February 17, 2012 / 8:41 PM / in 6 years

Four ways to prepare for mega financial woes

NEW YORK (Reuters) - Peter Orszag, former budget director for the Obama Administration and now vice chairman of global banking for Citigroup, sees a “trifecta” of mega financial woes coming toward the end of the year that are unlikely to be tackled by Congress before election day.

Speaking at the Executives’ Club of Chicago on Wednesday, Orszag said he sees this moment as a collision between dysfunctional national politics and the ongoing economic malaise. It is “a rare moment in economic history -- a tectonic plate shift,” he says.

I prefer to call what he identifies as the trifecta as a triple-strength witch’s brew: The expiration of Bush-era income and estate-tax cuts and $1.2 trillion in automatic budget cuts triggered by the debt-limit compromise passed last year.

If the Bush-era tax cuts expire -- a move endorsed by the proposed White House 2013 budget proposal -- then millions may find themselves in higher tax brackets. Estate taxes would also revert from a $5 million exemption and 35-percent rate to 55 percent with a $1 million exemption.

There’s more bad news if Congress remains at loggerheads: The $1.2 trillion in triggered cuts would impact everyone from the Pentagon to Medicare recipients, although specific program parings haven’t been identified. It may put the brakes on a U.S. economy still lumbering along in recovery mode.

Orszag estimates that the budget cuts and tax increases could clip up to 4 percent from gross domestic product. By my back-of-the-napkin math, that potentially triggers another recession.

What will Congress do to avoid this caldron?

Orszag, who once had a seat among the inner circle of White House policy planners, says Congress may choose the “fall over the cliff” strategy and not do anything during the lame-duck period between election day and when the new Congress is seated in 2013.

Despite the recent compromise reached in extending the payroll-tax cut and jobless benefits, Congress is expected to do little else of substance for most of the year.

Orszag says congressional action is stymied by “hyperpolarization” -- where there is political center in which to forge compromises on major tax, social program and spending issues. In the interim, Americans are left wondering how to plan for their financial future, a mass uncertainty that is contributing to the dismal poll ratings for Congress these days.

As you prepare your 2011 taxes, it’s an excellent time to talk to your advisers to see what you can do to avoid huge surprises 10 months from now. Here are four ways to prepare:

* Talk to your financial, tax and estate planners about several scenarios. What will you need to do if the tax cuts expire? Will you need to start rounding up more deductions for 2013? What about your estate plan? There are a number of strategies involving trusts, gifting and life insurance that can reduce its taxable value.

* Review your European exposure. Orszag’s biggest concern about the European sovereign debt crisis is a “contagion” to U.S. stocks. Are you exposed to some of the largest lenders to the most imperiled countries like Greece, Italy, Portugal, Ireland and Spain? If so, how can you reduce your stake in these countries?

* Where’s your volatility insurance? Every portfolio needs it these days. You can hedge large stock-market risks with bonds, inverse exchange-traded funds or put options. Work with a fiduciary adviser to run a fine-tooth comb through your portfolio.

* Keep on saving. If Medicare or Social Security cuts surface, you can be prepared for them by boosting contributions to your retirement accounts or other savings. Enroll in automatic savings plans through your employer, if you haven’t done so.

At the very least, educate yourself about worst-case scenarios and decide what you need to do. An investment policy statement outlining goals, risk and portfolio allocation is a good start. That way, when Washington’s toil and trouble starts bubbling again, you’ll be prepared.

Editing by Beth Pinkser Gladstone and Andrea Evans

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