What the new administration will mean for investors

The incoming Obama administration is likely to act quickly to kill the Bush tax cuts for households with incomes over $250,000 a year, and they may move to make any new tax law retroactive to Jan. 1, 2009. That was the assessment of Ken Kies, managing director of the Washington-based Federal Policy Group tax consulting division of Clark & Wamberg LLC of North Barrington, Ill. He spoke yesterday on InvestmentNews’ webcast, entitled “What the new administration will mean for investors,” and attended by more than 1,000 participants. Also on the panel was James Delaplane, a partner with Washington law firm Davis & Harman LLP. It was moderated by InvestmentNews deputy editor Evan Cooper and Washington bureau chief Sara Hansard. “[The administration] is facing a budget deficit in 2009 that could pass an eye-popping $1 trillion,” said Mr. Kies, who was chief of staff of the congressional Joint Tax Committee from 1995 to 1998. He predicted a repeat of the type of retroactive tax increase enacted during the Clinton administration in 1993. The incoming administration may call for an increase in capital gains taxes for upper-income households as it announces the next Treasury secretary, who could be Harvard University economics professor Larry Summers, Mr. Kies said. Additionally, it may move to make a capital-gains increase retroactive to the date of the announcement to avoid a sell-off in the market, he predicted. The current rate is 15%, and that could rise as high as 20% to 25%. “The myth is that Congress doesn’t raise taxes in a recession,” Mr. Kies said. Three of five major tax increases enacted over the last 30 years were during recessions, he noted. The new administration also will want to eliminate the abolition of the estate tax, now scheduled for one year only in 2010, “because if they do nothing about the estate tax come Jan. 1, 2010, the estate tax rate is zero, a fine planning opportunity for people prepared to take decisive action, but [it is] unlikely that Congress is actually going to let that happen,” Mr. Kies said. Democrats will likely move next year to make permanent an estate tax exclusion of $3.5 million, with a top estate tax rate of 45%, he said. But Mr. Delaplane said that “probably this election has fewer repercussions for investors than people would necessarily think.” The state of the economy and the financial crisis are more likely to be drivers of investment outcomes than the election, he said. However, higher income, capital-gains and dividend tax rates will lead to much investor interest in tax-preferred vehicles such as municipal bonds, insurance and annuities, qualified retirement plans, Roth individual retirement accounts and 529 college savings plans, Mr. Delaplane said. “The necessity of responding to the economic crisis and the Obama treasury taking over the management of the $700 billion financial rescue plan means that other issues have been bumped down the list somewhat,” including health reform and retirement savings changes, he predicted. Financial services regulatory overhaul will be a top priority next year, Mr. Delaplane said. But he noted that “the 401(k) system got beaten up pretty bad,” in hearings held recently by House Education and Labor Committee chairman George Miller, D-Calif. Criticism of 401(k)s centered on the high level of risk accountholders face, as well as the low savings rates and that too few people are covered. Democrats also are critical of tax breaks for 401(k) accounts because they are too favorable to upper-income people, and they may push for reducing tax breaks for higher-income people, Mr. Delaplane said. A focus of the next Congress will be on providing retirement savings coverage to people without employer plans, with the leading proposal being the “automatic IRA,” he said. That proposal would require employers who do not offer other retirement plans to offer payroll deduction IRAs to workers. They would not have to make contributions and they would not be subject to fiduciary obligations. In addition, many Democrats in Congress are reconsidering provisions that make it easier for advisers who work for companies that sponsor investments to provide direct advice for 401(k) participants, Mr. Delaplane said. Congress is likely to come back to Washington the week of Nov. 17 for a lame duck session to work on an economic stimulus package that will likely include extending unemployment benefits, investing in infrastructure, and providing aid to state and local governments, he said. During the session, Congress could consider giving taxpayers relief from minimum withdrawal rules that require people to take distributions from retirement savings accounts by age 70½, a proposal that has gained bipartisan support in Congress and which both presidential candidates and Washington-based AARP have called for, Mr. Delaplane said. That relief could apply to 2008, which would complicate planning because many retirement account holders have already taken distributions this year. That could lead to new opportunities to replace money that was withdrawn from retirement accounts, or it could lead to offsetting future required distributions against money that was already taken, Mr. Delaplane said. Congress is considering Mr. Obama’s proposal for relief from penalties for early withdrawals from retirement accounts of up to $10,000 in both 2008 and 2009, as long as income taxes were paid on the withdrawals, he said. For more, see the upcoming Nov. 11 issue of InvestmentNews