Be Proactive in Aligning Your Portfolio

With continuing stock market volatility and potential changes to the federal tax code looming on the horizon, 2021 has started out on an uncertain note for investors. Effective portfolio management at this time calls for safety and a conservative approach as investors focus on wealth preservation. A complicating factor is another anticipated round of COVID-19 stimulus relief legislation, which could impact the stock market.

Of particular concern are several major proposals by President Joseph R. Biden that bear watching by investors and their advisors.

Proposed Changes to Estate Tax

First is the estate tax. Dropping the individual estate tax exemption from the current $11.5 million to as low as $3.5 million to $5 million, as Biden proposed during the presidential campaign, could have a substantial impact in the Midwest considering the value of family farms and other businesses. It’s unknown at this point whether Biden will find the political will in Congress to enact the estate tax change, along with many others he has proposed. It’s likely that nothing will happen immediately, as Congress is not inclined to make substantial changes to the tax code while the economy is still fragile from the effects of COVID-19.

Biden also discussed eliminating the step up in basis, which resets the basis of inherited property to the date of the decedent’s death. Hence, stocks or real property that have been held for decades are valued, upon inheritance, at the current market value. Currently, if the heirs decide to sell, only the gain from the date of the inheritance to the date of sale is subject to capital gains tax, if at all.

Together, the reduction in the estate tax exemption and the elimination of the step up in basis could result in substantial taxes for many people who inherit wealth.

Proposed Changes to Capital Gains and Corporate Taxes

Also of concern are Biden’s proposals to eliminate the preferential capital gains tax rates for certain taxpayers and to raise the corporate income tax rate.

Biden’s capital gains proposal would subject long-term capital gains and qualified dividends to an ordinary income tax rate of 39.6% on income over $1 million. Current tax rates on long-term capital gains (gains made on investments held longer than one year) are 0%, 15%, 20%, and 23.8%, depending on income.

For investors who have maxed out their retirement savings opportunities, there are still some tax benefits in equity investments because of the existing capital gains treatment. If they don’t have that treatment available to them on securities, we fear that investors may direct their money to other investment opportunities instead of equities, creating unusual pressure on the stock market.

The president also has proposed boosting the highest corporate tax rate to 28%, from the current 21%.

Tax rates for C corporations went from a high of 35% down to a flat tax of 21% under the provisions of the Tax Cuts and Jobs Act of 2017. With the new administration proposing a boost to 28%, a negative impact can be anticipated on the profit that is available for distribution to shareholders. The stock market could see this potential as a significant negative event and react accordingly.

What To Do Now

In the long term, looking out over the next year or two, there are concerns about what happens when the post-COVID-19 economy takes off and these tax proposals become a reality. Currently, investors are rightfully concerned about the disconnect between Wall Street and Main Street. The stock market is performing strongly despite the extreme weakness of business performance in many sectors and high unemployment. Once the economy takes hold and Congress makes changes in the tax code, that could help align the stock market to where the real economy is, and possibly bring equity prices down.

The important thing to remember, as always, is not to let short-term headwinds change your long-term strategy. How you weather this period of uncertainty as an investor depends largely on your stage of life and unique needs.

If you are more than five years away from retirement, the current conditions should not impact your planning and overall investment and savings strategies. Stay the course.

If you expect to retire in five years or less, it may be wise to consider making some adjustments. To meet the challenges of today’s volatile market and political uncertainty, it may be necessary to go more conservative than you normally would, and to consider different investment instruments. With interest rates at historical lows now, advisors are having to be creative in the investments they utilize for conservative investors.  Please seek the advice of a financial professional to discuss whether some of these investments might be suitable for your portfolio.

At this point, it is advisable to be proactive and align your portfolio to the real risks and volatility in the market, particularly if you are within five years of retirement.

Contact your AdamsBrown Wealth Management advisor for a discussion of your needs.