Client Conference Call SummaryNovember 2013
Global Recovery, Rate Increases and Higher Taxes—What it All Means
On October 28, 2013, Fiduciary Trust held a client conference call offering answers to questions that have been top of mind for investors. The following is a summary of our call. You may listen to the replay here.
We Believe a Synchronized Global Recovery Is Underway
Despite uncertainties including the threat of default of the United States government, the US market is up over 23% this year and has now surpassed the peaks of 2000 and 2007 by about 17%. While minor corrections will likely take place along the way, we believe there is room for continued growth.
- Central banks across the globe are committed to increasing employment and generally getting their economies back on track after the financial recession that ended in early 2009.
- The Federal Reserve is continuing to buy massive amounts of Treasury and agency securities on a monthly basis as it has since late 2008, suppressing interest rates with the presumption that this will stimulate loan growth and business activity and help employment.
- Company earnings are growing at a rapid rate; analysts generally believe earnings will grow in the mid-teens year-over-year from 2013 to 2014, slow slightly in 2015 and then pick back up to double-digit growth rates in 2016.
- Europe is emerging from its shallow recession.
- China has been actively managing a slowdown to a sustainable growth rate.
- Japan's commitment to reflate its economy may be a tailwind to worldwide growth.
- Due to stronger earnings estimates, markets continue to appear inexpensive compared to historical levels.
Rate Increases Should Happen Slowly, Allowing Markets Time to Adjust
Rates have been extraordinarily low, with the 10-year Treasury bond dipping to about 1.6% last April and now rising to 2.6%. While this is a huge increase in percentage terms, this is still far from the 25-year average rate of 5.2%.
- We do not anticipate a dramatic near-term rise in rates. We expect the incoming Fed chairman to sustain the gradual transition and not allow a sharp spike in rates that would threaten recession.
- A 10-year Treasury rate of 4% could be quite possible by the end of 2014 or early 2015; moving gradually from the current 2.6% up toward 4% seems to be the reasonable trajectory.
We Do Not Believe Inflation Will Be a Driving Factor
Our view is that during this transition phase back to a normalized rate environment it will be the Fed's ability to effectively unwind its bond buying program and the demand for money throughout the economy that will drive interest rates higher—not inflation.
As opposed to the 1970s when inflation accelerated to a very high rate, today deflationary pressures around the globe challenge forecasts of near-term materially higher inflation. For example, prices of many key commodities and of labor are falling:
- Agricultural commodities show an average annual decline of .09% over ten years.
- Oil is 20.7% below the 2011 peak, and 39% off the prior high in 2008 just before the recession.
- Gasoline prices are just 8% above the ten-year average.
- Labor costs have hardly moved in ten years, rising 0.7% annually; as a major component of business costs, this slow rise is a strong headwind to rising inflation.1
Fed Tapering Should Not Cause a Significant Market Disruption
The way tapering is communicated will be critical. The Fed has already made one communication error last May resulting in a dramatic impact on the bond market. We doubt they will repeat this misstep.
- Given this backdrop and the strength of the economy, we do not expect the markets to react significantly when tapering begins.
- We expect tapering will be invoked gradually, and will most likely not begin until March next year or even later.
The New Medicare Tax Should Not Be Overlooked
New this year with the Affordable Healthcare Act of 2010 is the Medicare tax, affecting individuals with modified adjusted gross incomes over $200,000 and over $250,000 for married couples filing jointly.
- The Medicare tax imposes two different tiers of taxes: the first is an additional 3.8% tax on net investment income; the second is a 0.9% additional tax on earned income/wages.
- The maximum ordinary income tax rate has gone up from 35% to 39.6%, and including the Medicare tax, can be as high as 43.4% this year for some individuals—a 24% increase.
- The tax rate on long-term capital gains and qualified dividends has increased from 15% to 20%, and including the Medicare tax, can be as high as 23.8%—The 3.8% Medicare tax will also be applied to trusts with undistributed net investment income exceeding $11,950 in 2013.
Planning Strategies to Consider Now
Proactive planning will be very important this year, including preparing projections of estimated taxes and gaining an understanding of what one's liability is going to be.
- If possible, postpone income to 2014, including one-time occurrences such as bonuses or the sale of a business. Even in very low interest rate and low inflation environments, the time value of money means a dollar saved today is worth more than a dollar saved in the future.
- Accelerate any deductions into the current tax year, including moving any charitable contributions into 2013.
- Use capital loss carryovers against current year capital gains.
- Harvest capital losses in a portfolio in the current year.
- Individuals age 70 ½ or older should consider transferring up to $100,000 of their IRA distribution directly to a charitable organization, which could benefit individuals subject to itemized deduction phase-outs and taxpayers living in certain states that do not allow a charitable contribution deduction.
- Same-sex married couples must now file returns as married filing jointly or married filing separately. These individuals should also also look to see if amending prior returns may benefit them.
- Since the Medicare tax will be applied to trusts and estates with greater than $11,950 in undistributed income in 2013, trustees and executors should consider distributing that income to beneficiaries who might be in lower tax brackets.
TRUST AND ESTATE STRATEGIES
Complacency Is the Greatest Risk
Given today's relatively high $5.25 million gift and estate tax exemption ($10.5 million for married couples), people may feel complacent and fail to continue to proactively plan. It is important to remember that circumstances often change over time and estates can grow.
- Individuals should consider taking advantage of their $14,000 annual tax-free gift allowance this year and every year. This helps to remove assets as well as the future appreciation on those assets out of their estates.
- Similarly, individuals should consider paying for others' medical and educational expenses. These payments are not subject to gift tax and do not count against the exemption.
- Charitable strategies have become very important estate planning tools and can be beneficial as part of an estate plan given today's higher tax landscape. Structures such as Charitable Lead Trusts or Charitable Remainder Trusts can help provide both income tax benefits and estate tax benefits to charitably-inclined individuals.
- For estates that exceed the $5.25 million ($10.5 million for couples) exemption threshold, we continue to recommend traditional estate planning strategies such as Grantor Retained Annuity Trusts to move asset appreciation out of the estate.
State Estate Taxes Can Be Costly
Today there are 19 states plus the District of Columbia that impose an estate tax on top of the Federal estate tax, with some of those rates as high as 20%.
- Even though the Federal estate tax exemption is $5.25 million per person, the exemption at the state level can be much lower. For example, New York exempts only $1 million from state estate tax and New Jersey exempts only the first $675,000.
- Lifetime gifting is an important strategy for lowering an overall tax bill as many states with estate tax do not impose gift taxes, and assets given during one's lifetime will not be subject to state level tax.
This communication is intended solely to provide general information. The information and opinions stated are as of October 28, and may change without notice. The information and opinions do not represent a complete analysis of every material fact. Statements of fact have been obtained from sources deemed reliable, but no representation is made as to their completeness or accuracy. The opinions expressed are not intended as individual investment, tax or estate planning advice or as a recommendation of any particular security, strategy or investment product. Please consult your personal advisor to determine whether this information may be appropriate for you. This information is provided solely for insight into our general management philosophy and process. Historical performance does not guarantee future results and results may differ over future time periods. IRS Circular 230 Notice: Pursuant to relevant U.S. Treasury regulations, we inform you that any tax advice contained in this communication is not intended or written to be used, and cannot be used, for the purpose of (i) avoiding penalties under the Internal Revenue Code or (ii) promoting, marketing or recommending to another party any transaction or matter addressed herein.
President and Chief Executive Officer
Vice Chairman and General Trust Counsel
Vice Chairman and Chief Investment Officer
Director of Tax Services
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