I know from past year end debt ceiling debates that there are two things you are better off not watching in the making: sausages and economic estimates. With all the political pork barrel wrangling going on about how to reach a deal on the fiscal cliff and taxmageddon, it may be a great time to revisit what many investors are doing right now and do the opposite: not take capital gains on existing stocks, bonds, and mutual funds.Investors many want to look at the merits of tax deferral regardless of what goes over the cliff in Santa’s bag of tricks. Age old wisdom, which may have contributed to driving the market down 6% after the election is comparable to in the proverbial words of musician, Steve Miller, “go on and take the money and run”.
On January 1, unless Congress and the White House strike a deal, the tax rate on capital gains will jump to a top rate of 20% or a 33% gain. Imagine posing the question to clients “Now on this XYZ mutual fund, if we are able to gain 33% over the life of this investment we will have the enviable position of breaking even” This is certainly a challenging proposition in view of the chaos in the Middle East, D.C. and the markets performance for the last 12 years. Now, committee hearings in Washington are taking place about eliminating the current defined contribution structure in American retirement plans.
The consideration of taking the tax plunge this year to avoid a bigger one in the future may make sense for people who are day traders or with short horizons. For most investors, however, paying higher taxes later beats paying lower taxes now: the longer you can keep the government out of your pocket, the more wealth you should be able to build as the chart below demonstrates clearly. The decision to hang on may expose an investor to the risk of paying taxes at an ever higher rate down the road but it means that 100 cents of each dollar continues to rise like an annuity and earn potential triple tax deferred interest that compounds on principal, earnings and payouts . As an example, if you are able to earn at least 8% annually and the capital gains rate does not rise above the 23.8% ,as it will be at next year for joint couple making $250,000, if your time horizon is 5 years, hang on Sloopy.. Sloopy hang on! Even though, well- conceived Financial Plans should never be conceived on the basis of selling because of tax fears alone, the value of tax deferred interest and the power of an income that can’t be outlived and can be deferred and taken at will has never be so powerful. As Nuveen so eloquently has put if for many years, it’s not what you earn that counts, it’s that you keep that counts!
So as we go through the Holiday season to the brink of the Fiscal Cliff, congressional gridlock and considering whether to create an income that we can’t outlive by selling Apple remember the difference between Santa Clause, the tooth fairy, drunk and highly esteemed lawmakers. Three of the four are mythical creatures. Finding a retirement savior like a private pension is not mythical.