- There are still a lot of big-ticket items to be ironed out with the Build Back Better Act.
- The legislative uncertainty underscores the need to avoid hasty changes to your financial plans.
- No matter your income level, you can always explore tax-smart strategies designed to help you manage, defer, and reduce taxes before making long-term financial planning decisions.
- What matters most is plotting out all your goals and designing a financial plan that meets your needs.
Congress returns to work in 2022 with a major piece of unfinished business: the Build Back Better Act. With mid-term elections looming, passing major legislation will be tougher than ever. Odds are if anything passes it will be a significantly pared down proposal that may only be limited to tax increases on the very wealthiest Americans, and piecemeal tax cuts for many.
"The longer the process draws out, the less certainty there will be on reaching a deal that can garner enough votes to pass both chambers of Congress," says Jim Febeo, head of government relations at Fidelity.
What does that mean for savers and investors? For those concerned about how this might affect their wallets, the urgency to act in advance of major changes has dissipated. "At this point, people are doing their normal financial planning, and we are not seeing a rush to amend trusts or accelerate gains in anticipation of increasing tax rates," says Mike Christy, regional vice president of advanced planning at Fidelity.
For Lars Schuster, institutional portfolio manager with Fidelity's Strategic Advisers, Inc., this underscores the need to avoid hasty changes to your financial plans because of ongoing legislation.
"It's good to pay attention to ongoing debates, but don't let them drive your investment positioning in the moment," says Schuster. "Doing so before legislation is signed into law may lead to some near-term consequences, like pushing you into a higher tax bracket or causing you to miss out on long-term gains because you sold too soon."
So the ultimate financial planning lesson of this past year of political wrangling: Don't take action based on an interim read of an ongoing situation. Make a long-term investing plan and stick with it.
"Control what you can control," says Schuster. "That does not include global pandemics, supply chain issues that impact inflation, and ongoing debates over policy in Washington. What you can control is your investment exposures and ensure that they align to your financial plan."
The fate of the Build Back Better Act is now with the Senate. There are still a lot of big-ticket items to be ironed out, such as what will happen with the cap on state and local taxes, known as SALT, the continuation of the expanded advanced Child Tax Credit, and the overall cost of the provisions, considering fears about rising inflation. Then, if there are changes, these would have to be approved by the House of Representatives.
New year's tax strategies
No matter your income level, you can always explore tax-smart strategies designed to help you manage, defer, and reduce taxes before making long-term financial planning decisions. Among these: tax-smart asset location, where you use tax-deferred accounts when appropriate, charitable giving, and tax-loss harvesting, where you offset gains with losses.
Here are some strategies to consider:
- Roth 401(k)
If you are looking for tax-deferred or potentially tax-free growth, you might want to consider putting some of your retirement savings into a Roth 401(k) instead of a traditional 401(k), paying the tax now instead of later. Note that the contribution limit is the same for both: $20,500 in 2022, with $6,500 in catch-up contributions for those over 50. Many, but not all, 401(k) plans offer the option of a Roth 401(k). Some plans also allow after-tax contributions to traditional 401(k)s, up to the total defined contribution limit in 2022 of $61,000, which includes both employer and employee contributions. Some plans also allow converting those after-tax contributions to Roth 401(k) contributions. But be aware that this strategy, known as the "backdoor Roth," might be eliminated by future legislation. You should consult with your plan administrator if you have questions about your plan details.
- Deferred annuities
Some high-income investors, who have already taken full advantage of tax deferral through workplace plans like 401(k)s and/or IRAs, may still seek additional tax deferral. They may benefit from the use of low-cost variable annuities, which can bring a variety of benefits, including deferring investment gains until assets are withdrawn. However, these are complicated investments, so be sure to consult with a financial professional.
- Estate planning
Careful estate planning can also help you secure your financial future and generations to follow. The status quo may remain until 2026, when the current estate tax exclusion amount ($12.06 million for 2022) is set to shrink to an inflation-adjusted $5 million. If you already have an estate plan, you may want to ask yourself some follow-up questions and not be caught short if there are changes down the road. For instance, are your trustees or executors still appropriate considering your estate-planning goals? Perhaps they've aged or your relationship has changed. Also, are your children now of age? You may want to update provisions relating to your beneficiaries. You may also have had new family members join the family, or others may have left through divorce, or you could have moved to a state with different estate-planning rules. "An estate plan should evolve as your circumstances do," says Christy.
With equity markets hovering around all-time highs, and the prospect of rising interest rates in 2022, some people may also begin to evaluate their annual gifting strategy. For example, if you believe the markets may pull back, you might want to be prepared to make a gift when asset values have declined, with the hope that the appreciation to follow will be outside of your estate. On the other hand, if you believe the markets will continue to increase, gifting at the beginning of the year can help capture the appreciation throughout the year.
What matters most is plotting out all your goals and designing a financial plan that meets your needs. Then deal with the uncertainty about future tax rates by revisiting your plan at least once a year. This way, you can ensure your investments are aligned to that plan and that you have enough growth in your portfolio to offset any potential long-term tax impact. So stay flexible and keep an eye on how the legislative process progresses. If you think you may be personally affected, take the time to meet with a tax advisor and financial professional to review your situation and begin or refresh your plan.