In preparing for fiscal cliff, experts recommend staying calm, spending less
BY LAURIE WINSLOW World Staff Writer
Saturday, December 29, 2012
12/29/12 at 7:27 AM
Like lemmings headed for a drop-off, we all seem bound to go over the much-touted fiscal cliff if federal lawmakers don't do something before the end of the year to halt the stampede.
Should that happen, nearly everyone will be affected by tax hikes. But knowing how to prepare for the potential changes is not so easy or certain, financial planners say.
There are so many moving pieces and so much confusion about what may or may not be included in the changes that are set to take place, said Mark Butterworth, certified financial planner and president of Butterworth Financial Advisory.
"There is not a whole lot people can do or should do at this stage," Butterworth said. "Use some common sense. Don't get caught up in this to such a degree that (you) really panic, because there really is no reason to panic."
The "fiscal cliff" refers to a combination of expiring Bush-era tax cuts and government spending cuts that become effective at the end of December. If nothing is done, ordinary tax rates will increase, qualified stock dividends will be taxed at ordinary tax rates and long-term capital gains will be taxed at a higher rate next year.
Moreover, many itemized deductions will be subject to phase-out, and popular tax credits such as the earned income credit, child tax credit and American opportunity credits will be reduced.
Workers at all levels face tax increases next year. A taxpayer making between $50,000 and $75,000 would see an average tax increase of nearly $2,400, according to the Tax Policy Center. That translates to about $92 on average per paycheck if the worker is paid every two weeks.
Someone earning between $30,000 and $40,000 annually could expect an average tax increase of $1,417.
Dan Safranek, founder of financial services firm Safranek & Associates, has a starker estimate, saying the average person should expect taxes to rise $3,000 to $5,000 a year.
Expect changes
The world may not have ended on Dec. 21 as the Mayan calendar predicted, but for some it will seem like the world is coming to an end starting Jan. 1, because there is a lot of nasty stuff set to kick in, Safranek said.
For many, it will be too late to prepare for the changes, and they'll just have to ride the wave and go with it, he said.
Butterworth agreed that many people are going to be caught off guard, especially as they are getting ready to pay off Christmas bills.
Mainly, people's cash flow and income would be affected. Social Security payroll taxes are set to increase on Jan. 1, which means workers eventually would see a 2 percent cut in their take-home pay. In 2010, Congress approved a temporary reduction in the Social Security payroll tax, which took the tax from 6.2 percent down to 4.2 percent on the first $110,000 in earnings.
Many people have the misguided idea that the government will suddenly fix this fiscal cliff, but this is a longer-term problem that will take time and a willingness to compromise to fix it, said Steven Wilson, president of Steven L. Wilson & Associates Certified Public Accountants. It's not going to be cured overnight, he said.
"That's why I think people need to be cautious. They need to be careful with their spending, and they need to accumulate a nest egg, but in a diversified portfolio. Everybody should have little cash reserve.
"You need to be building a nest egg for yourself, because eventually either taxes have to go up or government spending has to come down. Either way, that is probably going to take money out of your pocket in the future," Wilson added.
What to do
Certified financial planners recommend, first and foremost, that people review their budgets and decide where they can cut spending in the next few months as they make the transition.
"You can't save money unless you understand where you're spending your money," Butterworth said.
If people really took a hard look at their spending habits and prioritize, they probably could reduce their spending by as much as 10 percent, Wilson said. He pointed to savings that can be found by cutting back on entertainment, minimizing car errands, re-evaluating insurance policies and cellphone plans, delaying big-item purchases, and so forth.
"So often our personal budget has just kind of happened to us as opposed to something that has been well thought out and addressed," Wilson added.
In some cases, people may want to review their retirement plans. If they've gotten in the habit of spending more money, they may want to consider temporarily reducing the contribution to their retirement plan for the next few months as they readjust, Butterworth suggested.
With the coming changes, millions more taxpayers also could find themselves subject to the alternative minimum tax, a complex and confusing tax that was designed years ago to target wealthy people who try to reduce their tax burden by using certain tax breaks.
People earning as little as $45,000 a year could be affected, said Safranek, who advises people to talk with an accountant to see how this tax might affect them.
Also, now would be a good time to review wills and make sure the right provisions are in place that will allow the executor of an estate to manage it in the most tax-efficient way possible, Wilson said.
Another change looming involves the long-term capital gains tax rate on assets, such as stocks, bonds and property held more than a year, which is scheduled to increase from 15 percent to 20 percent next year. Safranek said he knows several people who are scrambling to sell their businesses before the end of the year to take advantage of the historically lower rate.
For those in the lowest tax brackets, the long-term capital gains tax rate rises from 0 percent to 10 percent next year.
But many financial experts caution against making dramatic moves before year end and dumping stocks or other assets just because capital gains could be taxed at a higher rate next year.
Stock dividends, too, are set to be taxed at a person's ordinary income tax rate, which could have a significant impact on those in higher tax brackets. In some cases, investors may want to restructure their portfolios to focus on growth stocks - companies that are focused on growing their products and markets - rather than dividend-paying stocks, Safranek said.
"I would caution: Don't do anything until you see how things will play out. ... I wouldn't totally restructure my portfolio Day 1. I would sit tight and see what happens as things become clear," Safranek said.
Said Wilson: "We think that the markets will adjust and good companies will figure out how to make money and pay dividends regardless of what the environment is. ... Washington has a lot of work to do to get this thing fixed. I don't think it's time for us to all panic and hide."
The Associated Press contributed to this story.
Tips for preparing for the fiscal cliff
- Review your budget and expenses
- Look for ways to save, such as cutting entertainment, reviewing insurance policies, cellphone plans, etc.
- Review your will and make sure you have provisions in place that will allow your estate to be managed in the most tax-efficient way possible.
- Check with an accountant to see if you will be affected by the alternative minimum tax.
- Check with your doctor to make sure he or she is still seeing Medicare patients, as the Medicare reimbursement rate to doctors could drop significantly.
- Review your investment portfolio.
- Look at your W-4 withholding to see if anything needs to be adjusted.
Original Print Headline: Financial planners urge caution, staying calm
Laurie Winslow 918-581-8466
laurie.winslow@tulsaworld.com
