Monday, November 8, 2010

How to Invest After the Mid-Term Elections

5 profitable post-election predictions

By John F. Wasik
Author of The Cul-de-Sac Syndrome

USA-ELECTIONS/Remember that classic carnival ride, the “tilt-a-whirl?” That’s what financial planning will be like under the new Congress, when Republicans control the House of Representatives and the Senate is divided.

Some big decisions need to be made about taxes, retirement and estate planning laws – moves that Congress didn’t make before they recessed for the election.

The wrenching move to the right and the political wrangling about these key topics could be dizzying. That means you can either get motion sickness watching the two parties battle, or you can try to plan for your long-term goals no matter what comes out of Washington.

The most important legislation that didn’t get passed — or even seriously discussed — had to do with tax rates. The estate tax expired at the end of last year. So if someone you knew expired this year, then maybe you and other heirs get a free pass. (Congress could still pass a retroactive tax, though).

Income-tax brackets are also still in limbo. The Bush-era tax rates ranged from 10 percent to 35 percent; they previously ranged from 15 percent to 39.6 percent. Come 2011, if Congress does nothing, the higher rates will automatically return. And low 15 percent rates on dividends and capital gains will also rise. That brings me to my first prediction:

The Bush-era tax rates will remain. I don’t think either party will mess with them on the eve of a presidential election year. The sluggish economy is also a linchpin. There might be some compromise on when the higher rates will kick back in — maybe two or three years from now — if Congress can even reach an agreement on that. For now, though, I would say it’s not likely you will be hit with higher income taxes next year.

The estate tax will return with higher exemptions. Even mega-investor Warren Buffett agrees that some estate tax is necessary. While I don’t think we’ll see a return to the pre-Bush top rate of 55 percent on estates valued at more than $1 million, we’ll see some compromise on how much of an estate will be exempted from the tax. My guess is that Congress will use a proposal crafted by Senators Blanche Lincoln (D-Ark.) and Jon Kyl (R.-Arizona) as a starting point. They suggested a $5 million exemption and 35 percent rate, which is the top marginal income tax rate now. Look for the GOP-dominated House to go for an even higher exemption: $10 million wouldn’t surprise me.

Deficit cutting will eventually impact entitlements. This is a roundabout way of saying the House will begin the painful discussion of how to sustainably fund Social Security and Medicare. On the House side, I would expect to see a revival of personal savings accounts, which were floated during the Bush years, which would be carved out of Social Security contributions.

Medicare, which may run out of money in 18 years, has gotten some breathing room from health care reform, although tax increases or benefit cuts may still be on the table. Some GOP and Tea Party members have also said repealing health reform is at the top of their agenda, so this is a wild card. I don’t think any serious action will take place in 2011 on any of these programs. No matter what happens, fund your Roth IRA or 401(k). Somewhere down the road, a tax increase will eat up more of your retirement funds. Having tax-free income (you pay taxes only on the contributions in Roth funds) will be a big plus.

Retirement savings may be bolstered. There have been “Auto IRA” proposals in various House and Senate committees for years to bolster retirement savings at small businesses that both parties have supported. Yet these programs have never reached the floor of either chamber. They might make it through next year.

Stocks will be a smart investment. Neither party will have any impact on the business cycle. Corporations have trillions sitting in their treasuries; the more mature companies are still paying healthy dividends that beat most pathetic money-market fund yields. It doesn’t make sense to sit on the sidelines waiting for something dramatic to happen. Invest in stocks through an index fund such as the Vanguard Total World Stock exchange-traded fund.

The only thing I can guarantee is that the coming Congressional conflicts won’t be dull. You’ll see all sorts of fur fly over tax rates and paring the federal budget deficit. Just make sure that you’re positioned to take advantage of any economic rebound. That’s one thing that everyone wants to be optimistic about.

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