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Election Impact: Looming Tax Hikes And Uncertainty Haunt Wealth Managers

Charles Paikert

18 September 2012

This is part two of a mini-series on the presidential elections. To view part one, outlining the candidates' different tax plans affecting HNW clients, click here.

The specters of rising taxes and continued political and economic uncertainty have become front-and-center issues for wealth managers as the US presidential election swings into high gear.

“We’re getting a lot of questions about what to do now,” said Carol Kroch, head of wealth planning for Wilmington Trust Company. “Our mantra has been: ‘Regardless of who gets elected, don’t expect to know all the answers immediately after the election.’”

With the Bush tax cuts set to expire in 2013, upper-income clients face higher income taxes, as well as increased taxes on capital gains, investment income and dividends, and a steep cut in estate tax exemptions. While President Obama strongly supports these changes, his Republican challenger, former Massachusetts governor Mitt Romney, just as vigorously opposes them. (See here.)

Indeed, despite Romney’s vow to repeal all gift and estate taxes, the current $5 million estate tax exemption for individuals ($10 million for a married couple) is set to drop to just $1 million on January 1, while the top tax rate will rise from 35 per cent to 55 per cent.

Ticking Clock

As a result, wealth managers have been busy advising wealthy clients on their options, including considering selling a business this year instead of next, using alternative vehicles such as grantor retained annuity trusts, and, of course, making gifts to take advantage of the tax benefits of the current law before December 31.

“Clients are deciding whether they can afford to give money to their children before the end of the year, and we’ve been very busy counseling people,” said Jeff Maurer, chief executive of New York-based Evercore Wealth Management. “Clients are gauging how much they need to live and it’s a tough time to do that because returns from portfolios are not what they used to be. We’ve seen people with $50 million who don’t think they can afford to give $5 million and people with $25 million who think they can.”

Clients considering making gifts or transferring an estate this year need to have appraisals done as soon as possible, said Kroch, who is also a managing director overseeing charitable trusts for Wilmington. “They need to inventory their assets and see what needs to be appraised, because the clock is ticking,” she said.

Medicare surcharge: “most notorious” new tax

The new Medicare tax of 3.8 per cent on investment income that was part of the 2010 Affordable Care Act is also set to take effect on January 1. Martim de Arantes Oliveira, West Coast regional director for Silver Bridge Advisors, calls the Medicare surcharge the “most notorious” new tax impacting his clients because it would hike the top tax rate on long-term capital gains for upper-bracket taxpayers to 23.8 per cent and to 43.4 per cent for dividends.

As such, de Arantes Oliveira is advising clients to consider accelerating investment income into 2012 and taking capital gains this year to take advantage of the lower tax rates. He also noted that “active income,” or income that is generated by an individual actively involved in a business such as real estate is not subject to the Medicare surtax.

While tax increases in ordinary income, capital gains and dividends for 2013 won’t be on spreadsheets until spring of 2014, wealth managers are beginning to factor the scheduled changes into their planning advice.

In addition to urging clients to explore selling a business this year, wealth managers are also advising corporate executives to see if they can take bonuses in 2012 to accelerate their taxable income and consider increasing their allocations to tax-exempt bonds.

“Don’t let the tax tail wag the dog”

More broadly, they are also recommending that wealthy clients “look at the benefits of a diversified portfolio,” as Kroch put it.

But wealth management executives also stressed that clients shouldn’t make investment decisions based on tax reasons alone, citing the old saw “Don’t let the tax tail wag the dog.” “You don’t want to make asset allocation decisions based on taxes,” said Steve Lockshin, chairman of Convergent Wealth Advisors.

For example, taxpayers also need to consider the time value of money, said Lisa Colletti, New York-based director of wealth management for Aspiriant. “If you accelerate income, you will enjoy the lower rate, but you give up the time value on the cash used to pay the tax,” Colletti noted.

She cited the example of a taxpayer, who if he sold a $100,000 investment, would realize a $50,000 gain. If sold in 2012, he would be subject to a 15 per cent tax rate but next year it could be as high as 23.8 per cent. If the taxpayer estimates that he will earn nine per cent on his investments over time, and expects to sell the assets within two years, he would be approximately $3,300 better off if he opts to accelerate the gain and pay the tax now. However, she pointed out, if he had a seven year time horizon, “he would be better off continuing to hold the investment and pay the higher tax rate down the road.”

Frustrating uncertainty

Taxes aside, uncertainty appears to be the biggest source of frustration for both advisors and clients. “We continue to see decisions that are short-term compromises, and that makes it harder to plan for the long-term,” Kroch said. “You don’t know the answer today; you don’t know when you’re going to get an answer, and if you do get an answer, you don’t know how long it’s going to be for.”

Or, as de Arantes Oliveira put it, “The problem is that there are so many things that could change, any investment advice you give one day might be inaccurate the next!”

On the other side of the table, said Gregory Curtis, chairman of Greycourt, a Pittsburgh-based investment advisory firm whose clients’ average net worth is approximately $200 million, “What I hear from clients is more than anything else they want certainty. Whoever wins the presidency, and whoever controls Congress, at least we will know what we’re dealing with.”

Surprising support for Obama

Curiously, perhaps, Curtis and other executives who work with wealthy clients said the political preferences of their clients tend to more or less evenly split, reflecting national polls, while a poll taken last month by the Financial Services Institute found 81 per cent of advisors supported Romney.

Nor are wealthy clients overly concerned if Obama wins, according to Lockshin. “It’s not that big a deal,” he said. “Most wealthy people maintain a significant allocation to non-taxable investments. They haven’t shown a lot of concern.”

To be sure, wealthy families are also “very frustrated” by the “lack of clarity and a clear path forward” in Washington, said Sara Hamilton, founder and chief executive of Chicago-based Family Office Exchange.

But the prevailing mood of uncertainty also has a silver lining for wealth managers: “It makes wealth advisors all the more critical to families trying to do thoughtful wealth planning,” Hamilton said.