[i] R.O.I.
By BRETT ARENDS
How an Obama Win Would Affect Your Pocketbook
June 6, 2008 10:22 a.m.
Well, we finally have a Democratic nominee.
Yes, a lot of water still has to flow under the bridge. The only thing we know for certain right now is that a new president and a new Congress will be sworn in next January.
But as Barack Obama is the man of the hour, it’s a reasonable time to ask what his election might mean for you and your family’s money.
This is not a political column, and in this space I take no stance about who should or shouldn’t win. I am only concerned with what you should do to prepare for contingencies. Over the coming months I expect to write a lot about what the elections might mean for your personal finances.
It’s a tricky task, because neither party or presidential candidate has any interest in being too specific about their taxing or spending plans. And of course a lot will happen in the economy, as well as politics, before anything changes on the statute books.
Nonetheless, if Senator Obama wins in November and he has strong majorities in Congress as well, there are three moves that might be worth thinking about to improve your own financial position under the next administration.
Cash in any big capital gains on stocks or mutual funds before the end of this year.
Make big changes to what you hold in your IRA and other tax-deferred accounts.
And, perhaps, move some of your other investments into tax shelters, like low-cost variable annuities.
Why?
The Bush tax cuts, which came into effect in 2003, are already set to expire in 2011. And politics, as well as the huge budget deficit, make it likely they will do so. That will probably mean big changes to the tax rates on capital gains and stock dividend income, among others. Senator Barack Obama has already acknowledged that he may be willing to raise the top rate on long-term capital gains still further, to 28%. That was the rate in 1997. Today it’s just 15%.
So if you are sitting on a huge profit in, say, your Apple stock, if the Democrats win in November you might want to cash it in before the end of the year. “Go ahead and sell it” says Benjamin Tobias, a financial planner in Plantation, Fla. “Pay the 15% tax, and put a happy face on the check to the IRS because you’re only paying 15%. Next year, who knows what you’ll be paying?”
As for your IRAs, 401(k)s and other tax-deferred accounts: Under the current regime, it makes sense to use them to protect your Treasury and corporate bond income from the IRS rather than your stocks. That’s because your stocks already pay low 15% federal taxes, both on dividends and long-term capital gains, without a shelter.
But that’s only because the Bush tax cuts favored stocks over bonds. In the past the two have been treated more equally. And if the next Congress and President restore that situation, it will make sense to swap your holdings around. Move the bonds out of your IRA or 401(k), and move your stocks into it. Why? In an environment where stocks and bonds are taxed the same, you should probably shelter the stocks instead of the bonds because those are expected to produce the greater-long term gains.
And that leads, third, to the controversial subject of variable annuities.
These are investment and insurance products that enjoy tax advantages because the IRS treats them as insurance.
Bad variable annuities are high-cost rip-off products you should only recommend to your worst enemy.
But good VARs, such as those offered by Vanguard or Fidelity, are inexpensive tax shelters. Mutual funds held in a variable-annuity account are sheltered from taxation until you finally withdraw the money.
(They are complex in other ways. You need to study them in detail before investing, and they are best used for long-term investments. There can be penalties for early withdrawal before age 59 1/2.)
At the moment they suffer from one big downside: When you cash them in and take the money, the profits aren’t taxed at the low 15% rate on long-term capital gains, but at the higher ordinary income tax rates.
But if Senator Obama raises the long-term capital gains rate to 28%, then that distinction starts to get wiped out. You may find you pay little or no extra tax when you cash out a variable annuity �?? and meanwhile you have enjoyed years of enormously valuable tax deferral.
All this is an early exercise in projection. It’s way too early to make any moves based on the election, and you should probably seek professional advice before taking any bold steps with your money. It is also worth adding that a number of these changes might end up being brought in if John McCain becomes president as well. The one thing I am willing to say with some certainty is that the 15% tax rate on dividends and capital gains isn’t going to be cut.
Write to Brett Arends at brett.arends@wsj.com [/i]