Advisers Mulling Adjustments In Anticipation of Pending Fiscal Cliff Hot

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Planning Window Closing

For its part, Eaton Vance is telling advisers that the time to act is now. If the Bush tax cuts aren’t extended, taxes will rise sharply in 2013. Higher taxes combined with federal spending cuts next year could push us over that so-called “fiscal cliff,” the company said in various reports about the fiscal cliff that can be found at this website. (See table below.) Its key takeaway: The window of opportunity to plan for the likelihood of rising taxes is rapidly narrowing.


Current Top Rate

New Top Rate

% Increase

Income Tax




Capital Gains Tax




Dividend Tax




Estate Tax

35% ($5 million exemption)

55% ($1 million exemption)



Harvest Gains

Andrew Friedman, a principal with the Washington Update, writing for the Eaton Vance on Washington report tells investors to “sell assets to take advantage of existing capital gains tax rates.”

“Investors who are considering selling a business or dissolving a concentrated stock position, or who otherwise have significant unrealized long-term gains, should consider selling assets while the top capital gains tax rate remains at 15%,” Friedman writes.

Accelerate Income

In the Eaton Vance report, “Investing in a Rising Tax Environment 2012,” Friedman tells investors to take ordinary income in 2012 rather than in a later year when tax rates may be higher.

“With ordinary income rates expected to rise, investors might act to receive additional taxable income in 2012 rather than in later years,” he writes. For instance, executives could consider exercising nonqualified stock options this year so that the resulting income is taxed at prevailing rates.”

Defer Deductions

Friedman also recommends deferring “discretionary deductible payments (such as charitable contributions) to later years when they may be worth more due to higher tax rates.”

Consider Tax-free Income

As tax rates increase, demand for municipal bonds increases, because more people wish to reduce the tax they pay,” writes Friedman in his report.

Tax-efficient Mutual Funds

Friedman also suggests using tax-efficient mutual funds and other professionally managed tax-advantaged investment strategies. “A rise in tax rates can meaningfully reduce the net returns provided by tax-inefficient investments,” he writes.

Use Annuities and Life Insurance

Consider investing in annuities and life insurance that offer tax deferral, Friedman writes. “Life insurance provides tax deferral on unwithdrawn increases in cash value during life and a tax-efficient way to pass wealth to future generations,” writes.

Consider Roth IRA Conversions

Friedman also suggests convert a traditional IRA to a Roth IRA. “All individuals are now eligible to convert their traditional IRA to a Roth IRA, which permits future investment earnings to be received tax free,” he writes.

Stock market fallout

Meanwhile, Fidelity Investment says if we fall off the fiscal cliff, the impact in a worse-case scenario will be quite large. “The more fiscal austerity that kicks in, the bigger the effect it has on economic growth,” says Dirk Hofschire, senior vice president of Asset Allocation Research in the report. “Depending on how you measure it, the automatic spending cuts and tax hikes would cut as much as 4%-5% of GDP. If you consider that the economy is growing around 2% a year, that would be enough to throw us back into recession.”

What’s more, he said corporate earnings could decline by double digits, perhaps as much as 20% or more. “If this happened, it would have a tremendously negative impact on the stock market and other riskier asset categories,” he writes.

Bonds Will Fare OK

Fidelity does, however, say the fallout from going off the fiscal cliff won’t be all that bad for bonds. Bill Irving, portfolio manager, Fidelity Government Income Fund, writes in the same report: “If the government does nothing and the spending cuts and tax increases take effect, we get a big fiscal contraction. As painful as that is, I think it’s a very good scenario for the bond market. That's because the fiscal contraction likely means slower growth and lower inflation, which means lower bond yields.”

Don’t Do A Thing

Of course, there are those who don’t see any need to act just yet. In fact, Jeanne Gibson Sullivan, CFP of Financially in Tune is not among those who are making adjustments to her client’s portfolios.

First, she says money that her clients need over the next one to three years is never invested in risky assets. “Thus I don’t worry as much about what is ‘possible’ vs. what is ‘probable’ in the next few months,” says Gibson Sullivan.

What’s more, she doesn’t plan on making any changes before the fiscal cliff deadline. “I did not make any big moves before the recent Greek elections, nor do I anticipate any major changes before the fiscal cliff deadline,” Gibson Sullivan says.  “So much is ‘possible’ between now and then, impossible to predict what is ‘probable.’”

That said, she says favors – given the volatile and uncertain climate in general – dividend stocks more than she would ordinarily. In addition, she has concerns about current valuations and is favoring large cap stocks over small cap stocks. This concern was reinforced by Jeremy Grantham during his presentation the just-held Morningstar conference, which Gibson Sullivan attended.

And then she has this reason for not making any adjustments. “I find that the worst events for the markets are events that are not predicted – not those such as the ‘fiscal cliff’ or the Greek elections that are analyzed over and over again,” she says.

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