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Capital Gains Strategies to Keep Clients on Track for Retirement

Potential changes from the Biden administration and the specter of retroactivity loom large.

As we enter into a new era of tax code proposals from the Biden administration, it’s important to be thinking about what those changes may mean when planning for the upcoming tax season and retirement. This is especially important for wealthy individuals, who will be affected by the capital gains tax.

The proposed tax increase on capital gains would be applied to taxpayers with annualized realized gains over $1 million. These high-net-worth individuals will have to pay a higher tax rate of 39.6%, which is almost double the current 20% rate for individual taxpayers.

What Biden’s announcement to potentially make cap gains retroactive means for investors.

Unlike with previous tax plans, there is a potential for a real fly in the ointment that could significantly alter how individuals protect their wealth. That’s because Congress is discussing making these changes retroactive to April 28, 2021. Although it is important to note that Congress has historically not effected tax bills on a retroactive basis. There is a lot of negotiating still to come in a very divided Congress before any new tax proposals become law.

The proposed retroactive effective date should not change clients’ fundamental investing. They will still invest in good investments regardless of the tax consequences, and investors will continue to buy stocks as long as the stocks they own continue to perform well and meet their expectations. Tax policy should never direct investment decisions.

Tax planning strategies for investors to consider.

If a rate increase is enacted, there are a few tax planning strategies that will become more powerful. The first is an accelerating gain realization to a period before the effective date of any legislation. This is moot if the legislation is made retroactive but if the effective date is, for instance, January 1, 2022, gain realization in 2021 will be considerably less expensive than in 2022.

The second planning strategy to consider is charitable giving with appreciated securities. A taxpayer not only receives an income tax charitable deduction for the value of the security, but the capital gain is not realized when the security is transferred to a charity. This charitable strategy will also become more valuable in a high tax rate situation

Lastly, investors may simply hold on to their investments for longer periods so as not to realize capital gains.

How capital gains can impact retirement planning.

It’s imperative to think about how these tax laws are impacting not just tax planning and investing, but other areas of financial planning such as retirement planning. There’s currently a discussion about limiting a step-up in cost basis of an inherited asset (stocks, bonds, real estate, etc.) after someone’s death, which often reduces the capital gains tax owed by the recipient. If that does happen, advisors may be more aggressive with gain realization especially when working with more elderly clients on their estate plans. This will also be an important consideration for those planning their retirement.

If this change does come into effect, it may become more appropriate to increase fixed income investments in taxable accounts.

What clients can do now to protect assets and prepare for retirement.

There are a few things that should be considered in advance within the five years leading up to retirement—especially when policy changes are happening that could impact client assets and retirement plan. Below is a brief checklist Cambridge Trust’s wealth management team recommends to clients if they are close to or within the five-year mark:

Reevaluate your risk profile. Talk with your financial advisor to make sure there’s enough growth to outpace inflation on your risk profile and, depending on the risk profile, ensure asset allocation is a little more conservative.

Think about your retirement budget and cash flow needs. Think through how these current tax laws could impact your retirement budget and readjust your cash flow needs and investment strategies accordingly.

Regularly check in with your advisor to keep your financial plan updated. If you haven’t done so recently, check in with your financial advisor and update your financial plan to make sure it’s current.

Stay educated and informed. Above all else, stay informed about what’s happening with tax policy changes and how they could impact your financial plans. There are various personal finance newsletters, columns and podcasts to keep up-to-date from reputable sites such as Bloomberg, CNBC, The New York Times and The Wall Street Journal

David Strachan, CTFA, is senior vice president and director of fiduciary services at Cambridge Trust. 

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