A look at some financial changes & the opportunities they may present.

Every year brings some financial change, so here are some relevant changes relating to investment, tax and estate planning for 2012.

Retirement plans. 401(k), 403(b) and 457 plan annual contribution limits rise slightly to $17,000, and you can contribute an additional $5,500 to these accounts if you are 50 or older this year. IRA contribution levels are unchanged from 2011: the ceiling is $5,000, $6,000 if you will be 50 or older.¹

As you strive to contribute as much as you comfortably can to these accounts this year, you will probably notice some changes with the retirement plan at your workplace. In 2012, retirement plan sponsors (i.e., employers) will have to note all of the fees and expenses linked to the funds in the plan to plan participants. So if you have a 401(k) or 403(b), you may notice some differences in the disclosures on your statements and you will probably notice more information coming your way about fees. There is also a push in Washington, D.C. to have financial companies provide lifetime income illustrations on retirement plan account statements, projections of your expected monthly benefit at retirement age.²

Income taxes. Wealthy Americans are set to face greater income tax burdens in 2013, so 2012 may be the last year to take advantage of certain factors. For example, the top tax bracket in 2013 is slated to be at 39.6% instead of the current 35%. This year, capital gains and dividends will be taxed at 15% or less for everyone, 0% for those in the 10% and 15% tax brackets. In 2013, the qualified capital gains tax rate is scheduled to rise to 20% and qualified dividends will be taxed as ordinary income. So taking a little more income in 2012 could be smart.³

In 2013, the wealthiest Americans are supposed to be hit with new Medicare taxes: a new 3.8% levy on unearned income (such as capital gains, income from real estate, dividends and interest) and a new 0.9% tax or earned income. So next year, the truly wealthy could effectively face in the neighborhood of 45% federal taxes.³

Additionally, the IRS is planning to limit itemized deductions for upper-income taxpayers in 2013. A phase-out will also apply for the personal exemption deduction.³

Estate & gift taxes. At the end of 2012, some very nice estate tax breaks could sunset. Barring action by Congress, 2013 could see a 20% leap in the federal estate tax rate from 35% to 55%. The individual estate tax exclusion (currently $5.12 million) is scheduled to be reduced to $1 million.³

As we have unified gift and estate tax rates, those numbers and percentages also apply to gift taxes. That is, from 2012 to 2013 top federal gift tax rate is set to go from 35% to 55% and the lifetime gift tax exemption amount is scheduled to fall $4,120,000 per individual to $1 million. The annual gift tax exemption is $13,000 per recipient in 2012; there is an exemption limit for qualifying educational and medical payments. If you want to gift relatives or friends, you may want to avoid procrastinating for another very good reason: when you make such a gift early in a year, the recipient will gain both the principal and any appreciation tied to the gifted asset in that year.^3,4

Speaking of gifts, we said goodbye to charitable IRA gifts in 2011. The IRA charitable rollover, a boon to non-profits and a handy tax deduction option for taxpayers older than age 70½, was not extended into 2012, not even temporarily as a sweetener to the payroll tax extension bill. There is hope it will be back. Two bills have been introduced in Congress with that goal, one sponsored by Sen. Olympia Snowe (R-ME) and Sen. Charles Schumer (D-NY) and another by Rep. Wally Herger (R-CA) and Rep. Earl Blumenauer (D-OR). The proposed legislation would let IRA owners start making charitable IRA gifts at age 59½ and remove the $100,000 limit on the rollovers.⁵

The limits on the generation-skipping transfer tax could change, too: assuming the Bush-era tax cuts do sunset, the GSTT rate would jump from 35% this year to 55% in 2013, with the GSTT exemption falling from $5,120,000 per person this year to roughly $1.3 million per person next year.³

So given all these changes, it might be wise to meet with the financial professional you know and trust early in 2012 as you strive to start the year off on the right foot. You have until April 17 to file your federal return, but you can plan now.

Citations:

1. www.irs.gov/retirement/article/0,,id=96461,00.html [10/20/11]
2. www.marketwatch.com/story/retirement-plan-changes-coming-in-2012-2011-12-29 [12/29/11]       
3. www.sbnonline.com/2012/01/how-to-approach-tax-and-estate-planning-opportunities-for-2012/?full=1 [1/3/12]
4. www.advisorone.com/2012/01/06/10-tax-tips-for-advisors-in-2012 [1/6/12]
5. www.northjersey.com/news/business/business_opinion/136217658_Payroll_tax_cut_benefits_charities.html [12/25/11]

This post is actually an article written by Epic Capital’s Managing Director, Edward Doughty, CFP® that was featured in the Charlotte Business Journal’s December 5th 2011 issue.  Here is the article as it appeared, and in it’s entirety:

The Congressional Joint Select Committee on Deficit Reduction (the Super Committee) failed at its task of finding $1.2 trillion in debt savings over the next 10.  Now, the process known as sequestration, which triggers automatic spending cuts, is slated to kick in January 1, 2013. The cuts must be split evenly between defense and other programs, and raising taxes is not imposed by the process.   And with next year’s elections, the stage is set for more legislative inaction. 

Regardless of the 2012 election results, if Congress fails to pass legislation and the Bush tax-cuts expire, taxes will increase across the board in 2013.  So with just over one calendar year before the tax cuts are slated to expire, some observers believe this is one of the best environments for estate planning in a generation.  Others make the case that there are too many unknowns to make estate decisions that are irreversible.  Here are some facts to consider before you decide.

Last December, the Middle Class Tax Relief Act reinstated the estate tax after it had lapsed.  The estate tax exemption (the amount in an estate that is not be subject to estate tax) was raised to $5 million per person and $10 million for married couples.  The exemption was further expanded further by making it portable.  In other words, what the first spouse doesn’t utilize upon his or her death of the $10 million, the surviving spouse can utilize (although one must file an estate tax return within nine months of the first spouse’s death to do this).  A tax rate of 35% would then be applied to assets over that limit. 

If gifting assets to one’s children, grandchildren or a charity of choice is a priority, then the Middle Class Tax Relief Act could serve as a short-lived charitable gift from Congress and a great way to help reduce the tax liability on an estate.  Here’s why:  In addition to estate-tax exemption, Congress unified the new estate-tax laws with a more generous gift-tax law.  Individuals can gift up to $5 million during their lifetime, or at death, and do so on a tax free basis.   For example, an individual who uses $3 million for gift tax exemptions while living, will at death have $2 million remaining for an estate tax exemption.

These generous exemption levels and the idea of portability last for the remainder of this year and for calendar-year 2012.  As the law stands, once we turn the calendar into 2013, we revert back to $1 million exemptions and the estate tax rate would jump back up to 55%. 

Another estate-planning opportunity resides in low, current interest rates that are close to 0%.  Parents can make structured loans to their children or fund a trust at a low cost.  One example is a grantor-retained annuity trust.  This allows for appreciation on assets that are placed into the trust (above a pre-determined rate) to pass onto the beneficiaries without being subject to estate or gift taxes.  That pre-determined rate right now is 1.4%, not a high hurdle.  One should seek the counsel of an estate-planning attorney for the intricacies that are involved with such a trust.  Today’s low interest rates can play a key role in certain tax-minimization strategies. 

Business owners may also find the current laws very favorable for passing their interest in a business into the hands of the next generation of family ownership.  This is especially true if that business owner is married and the couple can jointly use the $10 million lifetime-gifting exemption.  For a business valued in excess of that amount, the couple could sell remaining shares using intra-family loans, again at very favorable interest rates.  The current IRS interest rate on an intra-family loan of less than three years is 0.19%.  For a longer loan, such as nine years, the current rate is 2.67%.  It doesn’t take a financial guru to realize that those are some attractive rates for loans.

As mentioned earlier, federal spending cuts are scheduled to take place in 2013, but there’s talk of some cuts coming earlier.  On the chopping block are the current exemption levels affecting estate and gift taxes.  So it is actually uncertain whether the current exemptions will remain intact though 2012.  Proper planning is more difficult because of the wide range of possible changes being tossed around.

At one end of the spectrum is a total repeal of current limits, reducing the estate- and gift-tax thresholds back to 2009 levels.  They are a $3.5 million exemption for estates, and a $1 million lifetime exemption for gifting.  At the other extreme is the possibility of a return to the original $1 million estate-tax exemption with an estate-tax rate of 55%, coupled with a restriction or repeal of many favored estate planning techniques.  That could affect techniques such as the grantor-retained annuity trust and the discounts for family transfers.

Despite the uncertainty, estate-planning efforts should be aimed at accomplishing your own personal goals, not solely on the basis of saving taxes.  Gifting money to children or a charitable cause, or keeping a business in the family should be the underlying reasons for any planning.  But it may prove wise to begin putting some planning strategies in place to get things started.   This could allow for additional flexibility going forward and a rapid expedition of a strategy, if needed, based on future legislation.  

1. Deferring income to 2012 means postponing taxes

Consider opportunities you might have to defer income to 2012. You might be able to delay a year-end bonus, for example. If you’re able to push what would have been 2011 income into 2012, you may be able to put off paying income tax on the deferred dollars until next year.

2. Paying deductible expenses sooner may help you in 2011

Does it make sense for you to accelerate deductions into 2011? If you itemize deductions, it might help your 2011 bottom line to pay deductible expenses like medical costs, qualifying interest, and state and local taxes before the end of the year, instead of waiting until 2012.

3. Income tax rates to remain the same in 2012

The same six federal income tax rates that apply in 2011 will apply in 2012. So, depending upon your income, you’ll fall into either the 10%, 15%, 25%, 28%, 33%, or 35% rate bracket. And, as in 2011, long-term capital gains and qualifying dividends will continue to be taxed at a maximum rate of 15% in 2012; and if you’re in the 10% or 15% tax rate brackets, a special 0% tax rate will generally continue to apply.

4. Is AMT a factor?

If you’re subject to the alternative minimum tax (AMT), special rules apply. For example, the AMT rules can effectively disallow a number of itemized deductions, making it a potentially significant consideration when it comes to year-end planning. You’re more likely to be subject to AMT if you claim a large number of personal exemptions, deductible medical expenses, state and local taxes, and miscellaneous itemized deductions. If you’ve been subject to the AMT in the past, or think that you might be for 2011, you’ll want to make sure that you understand how the AMT rules might affect you.

5. IRA and retirement plan contributions

Employer-sponsored retirement plans like 401(k) plans and traditional IRAs (if you qualify to make deductible contributions) present an opportunity to contribute funds on a pre-tax basis, reducing your 2011 taxable income. Contributions that you make to a Roth IRA (assuming you meet the income requirements) aren’t deductible, so there’s no tax benefit for 2011–they’re still worth considering, though, because qualified distributions are free from federal income tax. The window to make 2011 contributions to your employer plan closes at the end of the year, but you can generally make 2011 contributions to your IRA up to April 17, 2012.

6. Special distribution requirements at age 70½

Once you reach age 70½, you’re generally required to start taking required minimum distributions (RMDs) from any traditional IRAs or employer-sponsored retirement plans you own. It’s important to make withdrawals by the date required–the end of the year for most individuals. The penalty is steep for failing to do so: 50% of the amount that should have been distributed. Barring additional legislation, 2011 will be the last year to take advantage of a popular provision allowing individuals age 70½ or older to make qualified charitable distributions of up to $100,000 from an IRA directly to a qualified charity (these charitable distributions are excluded from your income, and count toward satisfying any RMDs that you would otherwise have to take from your IRA for 2011).

7. Depreciation and expense limits to drop for business owners and the self-employed

If you’re a small business owner or a self-employed individual, you’re allowed a first-year depreciation deduction of 100% of the cost of qualifying property acquired and placed in service during 2011; this “bonus” first-year additional depreciation deduction will drop to 50% for property acquired and placed in service during 2012. For 2011, the maximum amount that can be expensed under IRC Section 179 is $500,000, but in 2012 the limit will drop to $139,000.

8. Last chance to deduct energy-efficient home improvements

This is the last year you’ll be able to claim a credit for energy-efficient improvements you make to your home (up to 10% of the cost of qualifying property). Improvements can include a qualifying roof, windows, skylights, exterior doors, and insulation materials. Specific credit amounts may also be available for the purchase of energy-efficient furnaces and hot water boilers. However, there’s a lifetime credit cap of $500 ($200 for windows). So, if you’ve claimed the credit in the past–in one or more years since 2005–you’re only entitled to the difference between the current cap and the amount you’ve claimed in the past.

9. Other expiring provisions

Barring additional legislation, this is the last year that you’ll be able to elect to deduct state and local general sales tax in lieu of state and local income tax, if you itemize deductions. This also will be the last year for both the above-the-line deduction for qualified higher education expenses, and the above-the-line deduction for up to $250 of out-of-pocket classroom expenses paid by education professionals.

10. Get help

Making effective year-end moves requires a solid understanding of the rules that are in effect for both 2011 and 2012. It also requires a comprehensive grasp of your overall financial situation. A financial professional can help you evaluate potential opportunities, and can keep you apprised of any last-minute legislative changes.

The European summit on October 26, the fourteenth in 21 months, finally produced a deal in a late-night negotiating session. European leaders announced a deal that was close to what had been carefully leaked over the prior weeks of deliberations and had helped the S&P 500 Index to rally off of the lows of the year. From the closing low on October 3, the Index has climbed nearly 17% in just three and a half weeks and is on pace for the largest monthly gain since 1987.

Overall, the statement confirms the view that the risk of a 2008-like financial crisis erupting in Europe, which has been the focus of global markets in recent months, has been taken off the table. However, over the long term, concerns remain about the outlook for economic growth in Europe and the ability of some peripheral countries to meet budget targets. While the statement does not clarify all the details, it does lay out the three most important aspects of the rescue package:

Reducing Greece’s debt. The package cuts Greece’s debt burden with a 50% “haircut” on Greek bonds. Private investors, including banks, will swap their Greek bonds for those with half the face value, but higher quality given an additional 30 billion euro cushion provided against further losses. 

A bigger buffer against bank losses. Overall, European banks will be required to raise 106 billion euros to temporarily maintain a higher buffer against additional losses on their bond holdings. Banks will be given the opportunity to raise this capital on their own and plug any gaps with funding from their own government and the ability to tap the European Financial Stability Facility (EFSF) as a last resort.

Insurance against loss on European government bonds. The EFSF will provide guarantees against the first 20-25% of losses on about one trillion euros of European government debt.

The concerns may be shifting from a crisis to a recession in Europe, as it is likely that Europe will experience a mild recession next year. However, European growth could be even weaker in light of the spending austerity and potential for less lending by the banks. The next step in a successful plan to stabilize Europe is for the European Central Bank to cut interest rates soon and reverse the two rate hikes they made earlier this year to promote growth and lending.

While the devil of the European plan remains in the details, the deal could shift investor focus to U.S. markets where economic growth and corporate profits continue to chug along. Third-quarter economic growth, as measured by gross domestic product (GDP), was recently reported at 2.5%, nearly double the pace of growth witnessed in the first two quarters of the year combined. Within the S&P 500, 75% of the companies that have reported third-quarter earnings thus far have exceeded expectations and the companies, in aggregate, are tracking to 15% year-over-year earnings growth, surpassing the 12-13% growth rate that was forecast. Given the current backdrop, we adhere to our forecast of a moderate upside from current levels for the S&P 500 Index in 2011, though we expect the market to remain volatile between now and year-end.

To that we say, just when you think all is lost, it is often not.  Keep the plan the plan, and don’t let emotions derail your wiser efforts.

Ever since the possibility of default on Greek sovereign debt has become headline news, a lot of people have found themselves wondering, “How is it possible for the financial problems of a country so small and so far away to create such turmoil in the world’s markets?” What’s happening in Europe is probably affecting your portfolio right now, regardless of the quality of your holdings or how well diversified you are.

Just what is all the shouting about? It’s no secret that the so-called PIIGS nations (Portugal, Italy, Ireland, Greece, and Spain) are having difficulty coping with the debt that years of deficit spending have created. A robust global economy helped to mask the problem, but in recent years the burden of sovereign debt–bonds issued by sovereign governments–has become increasingly unsustainable. With debt at roughly 140% of its gross domestic product,* Greece is particularly troubled. Imposing austerity measures required by its European colleagues has added to the country’s recessionary woes. That in turn has made it even more difficult to achieve mandated deficit reduction targets in order to qualify for additional installments of financial aid from the European Financial Stability Facility (EFSF) set up last year by 17 eurozone countries.

Bank exposure

One of the chief concerns about the possibility of default on sovereign debt has to do with the financial stability of banks that hold it. Some of the largest French banks have already suffered downgrades of their credit ratings because of their extensive holdings of debt from troubled European countries, particularly Greece. If a Greek default made banks reluctant to lend to one another, that could affect credit markets worldwide.

American banks hold very little Greek debt compared to European banks; however, they could face a different challenge. Understanding why requires some basic awareness of a type of derivative known as a credit default swap. Investors with large bond holdings from a particular borrower often try to protect themselves against the possibility that the borrower will default by buying a credit default swap on that debt as a type of insurance. The company that issues the credit default swap agrees to cover the bondholder’s losses in case of default. The more risky the issuer–for example, Greece–the more likely bondholders are to try to protect themselves with swaps. However, in some cases, a company may have issued so many default swaps on a particular issuer that it could be overwhelmed by the claims resulting from the issuer’s default.

Such derivatives can create a ripple effect in financial markets. If the company that issued the swaps can’t make good on them, the institutions that relied on that protection also can find themselves in trouble, which multiplies the impact of a major default. U.S. financial institutions are major issuers of credit default swaps, and the potential impact of a Greek default on them is unclear. However, since the 2008 financial crisis, U.S. banks have been forced to hold greater capital reserves to deal with contingencies, and Treasury Secretary Timothy Geithner recently said that banks here have reduced their exposure to the debt of troubled countries.

Potential for tighter credit leading to recession

Lending worldwide hasn’t fully recovered from the last financial crisis, and has helped keep global economic recovery sluggish. Fiscal austerity measures taken to try to reduce deficits have also taken their toll, hampering economic growth and making it even more difficult for countries such as Greece to balance their budgets. If banks’ lending ability were impaired further by a financial crisis brought on by a default on sovereign debt, tighter credit could increase the odds of renewed recession.

Also, Europe represents a major market for many American companies, and a recession there wouldn’t help an already slowing global economy.

Greece could be the tip of the iceberg

Even though Greece is the immediate concern, larger economies in Europe actually could represent a bigger threat. Italy and Spain both face sovereign debt burdens and deficit problems. Italy’s economy is more than five times that of Greece; Spain’s is more than four times bigger.* If either country were to decide it needed to restructure its debts as Greece is attempting to do (which ratings agencies could see as a form of default), that would have a much bigger impact than Greece. If a Greek default would have a ripple effect, a default by either Spain or Italy could cause waves.

To compound the problem, as investors have become increasingly concerned about the possibility of debt contagion in Europe, borrowing costs for both Italy and Spain have risen. At recent auctions, nervous investors have been demanding higher interest rates to compensate them for the higher perceived risk of buying that sovereign debt. As any credit card holder knows, having to pay a higher interest rate makes paying off debt and balancing the budget more difficult. A Greek default could make investors even more nervous about buying other troubled countries’ debt, and being frozen out of credit markets would likely aggravate fiscal problems abroad.

All politics is local

There have been signs in recent months that voters in stronger economies such as Germany are beginning to question why they should continue to support countries that have not been as disciplined about balancing their budgets. Also, investors worry that the financial support available from the EFSF may not be sufficient or available quickly enough to avert problems. Though there has been no shortage of suggestions for how to deal with the situation–issuance of euro bonds backed by all eurozone members, leveraging the EFSF’s existing assets, greater fiscal integration among countries, Greece returning to its own currency–questions about the ability and willingness of other countries to support the eurozone’s weaker members have caused investor anxiety worldwide.

Financial markets hate uncertainty, and the situation has contributed to the recent volatility across a variety of asset classes that don’t usually move in tandem. However, Europe has the benefit of having watched the United States deal with its own difficulties during the 2008 crisis. Also, European leaders have generally reaffirmed their determination to defend the euro at all costs.

Uncertainty about Europe could persist for months, but it’s important to keep it in perspective. While you should monitor the situation, don’t let every twist and turn derail a carefully constructed investment game plan.

*Source: CIA World Factbook 2011

We are once again starting to hear the rumblings of the most overused financial term in the last decade … the infamous “Double-Dip”.  Yet for the longest time, one would only associate that phrase with a trip to Dairy Queen, Baskin Robins, or maybe even these days Ben & Jerry’s or some newly launched frozen yogurt chain.

What’s the chance of a “double dip” recession? Statistically very slim, as it has only happened two other times in the last one-hundred years (and in both cases the circumstances were very different). But don’t pop the cork yet. As any sports affectionado would well acknowledge, stats and records are broken regularly … think Rory McIlroy in this year’s US Open, tying or beating twelve records. When it comes to managing one’s finances, it’s wise to follow the golden rule of the beloved Boy Scouts and “be prepared” (rather than unprepared for the unexpected).

If one is struggling financially, improvement can only come with change – and it starts with doing a little financial check-up from the neck up. There are really only three ways to live one’s “Financial Life” – one can live above their means and go deeper and deeper into debt; live at their means – spending what they want, when they want, and saving very little; or (drum roll please) … one can live below their means … saving regularly and thereby creating a safety net that can be relied upon when times get tough.

Of course it’s easier to preach being financially prudent, than to practice it. As well, all circumstances are different and there are some very heart-wrenching personal situations out there – such as dual-income households dealing with one or both being unemployed – single parent households where the provider is unemployed – or major decreases in the income potential from retirement accounts and investment accounts that lost value just prior to retirement. It’s clear, these are … tough times.

Getting one’s financial life back starts with what’s upstairs. No, not by selling a stamp collection handed down by one’s grandfather or pawning a collection of baseball cards that are stashed away in boxes up in the attic, or even by sending a spouses jewelry to the latest “We Buy Gold” infomercial. It starts with one setting aside some time to take a hard look at how they lead their own personal financial life. It’s a holier than holy “come-to-terms-with-your-spending-habits-mental-time-out”.

First, one needs to look at what they earn each month (even if, for now, it’s unemployment income). The next step would be to determine where that money goes each month. Money in vs. money out. Simple math. Start by keeping a log – an honest log – of monthly bill payments, cash purchases, and debit card receipts. Keep in mind, a credit card purchase is borrowing … and that’s debt … and a good indication (in most cases) that one is living above their means.

This spending log should be kept for 60-90 days. Yes, 60-90 days, because there’s a lot of 30-day diets that are proof that thirty-days doesn’t cut it. At this point, it should become pretty clear where unneeded spending is taking place, and where one can make adjustments. The goal is to replace that spending with saving. This is a great exercise for everyone – low income earners and high income earners alike. Whether one earns $50,000 a year or $500,000, spending vs. saving as a percentage of what one earns is all relative. Even Mr. “Your Fired” had to file for bankruptcy one time.

There’s no silver bullet for turning one’s financial situation around easily … if there was, no one would be concerned about their own financial future. Getting back on the road to a great financial life starts with one’s own admission of what takes them off that road. This finding is then followed by the determination to get back on that road, and having the discipline to stay on it … and not pull over to buy more frozen yogurt.

Be sincere in this effort, because if one can’t control the money coming in, the only thing one can control is the money going out.

The summer of discontent stretches on. As July ebbs into August, we have no resolution on the federal debt limit issue. The possibility of default is still in play. Republican leaders want major cuts to entitlement programs as a condition of raising the debt ceiling; Democrats agree on the necessity of cuts but also want tax hikes for the wealthiest Americans to bring in added revenue.

A trillion-dollar divide. On July 14, CNBC.com reported that both parties had tentatively agreed on nearly $1.4 trillion worth of reductions to the federal budget. That’s not too surprising: $1.4 trillion is the projected size of the budget gap for the fiscal year ending in September. Republicans have called for $2.4 trillion in cuts.^1,2

This federal belt-tightening is going to lead politicians, economists and consumers into the second part of the debt cap conversation. Two very important questions demand our attention.

If we cut trillions from the federal budget, how will that affect GDP? In fiscal year 2009, federal spending represented 24.7% of U.S. gross domestic product. The Office of Management and Budget projected this figure to grow to 25.4% in FY 2010 and stay at 25.1% in FY 2011. The percentages haven’t been this high since 1946.³

The OMB thinks that federal spending will average about 23% of GDP between here and 2020; the Congressional Budget Office thinks the percentage will be slightly greater. It is worth noting that the federal government has only gathered (on average) 18.5% of GDP in tax revenues annually across the past 30 years. A decline in GDP means less tax revenue coming in, and less tax revenue may increase pressure to trim Medicare and Social Security. That’s a scenario that implies a quick sunset for the EGTRRA/JGTRRA tax breaks that Congress has extended.^3,4

Will consumer spending continue to grow with less federal spending? The 2008 stimulus either propped up consumer spending or at least encouraged consumers to think more positively about it. There has been talk of a $196 billion haircut to federal nondefense discretionary spending across the next two fiscal years; one liberal think tank, the Economic Policy Institute, thinks this could remove 900,000 jobs from the economy next year and 1.3 million jobs in 2013, which would not bode well for housing, discretionary spending, retail sales, durable goods orders, consumer credit –the list is long. Conservatives counter with the belief that the economy has recovered to the degree that it doesn’t need such massive federal spending, and that the economy will strengthen further over the next couple of years.⁵

If the economy wanes, what happens to stocks? The mood on Wall Street doesn’t always correspond to the mood on Main Street, but this much is certain: pre-retirees can’t stomach another stock market downturn. Investors who are a decade or less from their envisioned retirement dates cannot imagine pushing back retirements even further. Recently, the mood on Wall Street has been cautiously bullish – but if the bulls bolt thinking that the economy is stagnating or sliding back into recession, the near future may call for some active or tactical portfolio management.

Let’s hope the “what if” stays hypothetical. The brinkmanship will probably give way to an accord at the tenth or eleventh hour, and we may see small short-term cuts as a prelude to bigger long-term cuts and reforms to entitlement programs.

What if no deal is reached by the August 2 deadline set by the Treasury Department? The Bipartisan Policy Center forecasts that the federal government would have to spend $134 billion less than planned during the rest of the month. So $134 billion would be removed from the U.S. economy in 29 days. This is more than 10% of America’s monthly GDP. Imagine that happening for a start, and then factor in a 9% jobless rate and the possibility of a stock market swoon and higher interest rates.⁶

It is not a pretty scenario, and it is one the U.S. will hopefully avoid. If a new Reuters poll is any indication, most economists think disaster will be averted – 38 of 40 economists recently surveyed by the news agency believe legislators will reach a deal before August 2 rolls around.¹ 

When will the debt ceiling issue be solved?  The NFL, the NBA, the EU, Congress … wherever you look, it seems people would rather wrangle these days than resolve their differences. The U.S. Treasury has set a hard deadline of August 2 for Congress to settle its divide on the federal debt ceiling, and if partisan bickering interferes, the world economy could suffer a severe hit.

 What would happen if we miss the deadline? According to federal budget analysts at the Bipartisan Policy Center, the Treasury would only be able to make a slight majority of its 80 million monthly payments in August. Treasury Secretary Timothy Geithner would likely be put in the same position as a struggling consumer low on cash and behind on his bills: he would have to selectively decide which debts to pay for the month and which to ignore.¹

Should August 2 come and go without a solution, Congress’s inaction (and Geithner’s subsequent decisions) would have dramatic global repercussions. Most likely, his big priority would be to pay off bond investors so that a formal default wouldn’t occur. Yet even if these institutional investors are assuaged, the Treasury would still have to postpone millions of payments at home … payments to Social Security recipients, federal employees, contractors and soldiers possibly among them.¹

So technically, America wouldn’t actually default come August 2 – certain federal payments would be delayed. The federal government’s existing revenue stream is decent enough so that it could still pay interest and principal on unpaid debts. ²

 That said, the postponed federal payments would have a dramatic impact on cash flow, consumer spending, consumer credit and even interest rates.

 S&P threatens to give America a D. The venerated credit rating agency says it will cut the U.S. debt rating from AAA all the way to D if the debt cap isn’t increased by the August deadline. (That’s right – the U.S. would go from the best credit rating to the worst.) Moody’s has indicated it would cut the U.S. rating to somewhere in the Aa range, which is three steps beneath its highest ranking.³

On Bloomberg Television, S&P sovereign rating committee chairman John Chambers warned that a U.S default would rock global markets in a way that would be “much more chaotic” than the shock from the 2008 Lehman Brothers bankruptcy. Fitch Ratings is less gloomy; on June 21, it characterized the U.S. as “very likely” to raise its debt ceiling before the deadline looms.³

 It may just be a matter of time. This negotiation is ultimately like so many others: a ticking clock will exert the most leverage. Given the gravity of what could happen, concessions will inevitably occur, a deal should happen (albeit probably at the eleventh hour), and both sides will put their own spin on the agreement. Until then, a hint of tension haunts Wall Street.

Citations:

1. money.cnn.com/2011/07/01/news/economy/debt_ceiling_deadline/ [7/1/11]
2. money.cnn.com/2011/05/23/news/economy/debt_ceiling_deadline/index.htm [5/23/11]             
3. bloomberg.com/news/2011-06-29/moody-s-would-likely-cut-u-s-debt-rating-to-aa-range-in-event-of-default.html [6/30/11]
4. content.usatoday.com/communities/theoval/post/2011/06/poll-obama-leads-gop-candidates-but-remains-vulnerable/1 [6/3/11]5 – montoyaregistry.com/Financial-Market.aspx?financial-market=tax-loss-harvesting&category=31 [7/3/11]
5. montoyaregistry.com/Financial-Market.aspx?financial-market=tax-loss-harvesting&category=31 [7/3/11]

Greetings from Charlotte, North Carolina, and Welcome to Epic Capital’s first ever “Epic Insights” blog post!

Ever since Epic Capital was started, it has been a goal of ours to break down the walls of conventionalism when working with a financial management firm.  Most practices tend to isolate their clients and treat them merely as a customer rather than the purpose of their firm’s existence.  In the conventional model, the advisor dictates the relationship.  At Epic Capital, we look to put our clients at the center of our day and then we revolve around them.  We look for our clients to be as involved or as uninvolved as they feel they’d like to be in our working relationship.  If e-mail is their communication tool of choice, we oblige.  If they prefer a 30-minute phone consultation once every month, we can accommodate.  If they would like to do a financial plan review via a live web-feed or screen-share, we’ll do that too.  They call the shots and we customize our interaction accordingly.

We recognize the value of our client’s time.  We value time too.  It is our belief that the more effective we are working with our clients in a manner that is best suited for them, the smoother the exchange in conversation and more gets accomplished.  The end result is a savvier investor, a relationship that is based on mutual trust and respect and a better flowing channel of communication between the client and the advisor.

This blog is simply another form of that communication.  We look to educate our clients to provide answers, ideas, and our thoughts and insights into the “goings on” in the always complicated world of managing one’s own finances.  The more we provide and the more transparent we are in our thinking, the more value we bring – and that is why our clients hire us – for the value we bring in assisting them in achieving their True Wealth. For we see “true wealth” as being the goals that become a reality when one properly manages their finances.  Such goals are: sending a child to college, providing quality care for an aging parent, creating a lasting legacy for generations to come, or simply living the lifestyle you’ve always envisioned during your retirement years.

As we mentioned earlier, we want to keep this particular post short for there is much more to come later.  Some of the topics of future discussions are already listed in the left-hand column of this web-page.  We truly hope you enjoy Epic Insights, and be sure to check back regularly to keep up with the thoughts and ideas that we’ll be sharing as we flip the calendar of life forward.

Edward R, Doughty, CFP® – Managing Director