Updated: Oct 28, 2020
If you were like most Americans, you probably sat in awe and disbelief on Sept. 29 as you watched the presidential candidates exchange blows over who's better fit to run the country.
The focus of the presidential debate was, well, hard to say. Too many interruptions and name calling overshadowed what many hoped would be an insightful glimpse into each candidate's plans for the future.
On the minds of many investors, particularly those who are nearing or in retirement is how will the outcome of the election affect my tax situation and my investments.
Here's the rub: Donald Trump is in favor of lowering taxes across the board, while his Democratic counterpart Joe Biden plans to increase taxes on wealthier individuals in the highest tax bracket should he win.
This topic has sparked significant interest over the past few weeks as many Americans are concerned their taxes may go up.
Before diving into the particulars of each candidate's tax plan, it's important to remember that no one knows who the President will be!
It's easy to get caught up in the political hysteria plaguing the media, especially this year. It's even easier to feel nervous and anxious about what's to come, so much so that you contemplate making changes now to your investments before knowing for sure how the November election will play out. Rarely, if ever, is it good practice to make financial decisions based on predictions alone, especially if those predictions are politically veined.
The fact is, even if Joe Biden becomes President and proposes a complete overhaul of the tax code, it will likely take months if not years for his proposals to take effect. And that's if Congress approves it in a timely fashion which, if recent history is any guide (A'hem, cue the stimulus bill), it's about as likely as an alien invasion.
Your best course of action at this point in the game is to be patient but intellectually curious. Learn as much as you can now about how each party's tax plans may affect your income and retirement, and then work with your trusted advisor to develop a plan of attack.
To help you better prepare, here's a summary of Trump and Biden's tax plans and how each may affect your retirement:
IF TRUMP WINS:
WHAT WE KNOW
Very little has been released regarding Trump's proposed tax plans, but pundits think he'll push to keep taxes lower for longer by extending the Tax Cuts and Jobs Act of 2017 (TCJA), which is set to expire in 2025. As such, investors can expect to see more of the same with the potential for a lower capital gains tax and a reduced income tax rate for middle-income taxpayers
HOW YOUR RETIREMENT COULD BE IMPACTED
The stock market popped the day Trump was elected back in November 2016 and through March of this year, it's been on a tear.
Although a Trump presidency has been viewed favorably by the markets, a lot has changed since 2016, most notably a global pandemic. Despite Trump's pro-market stance on lower corporate and individual taxes, concerns over when a COVID-19 vaccine would be ready, U.S.-China trade war and a rising federal deficit still remain in the forefront of investors' minds.
Based on the limited information released thus far, if Trump is re-elected investors could see a minor reduction in their tax bill, should set modest expectations for investment returns going forward and be prepared for bigger swings in their retirement accounts.
IF BIDEN WINS
WHAT WE KNOW
Should Joe Biden take the Oval Office, investors will likely see Democrats push to increase taxes, specifically for small businesses, large corporations and individuals earning more than $400k a year.
Unlike Trump, Biden has released several details regarding his tax plan. Of the many changes he plans to implement, here is a breakdown of the primary components investors should be aware of.
1. Plan to increase long-term capital gains and qualified dividend income tax rates to 39.6% on incomes over $1 million.
This is a substantial increase given the current rates for long-term gains and qualified dividend income for high income earners range between 15 and 20%.
Example: John and Patty Smith have $1 million in taxable income. They've held Amazon stock for years and per their advisor's advice, decide to sell a large portion of their holding resulting in a taxable gain of $500,000. Under Biden's tax plan, the Smiths would pay nearly $100,000 more in taxes than under the current tax structure.
2. Plan to increase the top individual tax rate for taxable incomes over $400k by 2.9% to 39.6%.
Pretty straightforward calculation, but if you're earning $500k per year, you'd see your tax bill increase by $14,500.
3. Plan to raise the social security wage base from $137,700 to $400,001.
The social security tax rate is currently 12.4% of gross wages split between the employee and the employer. An increase in the wage base, or maximum amount of income social security can be taxed on, would mean an additional $16,200 or more in payroll taxes coming out of your pocket if you make more than $400,000 a year.
4. Plan to reduce itemized tax deductions for those earning more than $400,000.
If you're accustomed to benefiting from deducting real estate taxes, charitable donations, state and local taxes and other itemized deductions on your 1040, be prepared to see limitations on what can deduct against your income going forward.
5. Plan to reduce estate tax exemption and eliminate step-up in basis at death.
The 2020 estate tax exemption is $11.58 million for individuals and $22.36 million for married couples. But with the TCJA sunsetting in 2025, these amounts are set to revert back to $5 million and $10 million respectively with Biden approving the reversion and eliminating the step-up in basis on inherited assets. Simply put, this means beneficiaries of large estates would stand to inherit less and owe more in taxes.
6. Plan to offer tax credits for 401(k) contributions.
Although the details have yet to be ironed out, workers participating in their company's 401(k) plan may see bigger tax breaks going forward.
Instead of receiving a tax deduction on amounts contributed to a 401(k), participants would receive a tax credit estimated to be 26% of the amount contributed. A tax credit is far more valuable than a tax deduction as it results in a dollar for dollar reduction in your taxes.
Example: John and Patty Smith have $170k in taxable income and are in the 22% tax bracket. Patty contributes $10,000 to her 401(k) each year. In 2020, the Smiths would get a tax break of $2,200 while Biden's plan would save them $2,600 in taxes.
7. Plan to increase tax benefits on long-term care premiums paid with retirement assets.
No specifics have been released yet, but retirees with long-term care policies may benefit from tax incentives if they pay their premiums with retirement assets.
HOW YOUR RETIREMENT COULD BE IMPACTED
Higher taxes generally mean less money for consumers to spend and companies to dish out in dividends - at least that's traditionally how the market has looked at it.
According to a recent Barron's article, the short-term effect of tax hikes on the market could result in a 5% decline in stocks based on post market trends in 1986 and 2012 when capital-gains taxes were increased. However, the article concludes most economic models don't portend a negative impact on the economy over the long-term.
Those earning more than $400k per year would most likely see an increase in their tax bill which may further exacerbate market gyrations in the near-term, however the market has remained resilient these past few months and appears to be accepting the likelihood of Joe Biden becoming the 46th President of the United States.
With the expected increase in mail-in ballots this election, there's a good chance we won't know who our next President will be until weeks after the election.
What we do know, however is the U.S. is the fourth-lowest taxed country in the world, something Joe Biden and the Democrats aim to change with planned tax hikes.
We also know Trump and the Republican party plan to deliver more of the same regarding tax policy in an effort to stimulate economic growth despite a mounting federal deficit.
Regardless of who's elected, it's almost certain the stock market will overreact, at least in the near-term, but should begin to stabilize over time as the market digests the election results and becomes acclimated to our new president.
If you're someone who may be impacted by higher taxes under a Biden administration, now is a great time to sit down with your tax or financial advisor and begin to develop a plan. Even if you anticipate little if any changes to your tax bill, you could certainly benefit from a thorough review of your financial situation to ensure you're positioned appropriately, as this election is likely to spawn volatility in the market.