Ep # 31: Will The Biden Tax Proposal Affect You?
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Benjamin Haas 00:02
Hi everyone and welcome to AB Conversations where we will help you CFP your way out of it. A podcast where you get into the minds of a couple Certified Financial Planners on how we think and feel about everyday financial planning questions and what should really matter most to you. A healthier financial life starts...now! Good afternoon, Adam. How are you today?
Adam Werner 00:32
Greatest 20 minutes of our week.
Benjamin Haas 00:33
That's right and another topic that is sure to stir the pot.
Adam Werner 00:40
Yeah, I said, it's everybody's favorite but also most hated topic. Taxes.
Benjamin Haas 00:48
Oh well, you know, taxes, politics, religion, wherever you want to go today, Adam. I'm along for the ride.
Adam Werner 00:55
Oh man, I don't even want to touch that with a 10 ft pole.
Benjamin Haas 01:00
All right, so let's just talk.
Adam Werner 01:01
Yeah, let's talk about the easiest one. Taxes.
Benjamin Haas 01:05
Yeah, making a lot of headlines. So, please set the stage for this.
Adam Werner 01:10
It's been floated, right? The new proposal by the new administration on the tax changes to the tax code. We just want to kind of highlight what some of those changes are, give our quick opinion on whether the likelihood that certain changes are actually going to get passed and why and I guess just give some context. Then hopefully, we'll be able to kind of pivot to let's focus on the stuff that matters. The things that you can control from a tax perspective because there are certainly parts of this proposal that you just can't control. Whether the corporate tax rate goes from 21% to 28% or maybe they compromise and it's 25%. To the you's and me's and to our clients. Maybe that has ramifications for the stock market but in our day-to-day lives, it should be neither here nor there.
Benjamin Haas 02:04
Yeah, so let me hit on, always good to give two quick disclaimers. Well, let me make it three. One, we're not tax professionals but I think people would recognize that in financial planning, like what we are to do is to be proactive, help you think about the long game, not the short game and that's why kind of understanding how your money is going to be taxed like we want you to focus on later in life, when you have to recreate your paycheck, you can control some of the timing here. Let's not lose focus on that but the other disclaimer is, pop quiz - our income tax code came to be at what time in history? Do you know?
Adam Werner 02:42
Nope.
Benjamin Haas 02:43
It's like, actually, I don't know the exact year either. Like 1915, like 1918. I only remember because income tax was passed to enable prohibition, right? It was going to replace that lost revenue but here's the point in bringing that up. If we've had a tax code for 100 years, it's changed 20-25 times so whatever comes out this new tax code, by the way,
Adam Werner 03:08
We vote for a new president every four years. So it's, yes, every four years, the tax law changes.
Benjamin Haas 03:13
You do the math? Yeah, that's the point. Let's talk about what the things are potentially going to be proposed. What do we really need to pay attention to on that? Because it's not to belittle it. Let's keep the perspective that financial planning is about making a plan and being ready to pivot when that time comes. So why don't we go through some of those hot topics like you said.
Adam Werner 03:33
Yeah, so I already talked about the corporate tax rate, which we believe for individual clients, once you're the owner of a corporation, it's kind of neither here nor there. The other big one that gets floated right now is that income tax rates on individuals are going to increase. Now that seems very targeted on the top income rate right now, going from 37% too 39.6% I believe was the proposal on income. I think for that tax rate, it's like $600,000 and above of taxable income.
Benjamin Haas 04:05
Yeah, the reports I read that are, if your family makes less than $400,000, these changes aren't going to affect you. If you make more than that, let's certainly talk about it. There are things that, you know, maybe you should be looking to do to adjust but the tax rate going up by 3%, again, we're not talking about huge increases. This isn't going back to tax rates of 70%.
Adam Werner 04:29
So yeah, I guess another, maybe not a disclaimer, but let's preface this by saying there's clearly a targeted intent behind this proposal that it is on corporations and on high income earners.
Benjamin Haas 04:41
Right.
Adam Werner 04:41
So the proposals that are coming through are very targeted in that way. Also, on the personal income tax side is, I guess it's an income tax, the slight update to the Social Security tax as part of the payroll deductions. Right now it's capped at $142,000 and change. You can earn above that but you're still only paying on that first $142,000.
Benjamin Haas 05:04
Right.
Adam Werner 05:04
They want to open that up for income above $400,000. So again, just levying additional payroll taxes, if you are in that high income earner threshold, which is where they want to focus right now.
Benjamin Haas 05:17
Yep.
Adam Werner 05:19
Again, I think the likelihood of those things going through is higher but it's yet to be determined where things actually fall in the end there.
Benjamin Haas 05:29
I think there are some other ones that we can quickly check through that are certainly making headlines and maybe something that we would need to be very thoughtful on our planning approach with but seem less likely. The estate tax certainly could come down.
Adam Werner 05:44
The estate tax exemption.
Benjamin Haas 05:48
Again, that's going to include very specific people. I think the big one that gave me alarm was that the step up and basis would go away. If someone passed away and left non retirement assets to heirs, that they would no longer have a step up and basis date of death value. They would have to assume the cost basis of the decedent. That would be major; however, administratively, very difficult.
Adam Werner 06:15
Yeah and they're not only that, but the way it's proposed right now, there's no income threshold, there's no asset threshold. So that would be applied across the board, which would somewhat go away from at least the way this proposal is intending to levy taxes on corporations and higher earners. This would affect everybody across the board. So that in its intent may not be directed and then to your point, administratively, yes, we have conversations with clients now trying to track basis of things that were bought decades ago and there's no good way about that. I can't imagine the IRS making that even more complicated for themselves when somebody passes away.
Benjamin Haas 07:01
Yeah, so is this a good time to pivot then? Is there anything else on that list?
Adam Werner 07:07
There was one last thing, again, it was on high income earners. It was taxing that investment income, right, potentially capital gains at ordinary income. So instead of the 15 to 20%, range, it's going to be that top income rate of 37%, or 39.6%, whatever it ends up being. Again, just another slight increase, I shouldn't say slight, it's a big deal,
Benjamin Haas 07:28
That would be a big deal.
Adam Werner 07:29
On those higher income earners and they're floating out, you know, a million dollars or more of income.
Benjamin Haas 07:35
Yeah, so then let's package that together. The point that we want to make here is, as planners, we certainly understand that we want to be able to control not paying more than our fair share, quote, unquote, in taxes in any one given year. But I think it's really important for us to look down the road, as I mentioned earlier and maybe you can help me just give some perspective here. We can really put any type of savings or investment into three different buckets. You're taxing me now, you're taxing me later, or you're taxing me never again. These are the things you can control when you talk about where you're saving, how you're investing. Maybe let's just go through that so we can keep that big picture perspective in mind when these new tax laws maybe come into play.
Adam Werner 08:23
Where do you want to start? Tax me now?
Benjamin Haas 08:25
Tax me now? You just talking about capital gains. Let's stay there for a minute.
Adam Werner 08:30
Yep. So any investments that you have outside of a retirement account, is in that kind of tax me now bucket. You're paying taxes on it from your income and then you're just investing the difference. That investment can kick off dividends, interest capital gains in any given year and you pay as you go.
Benjamin Haas 08:51
Right. Right. There's no tax deferral and I think what would also be important to know here is, part of the tax me now is giving you financial planning flexibility. When we talk about tax me later, it's probably putting money in an account that you can't access until 59 and a half, most commonly when we talk about those retirement accounts. We want to be thoughtful to you're not getting a tax advantage for putting money there, where you are getting flexibility. We've had clients that have done an awesome job saving for retirement. Want to retire at 55 (years old), but everything's in a qualified account and now we go, man, now we have to jump through some hoops to figure out how we're going to do this.
Adam Werner 09:30
Yes, yeah. It's the recurring theme I think from now to the end of this podcast is going to be the word flexibility.
Benjamin Haas 09:37
It goes back to then paying as you go is also something that you may not be able to control. I think this is one of those misconceptions that we want to make people aware of. If you're invested in a mutual fund, usually your taxes are going to be based on did you make money and then when you chose to liquidate it, you'll pay taxes on what’s called a gain. Or if you lost some money, we can actually claim some losses but inside that mutual fund there, as a money manager that's making changes here and there, are their investment policy. If they made some money, even if you didn't do anything different with your fund, they might kick that off to you. And guess what? That's going to show up in a tax return whether you're coming or not.
Adam Werner 10:17
Yep and it's confusing because those are also called capital gains distributions - different than the buying and selling capital gains that you would experience as the best investor. But yeah, those are the distributions that you can't control if you still continue to own that fund. It's coming to you whether you're reinvesting it, you're moving it to cash, or you're spending it, you're going to get taxed on it regardless.
Benjamin Haas 10:41
I think it's really important, again, to just understand how those things are taxed, either by your actions or by just inactivity and sometimes that's why people talk about owning stocks or owning exchange traded funds or maybe some different instruments, investment vehicles, that don't have that lack of control over capital gains.
Adam Werner 11:04
Yeah, there are certainly investments that are a little more tax friendly, within a non-retirement account, again, the flexibility just depending on what you own in different accounts. It's all specific to the situation.
Benjamin Haas 11:19
I guess the moral of the story on that bucket is there is flexibility, there are taxes, but we're really not going to let the specific tax code be the only determining factor on what we put into that bucket and what we invest in. It does have to come back to the financial plan and when you're going to need access and what other things do you have going on?
Adam Werner 11:39
Yeah.
Benjamin Haas 11:40
So if people are a little focused on well, look, I don't need access to it now and I'm planning for retirement, that's where we start talking about that "tax me later" bucket and I guess to be clear, you're still going to pay ordinary income taxes on that money later in life. The tax rates at that time, nobody can know, right? We don't know where these things will go or how they will change. To our point, they change more frequently than we probably know but that's the gamble you're making. Save a buck today to have to pay taxes on it later and the old adage that I'll put it in that bucket because my tax bracket will be lower in retirement. I don't know Adam? If feels like we're probably going up with taxes overtime.
Adam Werner 12:21
Yeah, that seems like a harder and harder sell, or at least a steeper and steeper hurdle to feel like we're going to be in a lower tax bracket in the future. Again, the idea was in your income earning years, you should theoretically be at a higher bracket than when you're retired. You don't have that steady paycheck, maybe it's still security and your savings again, we would hope that you have saved in these different buckets, and can control your taxable income in any given year but it really is situational there too.
Benjamin Haas 12:54
Let's go to another kind of client example that's fresh in our mind. So great to defer the taxes, you know, tax me later but there are rules around that, too. I know I mentioned that you can't get to that bucket most often than not, you can't get to that bucket until 59 and a half but now at age 72 they forced that distribution on you. In some ways, you're creating a little bit more of a potential tax bomb later in life. Now, if you're going to take that money out to support you anyway, that's fine. Absolutely. That's what it's there for but we certainly run into enough clients that they did a great job saving. They're not spending a lot from that bucket and now that required minimum distribution hits, and boom, that's forced taxation. Now you can't control how much is coming out and what you're paying taxes on.
Adam Werner 13:43
The IRS I think, as I hope many people know, you haven't paid taxes on these dollars yet. If it's in that tax me later bucket, they want their revenue at some point down the line and they did change that recently. So now it's age 72 but yeah, they're going to force you to start to take chunks of that out and pay the taxes once you hit age 72 and beyond.
Benjamin Haas 14:08
Yeah and if you don't spend it all your heirs will have to continue to take those distributions. That rule changed recently too, now it's only 10 years to get rid of it. The point is, if we're talking about taxes within the lens of you want to be able to control when you're taxed, you can't control these tax brackets. You can't control those laws but if you can later in life control how much tax ability is going to be put upon you depending on what you pull from, you lose that flexibility when it comes to age 72 and so do your heirs.
Adam Werner 14:41
Yeah, so let's talk about that last bucket of the “tax me never,” maybe we can kind of give an example of what we mean by you know, being able to be selective in retirement will kind of give an example of pulling from different buckets to help isolate some taxes. So that last bucket is the tax me never. I shouldn't say, tax me never, tax me never again. The Roth IRA is a great example in that it's like the first bucket that you're putting money that you've already paid taxes on. You're not getting the tax deduction in any given year, like you were in bucket two but then it is growing tax deferred. As long as you take it out after age 59 and a half, other parameters that you need to follow, it comes out tax free. All of that growth is free and clear to you doesn't show up as taxable income in the future. Sounds pretty great.
Benjamin Haas 15:35
In our kind of Pennsylvania Dutch backyard, do you want to pay taxes on the seed or the harvest? If I can get all that growth that I'm hoping to see over time, to never be taxed, seems like a huge win. I'm giving up the deduction now, though and that has to be the tradeoff. This is why we say if you're concerned about taxes going up over time, if you're concerned about no control over those RMD's, this is why starting to save investing all the time, right? This is why starting to diversify where we have our savings, it's just really, really important.
Adam Werner 16:13
Yep.
Benjamin Haas 16:15
And I guess, so I give the example there too with we're thinking biggest picture on then what is passing to the next generation. Your heirs don't have to pay taxes on that money either. Like when you make the joke, pay taxes never again, it's really what it means.
Adam Werner 16:35
I don't even want to say this but it is the truth, right? Unless at some point, the tax code does change on those Roth 401(k)'s, Roth IRAs, that's always possible but as it stands right now, that is not the case. They are tax free to you, to your heirs, and beyond.
Benjamin Haas 16:58
So whether those things change or not, we'll go back to the whole premise here is -you can't control that we cannot know what's going to happen in the future. All we can do is work with the best information that we have right now and in our mind, that's not to make a huge bet on any one thing happening or not happening. So, there's arguments to be made for tax me now and keep some flexibility. There are arguments to be made in your situation to tax me later and defer that taxation and there's certainly an argument for tax free forever. Diversify, spread it out, control it.
Adam Werner 17:32
Yeah, diversification was the word that that I wanted to use. You just said it, it's we often think about diversification from an investment standpoint. We also like to layer that into tax diversification, right? Spread out between those three different areas. It just gives you the ability to make a decision in the future based off of those assumptions that we don't exactly know what that's going to look like. But if you have a little bit in every area, you can pick and choose based on that data in real time in the future, to just minimize, hopefully, the actual taxes you will pay to meet your needs.
Benjamin Haas 18:12
So if you're young, you're accumulating. Right? Let's not get tripped up by specific tax code conversation right now. Let's do the hard work of actually saving, diversifying that out. If you're in the later stages of life where you're in distribution stage and some of these rules are changing and affecting you. Great, let's have a conversation. There are ways that we can strategically try to go about this and think about what bucket we can pull from or you even have the opportunity for the most part to move money from bucket to bucket. There's like certain consequences to that but let's go through those tradeoffs. So regardless of your situation, let's keep it in perspective. It may not be a big deal, it's good to reevaluate it but again, let's not get too worked up about taxes just yet, see what actually happens.
Adam Werner 19:00
Yeah, you said it earlier and it's wanting to win the tax war, not necessarily the tax battle, it's play the long game. There's hopefully everyone's going to live a long and healthy life, you can spread this out over a longer period of time and again, just give yourself the ability to make those decisions in the future that feel better than they may today.
Benjamin Haas 19:23
So do you want to talk about politics and religion? Or should we just kind of save that?
Adam Werner 19:28
Save that for the next one.
Benjamin Haas 19:31
All right, hopefully it was helpful. I'm sure we'll have more on this as plans and proposals and legislation, whether it happens or not actually comes to fruition, but uh, in the meantime, keep focused on saving.
Adam Werner 19:44
That's it. Good point. Thank you.
Benjamin Haas 19:46
All right. Have a good one.
Adam Werner 19:48
You too. Bye.
Benjamin Haas 19:52
Hey everyone, Adam and I really appreciate you tuning in. Please note that the opinions we voiced in the show are for general information only and are not intended to provide specific recommendations for any individual. To determine which strategies or investments may be most appropriate for you. Consult with your attorney, your accountant and financial advisor or tax advisor prior to making decisions or investing. Thanks for listening!
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