By Sue Stevens
President Obama released his budget proposal to Congress today. It is one of several major new proposals aimed at dealing with our country's deficits so we don't end up like Greece. Or Cyprus.
I read the President's budget proposal last year. It included caps on how much municipal bond interest would be tax-exempt for "the rich." That hasn't come to pass--yet. Recognize that even though you'll hear a lot about various proposals, none of them will be law until they are passed by both the House and Senate. And we all know all too well how gridlocked that process has become.
Understanding the types of issues raised is helpful. We can start to strategize about how to protect your hard-earned assets from both the vagaries of the markets and taxes. All kinds of taxes--not just income taxes.
If you want to read the budget, all 244 pages, go to http://www.whitehouse.gov/sites/default/files/omb/budget/fy2014/assets/budget.pdf.
If you don't want to read all 244 pages, here's a summary of what I found most interesting:
Page 11: Energy Independence
Set a Goal to Cut Our Oil Net Imports in Half by the End of the Decade. Increased production of domestic oil and bio fuels, and improvements in the fuel economy of our cars and trucks, allowed the United States to cut imports of oil by almost one-third since 2008. To build on this progress, the President will propose new policies and investments to set us on a course to cut imports of foreign oil in half by the end of the decade, relative to2008 levels.
So it looks like full speed ahead on more drilling in North Dakota and fracking in lots more backyards. Let's hope Obama's clean energy initiatives will preserve our water supply in the process.
Page 16: Exports
Encourage Growth Through National Export Initiative. A critical component of building a stronger American economy is ensuring that U.S. businesses, farmers, and ranchers can actively participate in international markets by increasing their exports of goods and services. The Administration launched the National Export Initiative (NEI) in January 2010 with the goal of doubling U.S. exports over five years while supporting two million new jobs. The Administration is currently making historic progress toward this target—in 2012, exports of goods and services reached record levels of over $2.2 trillion, 39 percent above 2009 levels.
Two years ago at a University of Chicago economic briefing, the speakers pointed to future growth in U.S. exports. Fidelity Export & Multinational fund is up 12.62% in the past year. I'd keep an eye on exports from any economy where currency is devaluating. (Think Japan.)
Page 18: Automatic Retirement Contributions
Encourage Retirement Savings with Automatic Individual Retirement Accounts and Support for Small Employers Who Offer Retirement Plans. About half of American workers have no workplace retirement plan. Yet fewer than 1 out of 10 workers who are eligible to make tax-favored contributions to an Individual Retirement Account (IRA) actually do so, while nearly 9 out of 10 workers automatically enrolled in a 401(k) plan continue to make contributions. The Budget would automatically enroll workers without employer-based retirement plans in IRAs through payroll deposit contributions at their workplace. The contributions would be voluntary—employees would be free to opt out—and matched by the Saver’s Tax Credit for eligible families.
We used to talk about automatic enrollment in retirement plans years ago when I worked at Vanguard and then Morningstar. This idea has been around for years. Given how unprepared most of the Baby Boomers are for retirement, this won't save their retirements. But it might get some younger savers off on the right foot.
More Page 18: Limit Tax-Deferral on High Balance IRAs
Prohibit Individuals from Accumulating Over $3 Million in Tax-Preferred Retirement Accounts. Individual Retirement Accounts and other tax-preferred savings vehicles are intended to help middle class families save for retirement. But under current rules, some wealthy individuals are able to accumulate many millions of dollars in these accounts, substantially more than is needed to fund reasonable levels of retirement saving. The Budget would limit an individual’s total balance across tax-preferred accounts to an amount sufficient to finance an annuity of not more than $205,000 per year in retirement, or about $3 million for someone retiring in 2013.
This proposal is sure to create controversy. It's doubtful that it will pass. But it's one more way of penalizing "the rich." Why $205,000 a year is the magic number is a mystery. A lot more NY retirees will be seeking lower cost of living states where they can make that money stretch.
There is nothing to explain how this would work. Presumably if you had more than $3 million in anything tax deferred, you would lose the tax deferral on the incremental income on assets above the threshold. How would they figure out how much income is attributable to dollars about the threshold? It's a mystery. It sure would make figuring out required minimum distributions a lot more complicated.
More Page 18 (It's Just Packed with Interesting Items): Tax Estates at $1 Million (Again)
Return Estate Tax to 2009 Parameters and Close Estate Tax Loopholes. The Budget returns the estate tax exemption and rates to 2009 levels beginning in 2018. As part of the end-of-year “fiscal cliff” agreement, congressional Republicans insisted on permanently cutting the estate tax below those levels, providing tax cuts averaging $1 million per estate to the very wealthiest Americans. It would also eliminate a number of loopholes that currently allow wealthy individuals to use sophisticated tax planning to reduce their estate tax liability.
So try to die before 2018 when you'll get $10.5 million (increased for inflation annually) per couple. If I'm reading this right, this proposal wants to roll back the estate exemption to $1 million per person. That's what it was scheduled to go to January 1st this year.
That last sentence probably has GRATs in mind. Or family limited partnerships.
Page 25: Everybody Gets A Lower Mortgage Rate
Finish the Task on Universal Refinancing for Responsible Homeowners. The housing market is showing signs of healing and growth. Home prices are increasing, inventories are down, and sales and construction are increasing. However, too many Americans are still paying mortgage interest rates far above today’s historic low market rates because the reduction in their home
value over the past five years made them worth less than their mortgage and ineligible for refinancing. Last year, the Administration worked with housing regulators and the Government Sponsored Enterprises (GSEs) Fannie Mae and Freddie Mac to double the number of underwater homeowners assisted with refinancing through the Home Affordable Refinance Program (HARP). Around 1.1 million borrowers refinanced through HARP in 2012, bringing the total number of borrowers who have refinanced through HARP since its inception to 2.1 million. While this is an important step, the Administration believes that more aggressive action is needed and is calling on the Congress to take additional steps so virtually every family that has a standard mortgage and has been making its payments on time will have the opportunity to refinance their mortgage at today’s historically low rates. Specifically, legislation is needed to fully streamline HARP to increase access and lower costs for borrowers and provide those responsible Americans who happen not to have a loan guaranteed by the GSEs with access to a comparable streamlined refinance program. Helping families
refinance will help homeowners get into more sustainable loans, save each family on average $3,000 annually, enable many more to stay in their homes, and boost local economies.
I'm all for everyone getting a better mortgage rate. But I sure hope lenders have learned something about qualifying borrowers before we repeat the problem again.
Page 36: More Limitations of Itemized Deductions
Reduce the Value of Itemized Deductions and Other Tax Preferences to 28 Percent for Families with Incomes in the Highest Tax Brackets. The Budget would limit the tax rate at which high income taxpayers can reduce their tax liability to a maximum of 28 percent. This limit would apply to: all itemized deductions; foreign excluded income; tax-exempt interest; employer sponsored health insurance; retirement contributions; and selected above-the line deductions.
In the last tax law just passed in January, we saw a reduction of itemized deductions that can go as high as 80%. This proposal looks like it would expand on that and also phase out deductibility of medical expenses (not included in the last tax act), muni bond interest, employee health insurance, retirement contributions (not just the balance of $3 million) and potentially self-employment deductions that help offset the liability of self-employment tax.
In my humble opinion, it would be so much simpler (and fairer) if we just agreed to have a flat tax. No breaks for anybody and we all paid a flat percentage of income.
More Page 36: Buffett's Back
Observe the Buffett Rule. The Budget also puts forward a specific proposal to comply with the Buffett Rule, requiring that wealthy millionaires pay no less than 30 percent of income—after charitable contributions—in taxes. This proposal will prevent high-income households from using tax preferences, including low tax rates on capital gains and dividends, to reduce their total tax bills to less than what many middle class families pay.
So let's define "wealthy millionaires." Does that mean you earn over $1 million in income a year? The top ordinary tax rate now is 39.6%. You hit that if you earn over $400,000 single or $450,000 married filing joint. If you add in the loss of deductions and exemptions, it's more than that. And if you're self-employed and your company's income flows through your tax return, you've got to pay self-employment tax on top of that.
Or does it mean investment income from a portfolio? The assets in that portfolio were already taxed at ordinary income tax rates when they were earned. Taxes on dividends and capital gains are a second tax on that money.
Page 38: More Means Testing for Medicare
Increase Income-Related Premiums Under Medicare Parts B and D. Under Medicare Parts B and D, higher income beneficiaries pay higher premiums. Beginning in 2017, the Budget proposes to restructure income-related premiums under Parts B and D by increasing the lowest income-related premium five percentage points, from 35 percent to 40 percent and also increasing other income brackets until capping the highest tier at 90 percent. The proposal maintains the income thresholds associated with income-related premiums until 25 percent of beneficiaries under Parts B and D are subject to these premiums.
Fidelity has done a study that projects the average couple in retirement will spend $240,000 on health-related costs. I guess we'd better increase that amount and start revising retirement projections. It makes it very difficult to plan effectively if the rules for retirees keep changing. If you have accumulated over a million dollars for retirement, you may want to add in the cost of providing your own medical insurance.
Page 39: Higher Medicare Costs for Everyone
Promote Targeted, Shared Responsibility for New Beneficiaries. The Budget proposes three targeted policies to promote appropriate use of health care for new enrollees in Medicare starting in 2017. First, to strengthen program financing and encourage beneficiaries to seek high value health care services, the Budget proposes to apply a $25 increase in the Part B deductible in 2017, 2019, and 2021 for new beneficiaries. Second, Medicare beneficiaries currently do not make co-payments for Medicare home health services. This proposal would create a home health copayment of $100 per home health episode for new beneficiaries, applicable for episodes with five or more visits not preceded by a hospital or other inpatient post-acute care stay. Third, to encourage more efficient health care choices, the Budget proposes a Part B premium surcharge equivalent to about 15 percent of the average Medigap premium for beneficiaries that purchase Medigap policies with particularly low cost-sharing requirements. Medigap policies sold by private insurance companies cover most, or all, of the cost-sharing Medicare requires. This protection, however, gives individuals less incentive to consider the costs of health care services and thus raises Medicare costs and Part B premiums.
If you are age 62 or younger, listen up. This proposal is for you! If you buy a Medigap policy when you are age 65, the cost of your Medicare premiums go up. 15% of a Blue Cross/ Blue Shield of Illinois policy "F" would be about $500. And you pay extra if you need home health care. By the way, that long-term care insurance the government was going to provide to everyone a few years ago? That's off the table now.
Page 46: Chained CPI
In the interest of achieving a bipartisan deficit reduction agreement, beginning in 2015 the Budget would change the measure of inflation used by the Federal Government for most programs and for the Internal Revenue Code from the standard Consumer Price Index (CPI) to the alternative, more accurate chained CPI, which grows slightly more slowly. Unlike the standard CPI, the chained CPI fully accounts for a consumer’s ability to substitute between goods in response to changes in relative prices and also adjusts for small sample bias.
This has been in the news a lot lately since the press leaked what was coming in the President's budget. The idea is that a different measure for inflation will be used in calculating increases in Social Security payments. So payments will increase more slowly over time. If you're age 80 now, it looks like you might get to keep the old inflation increases. Unless you have "too much" money.
Page 131: Aid for Iraq
Includes $6.8 billion for the frontline states of Iraq ($2.1 billion), Afghanistan ($3.4 billion), and Pakistan ($1.4 billion), including $3 billion in base funding and $3.8 billion in Overseas Contingency Operations funding. The Budget prioritizes core diplomatic and development activities to ensure strong, lasting partnerships with these countries and to promote stability.
So that's where my taxes are going!
Page 171: A Great Time to Buy
We are selling off excess Federal real estate.
Hmmm. Maybe the Statue of Liberty is for sale. I wonder if I could afford it. I wouldn't want to get into a bidding war with China.
OK. Time to stop. Reading the budget is almost as much fun as reading new tax legislation.
Remember none of this has passed. It is not legislation. But it is being discussed in a serious way and we need to pay attention to decisions that will affect everyone we love.