* Some higher-income earners may seek to defer income
* Greater clarity seen encouraging investing in equities
* Markets volatility remains concern as debt battles loom
* Advisers say some clients may have to curb spending
By Jennifer Hoyt Cummings and Jessica Toonkel
Jan 4 With the fiscal cliff avoided and U.S. tax
rates rising for higher income households, financial advisers
have gone into overdrive to help their clients mitigate the
negative effects while trying to benefit from the greater
That means in some cases finding ways to defer income and in
others, working on ways to curb spending. It can also mean being
more aggressive about investing in equities rather than bonds or
While people at many income levels are going to face higher
taxes because a payroll tax cut that was brought in to stimulate
the economy has been allowed to expire, it is individuals
earning more than $400,000 of taxable income a year, or $450,000
for households, who are going to face the biggest increased
burden. Those are thresholds where the personal income tax rate
rises to 39.6 percent from 35 percent, and where the capital
gains tax goes to 20 percent from 15 percent.
Households earning between $500,000 and $1 million would see
an average annual tax increase of $14,812, according to the
nonpartisan Tax Policy Center. That includes an income tax rate
increase, the end of the payroll tax reduction, and a 3.8
percent tax on investment income for couples earning $250,000 or
more - a surcharge resulting from President Barack Obama's
health care reform law.
While these people may be very well-off by any standard, it
doesn't mean that some aren't overstretching their budgets. Many
are likely to have bigger mortgages and outsized expenses like
private school tuition or multiple homes.
For those living beyond their means or close to it, such a
tax rise could force them to cut spending by selling a holiday
home or a yacht or curb dining out at expensive restaurants.
Azim Nakhooda, chief executive of Cleveland-based Cedar
Brook Financial Partners LLC, said he will be telling many of
his high-earning clients, they have to reprioritize.
"For every dollar you had coming in, you now have 95 cents,"
said Nakhooda, whose firm manages $1.6 billion in assets. "How
do you want to divvy that up?"
Alan Haft, a financial adviser with California-based Kings
Point Capital LLC, has been fielding concerns from a
semi-retired client with $2 million invested, who was worried
about the impact of the changes on his and his wife's income.
To feel comfortable, they may need to trim spending, alter
investments or, in the worst case, sell one of two properties
they own on Nantucket island in Massachusetts, Haft said.
Some wealth advisers like Michael Conway, a New Jersey-based
adviser with Summit Financial Resources are recommending that
clients on the cusp of the higher tax rates try to defer income
into future years in case there are adjustments that might
benefit them tax-wise later.
There is a potential downside to such a strategy. Given the
United States has massive budget deficit and debt problems, it
is unlikely that personal income taxes will go down anytime soon
- they are, if anything more likely to rise further.
PUT OFF TO TOMORROW
Still, the capital gains hike could spark more interest in
deferral strategies, such as like-kind real estate exchanges, a
method that allows an investor to defer gains on the sale of a
property by purchasing a similar property in a certain amount of
time, said Matt Hilbert, senior tax manager at Pitcairn, a
family office in Jenkintown, Pennsylvania that caters to clients
with $25 million or more to invest.
Some insurance products, such as private placement
insurance, can also be used to defer gains for high-net worth
clients, Hilbert said. The policies are a type of variable life
insurance whose cash value is tied to how investments in the
policy perform - with any gains not taxable because they are not
a straightforward investment.
Those products are far from being for everyone. Purchasers
must meet hefty thresholds for assets including income and
investments. Premiums can start at $1 million for a $10 million
policy and the policy holder gives up liquidity and control over
Tax-deferring moves may be especially appealing to wealthy,
elderly clients. Deferring capital gains often helps heirs since
the gain is calculated based on market value when the grantor
dies, not when it was acquired. Beneficiaries can then sell the
asset at little to no gain.
The need to minimize potential estate taxes is no longer as
pressing for many families, since the exemption on the tax for
estates remains at just over $5 million.
PREPARING FOR VOLATILITY
Financial advisers say this week's tax deal doesn't mean
they are only suggesting defensive strategies - as it has also
created some opportunities for more aggressive investing. It has
removed an immediate uncertainty from the financial markets as
shown by the rally in equities. At the same time, the U.S.
Treasury debt market has been weakening.
In the final months of last year, Robert Fross, co-owner of
Fross & Fross Wealth Management in The Villages, Florida, had
several clients insist on moving all of their investments into
cash for fear that lawmakers' inability to come to a budget deal
would cause a "financial Armageddon." The firm manages $350
million in client assets, mostly for retirees.
Fross said he had no trouble Wednesday coaxing those clients
back into equities. But, he and other advisers say they're
cautioning clients to expect volatility - including big market
swings during what are likely to be contentious debates in
Congress over spending cuts and the debt limit.
The last time the debt ceiling was debated, in the summer of
2011, the Dow Jones industrial average saw several days in a row
of 400-plus point swings.
"I am telling (clients) it's still going to be very volatile
given the uncertainty around the debt ceiling," said Michael
Pomerantz, president of Pomerantz Financial Associates, a Cherry
Hill, New Jersey-based financial adviser with $80 million in
assets under management. His clients now investing in the
markets, do so over a period of time rather than all at once, to
protect against market swings.
Municipal bonds, which retained their tax-exempt status
during the fiscal showdown, are also something advisers and
strategists are recommending. Alan Dalewitz, a senior vice
president with Herbert J. Sims & Co, a Connecticut-based firm
focused on fixed income, said munis are one of his favorite
investments for clients right now, both because of their tax
status and because their valuations are attractive. But he is
also cautious - the tax exempt status may not make it through
upcoming budget negotiations, he noted.