March 25, 2020

How Will Government Spending Affect Your Financial Planning?

COVID-19 has taken an extraordinary toll on humanity in a few short months. The respiratory illness has killed over 22,000 people as of this writing and has caused global stock markets to come off of historic highs and drop toward recession. Governments around the world have responded to this crisis by cordoning off citizens and spending money at a breakneck pace. The United States’ similar response will have long-term impacts that may affect your financial planning today. This is the subject of today’s post – and an extension of my earlier post on financial planning in a bear market, which you can find here.

The U.S. began 2020 already in a tenuous spot financially – the country ran $1 trillion deficits in 2018 and 2019, and the Federal Reserve’s balance sheet was unexpectedly stretched in the fall of 2019 when the Fed injected over $200 billion into the overnight lending markets (and promised to continue providing liquidity to these markets through April 2020). Complicating matters for retirees, 2020 was to be the first year since 1982 that Social Security paid out more than it takes in, beginning a trend that is expected to continue into the next century.

Then COVID-19 arrived.

Over the last month, global stock markets have been heading toward recession, interest rates have dropped to almost zero, and the U.S. has committed to putting at least $700 billion more into the economy through a new quantitative easing program. This week, the Federal Reserve announced that they will be purchasing corporate bonds for the first time and that they will print as much money as it takes to “support smooth market functioning and effective transmission of monetary policy to broader financial conditions and the economy.”  All of this is happening while Congress debates at least another trillion dollars in relief spending.

Adding trillions of dollars in spending when already running trillion-dollar deficits is a dangerous way to budget, although it’s true that desperate times may call for desperate measures. In the case of the U.S., this is a bill that will one day be paid by our future selves and by our children, most likely in the form of higher taxes. As families consider the financial planning alternatives available to them during this public health crisis, they would be wise to keep an eye on the government’s response to the crisis to gauge how it may impact tax rates and the family cash flow in the future.

Income tax planning often involves weighing whether it is better to pay taxes at today’s rates than at rates in the future. Today’s top federal income tax rate is 37%. This top marginal rate is low by historic standards, as the top bracket has been under 37% in only 22 of the last 100 years (and it was below 35% for just 12 of those years). The top marginal federal income tax bracket is already scheduled to increase to 39.6% in 2026.

Should spending on COVID-19 recovery efforts increase the need to generate income tax revenue, these marginal rates may increase sooner than scheduled, and the rate may move closer to historic norms (the top rate was above 60% from 1932-1981 and was over 90% through the 1950s). Each of the remaining Democratic candidates for President is proposing substantial increases to the income tax burden felt by the highest income earners. Changes to the income tax system are generally not made retroactively, so families considering strategies that result in the generation of 2020 taxable income – Roth IRA conversions or withdrawing from Inherited IRAs, for example – ought to check with their accountant to make sure they are safe under the current rules. Couples making over $400,000 (and individual taxpayers making over $200,000) are in the highest two brackets and should take a hard look at these strategies, as it may be a long time before paying income taxes is as cheap as it is now.

The same analysis holds true as it relates to estate taxes: Fewer families are subject to the tax now than in prior years (the amount exempt from federal estate tax has gone from $600,000 per person in 1997 to $11.58 million per person in 2020), and those who pay the tax are doing so at a lower rate (the top rate was 55% in 1997 compared to the top rate of 40% in 2020). The Federal Estate Tax Exemption is set to drop to about $5.5 million per person in 2026. Estate planning attorneys have a variety of tools that help families gift their estate exemptions and, in an election year in which Democratic candidates are discussing changing the exemption to $3-5 million per person and increasing the rates, families whose net worth exceeds $6 million should pay close attention to these developments.

Current circumstances may make it difficult to focus on long-term planning. But for families that are choosing to engage in this sort of strategic thinking right now, 2020 presents a wealth of planning opportunities that may not last. Please contact our team if you would like to talk about how these issues affect you and your family.