Stern Advice-Your skin in Washington's budget game

WASHINGTON, April 10 Wed Apr 10, 2013 1:54pm EDT

WASHINGTON, April 10 (Reuters) - The budget that President Barack Obama unveiled on Wednesday has a long way to go before any part of it becomes law. It is basically his opening play in a long game that will involve the House, the Senate and countless lobbyists.

That game may never end - Congress hasn't passed a unified budget resolution since 2009. Federal programs have mainly been funded in a piecemeal way through so-called continuing resolutions that often keep money flowing without addressing policy.

The President's contention that he has already met Republicans half way - along with the inclusion in his budget proposal of some measures that are unpopular with his own party - does somewhat increase the chances of some tax and spending changes coming out of this year's financial wrangling. So does the broad desire on Capitol Hill to undo some of the automatic spending cuts called sequestration, and the fact that all parties will have to revisit the debt ceiling later this spring.

So, yes - at some point, it's probably going to cost you.

Most notable is the Obama budget inclusion of cuts to the inflation adjustments that Social Security recipients receive on their benefits annually. In the offing there are also possible limits on retirement account savings, increases in the costs of student loans and more tax hikes.

Here are some real steps you can take to protect yourself from that great unknown, while you watch Washington tussle.

-- Prepare for inflation. Opponents of Obama's proposal to link Social Security benefits to a so-called chained consumer price index are loud and plentiful. But it's been widely, albeit privately, acknowledged for years that one way the government could "fix" imbalances in the Social Security and Medicare trust funds would be to inflate their way out of trouble. Limit the inflation adjustment on benefits (while inflating up the tax payments that fund these programs) and you can pay them off with cheaper dollars.

A retiree who starts at 65 with $20,000 in annual Social Security benefits would be receiving $289 a month less after 25 years under the chained-CPI approach than she would under the CPI rule in effect now. Furthermore, items that retirees buy - notably food and healthcare - tend to have higher inflation rates than items they don't buy regularly, like consumer electronics.

So, look at keeping a corner of your 401(k) or IRA invested in items that will beat inflation over time - commodities, real estate and growth stocks. Resist the temptation to lock up too much of your money in an annuity that doesn't have an inflation adjustment for benefits. And if you're buying long term care insurance, make sure it ratchets up over time to account for price changes.

-- Understand your retirement savings. The Obama budget reportedly caps tax-deferred IRA accounts at $3 million; a level that seems to make it insignificant for all but the Mitt Romneys of the world. (he famously fessed up to having a retirement account worth as much as $101 million during the campaign.) But in fact, this provision is much more complex and could eventually hit as much as 5 percent of workers currently between the ages of 26 and 35, according to a review by the Employee Benefit Research Institute. That's because the provision actually limits IRA holdings to the level that would support a $205,000 retirement annuity. In 2013, that's roughly $3 million, because interest rates now are at historic lows. The amount of cash required to support an annuity falls as interest rates rise.

The President also proposes to save money by killing the so-called stretch IRAs, that allow children to inherit tax-favored IRAs and then keep them in force over their entire lives. This budget would instead require that they withdraw the money and pay income taxes on it within 5 years.

And he also is calling for a mandatory 30 percent tax rate on household income above $1 million.

What to do about this now? If you are a big saver, make sure you don't have all of your savings in tax deferred retirement accounts. You may be able to use 529 college savings plans and healthcare savings accounts to stockpile some money. Keep some money invested after taxes in municipal bonds or individual stocks. When you retire, you won't get stuck withdrawing huge sums from your taxable IRAs at all times, subjecting you to income tax and the possibility of limits that could render a percentage of your retirement account taxable in any one year.

-- Plan your charitable contributions over many years. The Obama budget raises what's become a perennial suggestion: A 28 percent cap on value of deductions that high earners can take. That would limit the value of writeoffs of home mortgage interest and charitable deductions, but it wouldn't do away with those write-offs altogether. If you are in a higher than 28 percent tax bracket, you may want to front load big gifts, even if you send them into a family-controlled trust or donor advised fund and then dole them out later.

-- Be careful about borrowing for the next college year. Rates on federal student loans are set to double from 3.4 percent to 6.8 percent on July 1, but both Republicans and Democrats want to avoid that. Obama's budget solution would be to tie those loans to market rates. That's sly, because under current low rates, it would probably drop the cost of loans for borrowers. But as future market rates rose, it could result in more costly college borrowing. Obama wants rates to stay fixed for the life of the loan, but watch that space before signing up for big college loans going forward. A "fix" that involves variable rates could end up costing more in the long term.