommended to pay the taxes from another source than the money in the IRA. If taxes are paid from the conversion, that money is taxed and potentially penalized for early withdraw if you are under age 59½.
Add Account Variety?
Just like a mix of investments may help manage risk in your portfolio, a mix of account types also may have advantages. One thought is to have both traditional and Roth IRAs to potentially draw on the benefits of each. Or you could consider other ways to add to your nest egg, such as with a Health Savings Account.
Deciding on account types is just one factor when it comes to planning for taxes or retirement. Make sure your plan considers other factors that are unique to you, such as when you’ll need the money and your tolerance for risk.
Note: Diversifying account types isn’t the same as diversifying investments. You need to think about how ALL of the investments in your accounts work together.
Revisit Your Estate Plan?
The value of assets passed on to beneficiaries is usually higher than when the owner acquired it. Currently, the appreciation is not taxed, and beneficiaries get a step-up in basis.
Exemptions to the Limit on Step-up in Basis
Family-owned farms and businesses passed down to family members who will continue to run them are generally not included in the proposal.
And gains would not be taxed if the property is contributed to a charity.
Under President Biden’s proposal, appreciation on assets of more than $1 million per individual taxpayer/$2.5 million per couple would be taxed at death.
Keep in mind that determining the original cost basis for assets held for decades is also one of the more complicated tax code changes to apply. You may want to consult with a tax advisor, financial advisor or estate planner to consider how your accounts, investments and other assets affect your overall financial and tax plans.
What About Tax-Loss Harvesting?
This strategy can be useful for taxable accounts to ease the sting of a future tax bill. It lets you sell an investment that has lost you money and offset the loss with a gain you have in another investment holding² if both events occur during the same calendar year.
You can also replace a security sold for a loss with another similar (but not identical or substantially equivalent) security to maintain a desired exposure. Of course, taxes alone shouldn't compel investment decisions.
There are specific guidelines for choosing a replacement security. It’s critical to understand the IRS wash-sale rule, which prohibits buying a substantially identical security within 30 days before or after selling a security at a loss.
The tax-loss harvesting approach can be complex. You may want to consult with a tax or financial advisor to help think through this and how it may affect your overall investment and tax plans.
Reevaluate Your Risk Tolerance?
Understanding your risk tolerance is just as important in good markets as it is in bad markets and should be evaluated periodically. There are many reasons why your investment mix can change over time. That’s why it’s always smart to think through your long-term financial plan and see if it’s still aligned with when you’ll need your money and how you feel about short-term volatility.
Having a diversified mix of investments (stocks, bonds, short-term securities) that don’t tend to react the same way to market events may help smooth out performance over time. When one investment type isn’t doing well, another may be in favor.
Knowing you’ve identified the correct mix of investments can help ease stress when volatility hits, but you may want to talk it over with a professional. If you’re concerned about which investments to select or how to diversify them, check with a financial advisor.
Potential Roadblocks for Policy Initiatives
We think it's important to keep in mind that Democrats currently hold the slimmest possible majority. And individual members of Congress can have competing objectives that limit policy options. This means that hotly debated measures have a difficult pathway to becoming law.
In 2017, for example, Republicans controlled the White House, Senate and House of Representatives, but were unable to pass a repeal of the Affordable Care Act. So, it’s also important to distinguish between policy initiatives that require a simple majority vote in Congress versus those that mandate a “supermajority” of 60% or even a two-thirds vote.
The potential of higher tax rates is like many other financial worries—evaluate it along with your overall goals—and respond, or stay the course, by being informed. Avoiding knee-jerk reactions can help you stay on your financial path.
Fact Sheet: The American Families Plan, whitehouse.gov, April 28, 2021.
Long- and short-term capital gains are taxed at different rates. Long-term gains may only be offset by longer-term losses. Likewise, short-term gains may only be offset by short-term losses.
IRS Circular 230 Disclosure: American Century Companies, Inc. and its affiliates do not provide tax advice. Accordingly, any discussion of U.S. tax matters contained herein (including any attachments) is not intended or written to be used, and cannot be used, in connection with the promotion, marketing or recommendation by anyone unaffiliated with American Century Companies, Inc. of any of the matters addressed herein or for the purpose of avoiding U.S. tax-related penalties.
This information is for educational purposes only and is not intended as tax advice. Please consult your tax advisor for more detailed information or for advice regarding your individual situation.
Diversification does not assure a profit nor does it protect against loss of principal.
Please consult your tax advisor for more detailed information regarding the Roth IRA or for advice regarding your individual situation.
Taxes are deferred until withdrawal if the requirements are met. A 10% penalty may be imposed for withdrawal prior to reaching age 59½.
This material has been prepared for educational purposes only. It is not intended to provide, and should not be relied upon for, investment, accounting, legal or tax advice.