Tax Planning and Investment Strategies: How to Plan for a Change in Tax Policy

By Christian Koch, CFP®

The current tax framework of dividends and capital gains taxed at 15% appears poised to change in the near future. This article addresses the historical context to investment tax rates and various tax strategies available to investors who climb aboard the bandwagon before tax policy changes.

A historically perspective is helpful to illustrate where we are today. During the 1976-1980 time period, Jimmy Carter was President and the top tax rate on (LTCGs) long-term capital gains was at a historical high rate of 39.9%. From 1981 to 1988, during the period which Ronald Reagan was president, tax rates declined further to 28% on LTCGs. Furthermore, during Bill Clinton’s term 1993-2000, the top tax rate on LTCGs was reduced further to 20%. Finally, during the 2001-2008 period, George W. Bush reduced the top tax rate for LTCGs to a unprecedented historically low point of 15%. Over the last 35 years, the top marginal tax rate on long-term capital gains has declined from 39.9% to the current 15% rate under President Barrack Obama.

Going forward, we believe tax policy will move higher back to more historically patterns. The timing in this change is likely to be in December 2012 range as the extension of the Bush tax cuts are due to expire on 12/31/12. However, “the market” is a forward discounting mechanism, which would suggest that market participants should start to anticipate the impact of a change in tax policy by next year.

Our Solution: Proactive Tax Planning with a focus on maximizing your Investment Strategy. In an environment where LTCG tax is on the rise which type of investment strategies does one want to emphasize? Growth versus Income? For example, a technology growth stock versus a utility stock? For individual’s in their early career, career development (age 35 to 50) and peak accumulation (age 50 to ages 58) financial life cycle, we would recommend individual stocks with attractive growth and valuation characteristics.

Another Important consideration is Asset Mix. For example, equity versus fixed income? For individual’s in the pre-retirement (3 to 6 years prior to planned retirement) and retirement (ages 62-66 and older) financial life cycle, we would recommend less exposure to fixed income investments. The Decumulation phase and investing for lifetime income requires a different strategy. This can be best achieved by investing in preferred stocks versus loading up on fixed income investments.

Reviewing your security holdings for tax-savings opportunities should be an important part of your year-end tax planning. The tax saving strategies presented above should be considered in light of your investment objectives and personal financial situation. However, being “aware” of the economic consequences that are inherent in a tax policy change is the key to being a successful long-term investor.

Author: Christian Koch

Mr. Koch is a Certified Financial Planner ™ professional. He is a NAPFA Registered Financial Advisor and is a member of the New York Society of Securities Analysts and the Harvard Business School Club of Atlanta. Mr. Koch has been awarded the Paladin Registry’s Five Star Designation (www.paladinregistry.com/advisor/christian.koch).

Contact Christian