By now I am sure you have heard the compromise President Obama made with the Republicans in order to correct some looming year-end tax issues. Part of this legislation has been expected for years, ever since the Bush JGTRRA and EGTRRA made some long-term term but not permanent tax reductions in several key areas.
The Bush legislation had lowered the income tax rate on corporate dividends, capital gains, income, and established new Federal estate tax exemptions increasing from the one million dollar level to $3.5 million, and then no estate taxes in 2010. However, on January 1, 2011, without action by Congress, the estate tax was to return with only a million dollar exemption and tax rates above 50 percent. Attorneys and financial planners had long expected the estate tax issues to be addressed before this compromise. Now that this legislation has been signed, do not expect the changes in estate taxes to be over.
The estate tax has long been treated like a ping pong game. When one party makes a change, it is not too far into the future when the other political party attempts to reverse the effects of the last change. In my opinion, those over the age of 70 may want to take very conservative steps with their estate planning. To expect the new $5 million per person exemption to stay in place for the next ten to thirty years may be wishing for too much. The same may be said of the new 35 percent tax bracket. Congress still has to deal with excessive debt levels and who better to have their taxes increased but those who can no longer vote! Thus, it may be four, six, ten years or longer, but Congress may once again look at estate taxes as a source of additional revenue. Those who have a net worth above $5 million may want to make planning decisions based upon a $3.5 million exemption per person and a tax rate of 40 percent. If the new levels remain intact till the time of your death, using more conservative figures will in most cases ensure a greater amount of wealth will be transferred to the heir. Failing to anticipate a change in future estate tax rates could prevent proper planning to take place due to age, time, or health, and result in more taxes being paid than necessary.
Those not too worried about estate taxes should be pleased to hear of the one year reduction in the Social Security tax. Presently, 6.2 percent of each taxable dollar on a paycheck is withheld and sent to the Social Security Administration. This tax is on every dollar earned up to $106,800 in a calendar year. For 2011, this tax rate will drop to 4.2 percent. This will be a great opportunity shore up retirement plans or reduce additional debt. Those making $40,000 per year, will have an extra $800 of take-home pay, or $33 per pay check.
For a 35 year old, an extra $800 into their retirement plan next year could represent an extra $7,453 in the plan's value at age 65, based upon an eight percent average return. The $800 could also be used to pay off the last of a credit card balance, thus making the card's minimum payment available for other uses.
If you are not careful, you may view the lower Social Security tax as an increase in pay and increase your spending accordingly. Clearly, the Government wants these dollars to find their way into the economy and positively impact the recovery, but those who live paycheck-to-paycheck may be surprised when the increase goes away in 2012. While the net check will increase, it is temporary and should be used to meet short-term goals rather than long-term obligations or fixed living expenses.
For assistance with portfolio allocations, insurance, estate planning, or investment management contact me at Quality Financial Concepts or one of the other Certified Financial Planners in our area. To continue a personal quest for education, you can also view our learning center on our website, www.goqfc.com. There you will find articles on a variety of topics, on-line seminars, calculators, as well as a host of other free tools.