ELITE ADVISOR BEST PRACTICES

Voting with Our Pockets

Advisors should help clients NOW to prepare for the November election outcome

By Deepa Venkatraghvan

Key Takeaways:

  • As balancing the budget becomes crucial, tax policy is likely to be an important aspect of this presidential election.
  • With all the uncertainty, the right information can empower you to take the right action.
  • Tax planning today can help lock in the benefits of the current low-rate regime.
  • But investments should still be made with a long-term horizon.


As we inch closer to the November elections, your clients are likely getting nervous about making investment decisions. Here we’ll take a look at important areas that might be impacted by the outcome of elections and the actions you can take to help your clients.

Return on investments

When it comes to investing, there are two main considerations—returns and tax policy. Let us look at returns first. Should investors be buying or selling equity right now? A simple Google search will bring up plenty of statistical reports. Most agree that, historically, markets perform well in an election year. This report for instance seems to suggest that the adage, “Sell in May and Go Away,” may not work in election years. Investors would have experienced positive rates of return as measured by the S&P 500 Index in nine of the last 12 election years by staying past May (Table 1).

But statistics on past performance are only one part of the story. For one, past environments have been nothing like the present. The country is still reeling from the financial crisis of 2008 (the S&P 500 lost 35 percent between May and December of election year 2008). The United States’ debt load has surpassed $15 trillion, and a lot of recent fiscal and monetary policies have not had their desired effect. Really, there is no predicting 2012 equity market performance.

Let’s talk about bond markets. A 2006 study in the Financial Services Review titled, “Tactical Asset Allocation and Presidential Elections,” reported that from 1961 through 2004, long-term government bonds produced an average annual return of 4.14 percent when a Democrat was in the White House and 10.80 percent when a Republican was in control. But, again, 2012 may be different. Bond market performance will most likely be driven by risk preference rather than by the presidential election.

Action: Building a portfolio on the basis of the client’s individual long-term financial goals is now more important than ever. Tantalizing as some statistics may seem, it is important to treat an election year as just another year in a quarter-century-long accumulation phase.

Bush tax cuts

Tax is likely to be one of the most important aspects of this year’s election outcome, at least going by the amount of debate being dedicated to it. First, we have the Bush-era tax cuts that will expire in 2012. These are among the changes set to take place:

  • The standard deduction for married couples will fall, and the ceiling of the 15 percent bracket for married couples will fall.
  • The 10 percent tax bracket will expire, reverting to 15 percent.
  • The child tax credit will fall from $1,000 to $500.
  • The tax rate on long-term capital gains earned by middle- and upper-income people will rise from 15 percent to 20 percent.
  • The tax rate on qualified dividends earned by middle- and upper-income people will rise from 15 percent to ordinary wage tax rates.
  • Tax brackets will change: The 25 percent tax rate will rise to 28 percent; 28 percent, to 31 percent; 33 percent, to 36 percent; and 35 percent, to 39.6 percent.

You can get more details here in this PDF.

Will the Bush cuts continue into 2013? President Barack Obama plans to call on Congress to extend the cuts only for those earning less than $250,000. He wants to raise the top two tax rates as well as increase rates on capital gains and dividends for the wealthy. Republican Mitt Romney, on the other hand, proposes a permanent extension of the Bush-era tax cuts, a reduction in top tax rates and elimination of capital gains tax for families earning less than $200,000.

Action: Given the state of the country’s budget, drastic tax reduction seems unlikely. Largely, investors need to undertake a wait-and-watch approach. If the stakes are high, you might want to review your client’s strategy and try to minimize capital gains taxes. Most experts agree that the current rate of 15 percent is as good as it can get. But again, this must be done keeping in mind the client’s long-term financial plan. Of the few other things to do, conversion to a Roth IRA might be a good one right now. If your clients have been putting off conversion to a Roth IRA, now might be a good time to act. If tax rates go up, clients will benefit from conversion. If rates don’t change, they have nothing to lose.

Estate tax and gift tax

Estate tax is one area in which Romney has taken a clear stand. He seeks to repeal the estate tax completely. On the other hand, as part of his deficit reduction plan, Obama is likely to keep his focus on taxing the rich. He has proposed a reduction in the exemption limit from the current $5.12 million to $3.5 million. However, if these cuts are allowed to expire, here’s what might happen:

  • The estate tax exemption will fall to $1 million.
  • The generation-skipping transfer tax exemption will fall to $1 million.
  • The tax rate, which is at 35 percent, will go up to 55 percent.
  • The lifetime gift tax exemption will also fall to $1 million, and the rate will rise to 55 percent.

Action: This might be a good time to review your client’s estate plan and try to lock in the current law. Making gifts today might be one option to consider for those who do not mind passing on their assets right away. Another option is to manage the estate through a trust between spouses.

Social Security and Medicare taxes

As part of Obamacare, a new Medicare tax of 3.8 percent on capital gains and dividends is likely to be introduced in 2013. The Supreme Court recently paved the way for the introduction of this tax, and it will apply to an income threshold of $200,000.

This will add 3.8 percent to tax brackets across the board. If the highest tax bracket goes up to 39.6 percent, the additional 3.8 percent will take it to more than 40 percent.

Action: This is just another number that will push tax outflows higher. Keep this in mind before making an overall tax plan for your clients.

With all this uncertainty looming, the prudent course would be to prepare for the worst while hoping for the best.


About the Author

Deepa Venkatraghvan, a Chartered Accountant (CPA) from India, is a financial journalist. Currently, she writes for India’s leading publication, www.economictimes.com on tax and financial matters impacting Indians living outside India. You can read her blog on personal finance – Money Happy Returns or follow her articles on Twitter.