A Look Ahead for Tax Planning:Expect the Unexpected
By: William Onorato, Senior Wealth Strategist
There is an old adage that says “expect the unexpected and the unexpected will not materialize.” With the 2020 presidential campaign in full swing and unprecedented turmoil in Washington, we thought this would be a good time to take a look at what might lie in store over the next few years from a planning perspective. As the Democratic field for president narrows, the candidates’ respective plans for tax policy are beginning to take shape. What we see is somewhat like a painting by Monet – very blurry close up but clear from a distance. While nothing in Washington is certain these days, the view of the Democratic candidates’ respective plans from a distance is quite clear that higher taxes are very likely if they are elected. Changes to income tax, corporate tax and estate tax policy as the candidates are proposing will require all aspects of planning to be reviewed, especially in the area of estate planning for high net worth clients.
Leading Democratic Candidates’ Proposed Plans (as of October 1, 2019)
According to the most recent poll by the New York Times, the top three Democratic presidential candidates are Elizabeth Warren, Joe Biden and Bernie Sanders. All three candidates have laid out their plans with respect to tax policy on their respective websites. A common theme of all three is to repeal the Tax Cuts and Job Act of 2017 (TCJA) and increase tax rates on higher earning families and businesses. No candidate is contemplating lowering taxes. The clear picture is that a Democratic president combined with a Democrat controlled House and Senate will likely bring significant changes to tax policy in 2021 (only 15 months away).
Table 1 below compares select aspects of each candidate’s plan with current law.
Joe Biden is the least aggressive of the three candidates based on what he has laid out so far, but he is largely silent on his plans for corporate tax and estate tax to date. Bernie Sanders is the most aggressive in all areas of taxation, setting for a top income tax rate of 70 percent and top estate tax rate of 77 percent. Elizabeth Warren’s plan calls for raising taxes in unconventional ways, such as a flat seven percent tax on corporate profits in excess of $100 million and increases in payroll tax rates. Again, the one common theme is that all are in favor of higher taxes to support their various other proposals.
Impact of Higher Taxes on Financial Planning
With the prospect of some income tax changes impacting households earning $250,000 or more of income, clients should review their financial plans with their advisors in 2020 to determine the impact of tax increases on their plans. An increase in income tax expenses will have a negative impact on retirement planning projections and could significantly change outcomes. In addition, increases in tax liabilities will also negatively impact household budgeting especially where budgets are tight due to college spending or other reasons. It may be wise for clients to make adjustments to spending and/or saving to lessen the impact of higher taxes on financial plans and keep them on target.
Impact of Higher Taxes on Estate Planning
Estate planning is an area that warrants close attention in coming years. Under current law, the estate tax exemption is $11.4 million, meaning that a married couple can pass on $22.8 million to their heirs free of estate tax. Bernie Sanders plans to lower exemptions to $3.5 million and increase estate tax rates to as high as 77 percent. Although silent on estate tax, Warren and Biden have expressed support for repealing the TCJA which would effectively restore estate tax exemptions to pre-2017 levels ($5.45 million plus inflation adjustments). Regardless of the 2020 election outcome, the TCJA mandates that the current exemptions and rates revert back to pre-2017 levels in 2026 if Congress does nothing. So if exemptions are reduced to as little as $3.5 million, a married couple would only be able to pass $7 million to heirs free of estate tax as opposed to $22.8 under current law. Such a significant reduction in the estate tax exemption would cause a wide range of potential issues.
One impact is that all formula driven allocations of an estate would have to be revisited to determine whether such allocations are still appropriate. The vast majority of estate plans contain formula provisions that tie a bequest to the amount of the estate tax exemption at the time of death. A reduction of the estate tax exemption to $3.5 million from $11.4 million would cause an $8 million swing in the amount of a bequest. That could result in a bequest being $8 million too much or $8 million too little depending on the desired outcome.
Another impact, and perhaps the most important impact, is that clients with a net worth significant enough to take advantage of the $11.4 million current estate tax exemption could potentially lose the ability to gift that amount. Again, a reduction of the estate tax exemption could occur as early as 2021 due to tax law changes brought about by a new administration or as late as 2026 due to the TCJA sun setting in 2026 without action by Congress. Clients who are in a position to make lifetime gifts should review their overall plans with their advisors. A plan to utilize the current exemptions should be developed and either executed right away or “put on the shelf” until tax law changes become more likely. The review should occur in early 2020 so as to avoid the mass rush we saw at the end of 2012 when exemptions were set to be reduced.
Let’s Get Prepared
Higher taxes will have far reaching impacts on clients’ lives. While there is certainly no need for panic at this time, we do think clients should start thinking about the various impacts higher taxes will have on their planning. Potential changes are not that far off, with the 2021 inauguration being only one year and around 100 days away. To that end, clients should talk with their advisors and review their planning over the next six months to make sure they are well positioned for potential changes, talk through what we can expect and prevent the unexpected from materializing.
Market & Economic Update
By: Nicholas A. Boyer, Chief Investment Officer/Executive Vice President
The Recession Story Is Getting Carried Away
If you pay attention to the news you wouldn’t know it, but we’ve just experienced another quarter of U.S. and global economic expansion, with only a modest slowdown in growth and very little structural change in underlying economic fundamentals.
Whether there is something broader at work is anyone’s guess, but there has been a lot of undue handwringing about recession that simply isn’t justified by the facts. As covered well by Zainab Sultan of the Columbia Journalism Review, we seem to have a real problem with some media and financial pundits who have been characterized as “weaponizing pretty benign economic data.” In fact, several notable pieces have been written recently, including one by the New York Times DealBook, exploring whether we are “talking ourselves into a recession.” 
What Is Really Happening?
The current news cycle remains laser focused on turmoil and downside economic and financial risks associated with U.S.-China trade relations, an inverted yield curve, negative interest rates, and the potential impeachment of the U.S. President. Yet for those interested in cutting through the noise and emotion, the data show the risk of an imminent U.S. recession remains low (see chart below). Meanwhile, despite bouts of substantial volatility, as measured by the CBOE Volatility Index or the VIX, equity volatility is down more than 40% year-to-date. Importantly, in 2019 U.S. equities have surged with year-to-date total returns for the S&P 500, Russell MidCap Index and Russell 2000 Index registering at 20.3%, 20.6% and 12.6% respectively. Additionally, U.S. bond markets have also produced extraordinary total returns year-to-date with Bloomberg U.S. Bond Aggregate Index and the Bloomberg Municipal Bond Index posting 8.2% and 7.0% respectively.
Cornerstone Macro. “We’re Not Worried About A Recession.” CSM Eco Outlook: U.S., October 8, 2019.
The U.S. economic expansion has reached a record 11 years in length – the longest in history – although as we’ve noted before, research by the Federal Reserve shows that economic expansions don’t simply die of old age. Currently, the U.S. economy continues to be driven by strong consumer spending, robust job growth, record low unemployment and wage growth that has outpaced inflation. While the manufacturing sector has come under some pressure, the U.S. economy has long been driven by the services sector, which remains quite healthy and firmly in expansion territory.
Globally, developed international economies have not kept up pace with the U.S. economic recovery since the Great Recession. The dysfunctional combinations of monetary and fiscal policies (notably in the Eurozone) have failed to drive more meaningful economic growth abroad, and have resulted in persistent geopolitical discord. More recently, the manufacturing slowdown has had a pronounced effect, specifically in Germany, where traditionally strong manufacturing output has historically bolstered growth in the Eurozone. At the same time, emerging market economies, despite strong absolute growth rates, have experienced substantial economic volatility due to global currency volatility and less favorable capital flows.
Still, to put it into perspective, 95% of the world’s economies are currently expanding. Meanwhile, the International Monetary Fund’s most recent World Economic Outlook still projects global growth of 3.2% in 2019 followed by 3.5% in 2020 – generally healthy rates and a far cry from a recession, which is traditionally characterized by negative growth rates. 
Yes, There Are Risks
As we’ve noted recently, nominal interest rates have been severely impacted by various forms of quantitative easing by central banks around the world. These monetary policies, combined with unfavorable global demographics (most of the developed world faces aging populations) have likely had an unprecedented impact on interest rates, having suppressed yields globally. Naturally, this has distorted global capital flows and bond markets, including specifically U.S. Treasuries. These trends may suggest that sovereign yield curves are becoming less a reflection of the economic health of a sovereign issuer, but rather being driven more by investor risk appetite (risk on / risk off decisions) in an era of cheap capital.
Meanwhile, there is no doubt the risks of excessive government debt have been well documented, and remain critical to monitor for the global economy. As we’ve noted, the Organization for Economic Co-operation and Development (OECD) statistics illustrate this growing problem, as the number of developed countries with a Debt-to-GDP ratio above 100% increased to 10 in 2017 from 3 in 2007 (this excludes China which is not an OECD member but registers well above 100% Debt-to-GDP). Yet, while this may become a significant problem longer term, today most sovereigns have not struggled to issue debt, while large new issuers may even enter the market for the first time this year as demand for sovereign debt remains healthy. Importantly, capital markets continue to function well, as the enormous amount of liquidity and credit available to businesses and consumers globally remains a strong support for the economy.
But There Is No Reason to Panic (It’s Never a Sound Strategy)
As Cornerstone Macro points out, “Yes, the Fed’s last tightening cycle helped slow growth, but limited economic excesses have cut the odds of a recession.” Indeed, it was the “financialization” of the economy that caused the last three recessions and outside of government imbalances, financial risks remain well contained relative to history.
So while we expect market volatility to increase as we head into a U.S. presidential election year, we want to remind investors to avoid the fear-based decision making that often proves harmful to longer term financial outcomes. As we’ve done consistently over the last few years, we will continue to keep a close eye on the facts rather than opinion, and will anchor our strategies to reality with data as our guide. Accordingly, we see no reason to make significant portfolio changes at this time, and encourage you to reach out with any questions or to discuss any of this in further detail.
1 Sultan, Zainab. “Recession Watch: Does Anyone Know What They’re Talking About?” Columbia Journalism Review, August 22, 2019
2 The New York Times DealBook. “DealBook Briefing: Could We Talk Ourselves Into Recession?” August 30, 2019
3 Cornerstone Macro. “We’re Not Worried About A Recession.” CSM Eco Outlook: U.S., October 8, 2019.
4 Bloomberg Market Monitor. October 12, 2019
5 Rudebusch, Glenn D. “Will the Economic Recovery Die of Old Age?,” FRBSF Economic Letter, Federal Reserve Bank of San Francisco, February 2016 (https://www.frbsf.org/economic-research/publications/economic-letter/2016/february/will-economic-recovery-die-of-old-age/)
6 Institute for Supply Management (ISM). September 2019 Non-Manufacturing ISM. “Report on Business.”
7 Goldman Sachs Asset Management. “Easy Does It.” Market and Economic Perspectives, October 2019.
8 International Monetary Fund. “Growth Projections.” World Economic Outlook. July 2019
9 Mester, Loretta J., Speech at The National Association for Business Economics/American Economics Association Meetings, “The U.S.
Economy and Monetary Policy,” January 3, 2016
10 Hong, Sungki and Shell, Hannah G., “Factors Behind the Decline in the U.S. Natural Rate of Interest.” Federal Reserve Bank of St. Louis,
Economic Research. April 19, 2019.
11 OECD National Account Statistics: National Accounts at a Glance, OECD Data, General Government Debt
12 Roy, Anup, “In a first, India to issue sovereign bonds in global market.” Business Standard. Budget 2019. July 5, 2019.
13 Bank of International Settlements. “Global Liquidity Indicators.” www.bis.org. September 22, 2019
14 International Monetary Fund. “Currency Composition of Official Foreign Exchange Reserves (COFER)”
(http://data.imf.org/?sk=E6A5F467-C14B-4AA8-9F6D-5A09EC4E62A4). September 30, 2019.
Schwab Trading Fee Compression
Effective October 7, 2019, Charles Schwab eliminated commissions for stock and ETF trading. Previously, the commission was $4.95. Please note, fixed income, transaction fee mutual funds and other select security trades continue to charge the current fees. The chart below summarizes the fee change for eligible trades. Contact your RKL Wealth Management advisor with any questions.
RKL Wealth Management Team News
We are pleased to announce the following promotions and role transitions for the following RKL Wealth Management team members.
- Semanchik Promoted to Portfolio Manager: Patrick Semanchik has been promoted to Portfolio Manager. In his new role, Pat works with clients to build customized investment portfolios.
- Kurtz Promoted to Wealth Advisor: Andrew Kurtz, CPA, has been promoted to Wealth Advisor. In his new role, Andy develops financial plans to help clients meet their needs.
- Palys and Dorsey Transition to New Roles: James Palys has transitioned into a Retirement Plan Analyst role, where he will conduct investment analysis and reporting for employer-sponsored retirement plans. Michelle Dorsey has transitioned into a Compliance Associate role, where she provides administrative and recordkeeping support to RKL WM’s compliance program.
In the season of giving, we invite you to join us for an evening of appetizers, drinks and mingling as our way of saying thank you for being our client. We hope to see you at one of our events!
Tuesday, November 12
RSVP date of November 1
Berkshire Country Club
1637 Bernville Road, Reading, PA 19601
Tuesday, November 26
RSVP date of November 15
Lancaster Country Club
1466 New Holland Pike Lancaster, PA 17601
Cocktail hour with heavy hors d’oeuvres begins at 5 p.m. Guest speaker begins at 6 p.m. Dessert to follow.
RSVP to Diane Loftus at 717.399.1637 or dloftus@RKLwealth.com.