Advisors Talking Roth, Tax Strategies With Looming Biden Administration

Still unknown: U.S. Senate control, and with it the fate of future federal tax policy. Still known: Mere weeks remain to convert to or open Roth IRA accounts to take advantage historically low tax rates.

Tax policy drives much of financial planning, especially for the upper registers of asset holders and earners. Although it looks like a certainty that Joe Biden will be the next president, not so certain is the fate of his wealth-redistributing tax plan.

That fate rests on the U.S. Senate’s political balance, with 50 Republicans and 48 Democrats, and all eyes on the Jan. 5 runoff for two seats in Georgia. Majority Leader Mitch McConnell already said he will be a tall hurdle for the Biden administration if Republicans hold the majority.

The uncertainty leads some tax experts and advisors to advocate talking to clients about planning now for changes down the road, particularly when it comes to Roth plan conversions.

David McKnight, author of Power of Zero: How to get to the 0% tax bracket, said Biden’s tax policy would squeeze high-net-worth asset holders and earners.

“The real biggies are for anybody making more than $400,000, he wants taxes to revert to the pre-2018 taxes, which is going to mean, the highest marginal tax bracket will go from 37 to 39.6,” McKnight said. “The big deal to me is a real big deal is he's planning on creating sort of this doughnut hole as far as Social Security and FICA taxation goes.”

FICA taxes cap at $135,700 salary in 2020. Under Biden’s plan, that cap would remain, but once salaries rise past $400,000, they would start paying again. The cumulative impact of taxes would grow onerous in McKnight’s estimation.

Because he was in California speaking at an event when he was reached by phone, he chose that state for an example of the impact.

“If you make more than $400,000, at that point, he will start charging you that amount in, you know, ad infinitum forever,” McKnight said, turning to the California example. “You would pay 39.6% on the margin. You pay 14% state tax. For silver [health plans], then you would pay at a 3.8% Obamacare surcharge. When you add all of that up, it ends up being about 72%. That is a really, really big deal if you are making good money.”

Another part of the proposal that caught McKnight’s attention is the 401(k) contribution changes Biden wants.

“The other thing he has talked about doing is leveling the tax benefits for contributing the 401(k),” he said. “Currently, if you make if you're in the 10% tax bracket, you contribute $10,000 to a 401(k). You're going to save 1,000 bucks. In the highest marginal tax bracket, you contribute $10,000 401(k), you're going to save 3,700 bucks, or when if Joe Biden gets his way to be 3,900 bucks. However, there's an additional change he wants to make. He wants to have the guy that's in a 10% tax bracket and the guy in the 39.6% tax bracket to have the same tax savings for contributing to that 401(k).”

The savings would be levelized in the middle at 26% savings whether the person is in the bottom or top bracket.

“If you're in the 10% tax bracket, you would save 2,600 bucks on the $10,000 contribution. If you're in the 39.6% tax bracket, you would save 2,600 bucks on that same contribution,” McKnight said. “Anybody who is in a higher tax bracket, then that 26% number is a disincentive in a massive way from contributing to a 401(k). They will most most likely want to contribute after tax dollars to a Roth 401(k).”

Advisors Agree

Bradley Lineberger, president of Seaside Wealth, in Carlsbad, Calif., agreed that Biden is proposing a significant tax burden on high earners, along with a stiffer corporate tax rate.

Lineberger also acknowledged that a Republican Senate would not open the gate very wide to those proposals, but those ideas are not going away.

“With a divided Congress, it's hard to know how much of his [Biden’s] agenda he will be able to get done,” Lineberger said. “We believe that tax rates are going up in the future, whether it's a Biden administration or a future administration. Therefore, taking the opportunity right now to consider Roth IRA conversions could prove to be very valuable in the future..”

That is not the end of that conversations, with other strategies available, he said.

“Looking at tax saving strategies like contributing to a defined benefit or cash balance pension plan for self-employed workers is valuable,” Lineberger said. “We are also making sure everyone we work with is maxing out pre-tax retirement savings accounts as well. If the step up in basis goes away, this also could change the distribution strategies retirees are using to take money out of their accounts.”

Elliot B. Herman, a partner at PRW Wealth Management, Quincy, Mass., said tax impact is one of the hottest topics of conversation at his agency.

“We are discussing both income and estate tax implications as well as investment ideas,” Herman said, acknowledging the unknown because of the Senate. “For estate taxes, we are discussing the likelihood that a change to the estate tax is probable either soon or at least when the sunset of current law happens in 2026. The idea of maximizing gifting under the generous rules at hand is a topic of discussion.”

The prospect of capital gains rate changes is also on clients’ minds, Herman said.

“That has pushed some to consider taking gains now,” he said. “Tax-loss harvesting is always a topic that would occur under any scenario but becomes potentially more important with a hike in rates.”

And, of course, IRA discussions are foremost.

“We've been discussing doing a [Roth] conversion with an offset of a donation that would reduce the tax hit,” Herman said. “Proposed changes to retirement plans have not gotten a lot of attention but could be very important for how we save for retirement.”

Another critical area for discussion is the affect on business clients.

“It is likely that a corporate rate increase would get done, as the proposed rate is still below the rate prior to the Trump tax cut,” Herman said. “The impact on corporate earnings is something else we are addressing as we look at areas for investment in the coming year.”

Steven A. Morelli is editor-in-chief for InsuranceNewsNet. He has more than 25 years of experience as a reporter and editor for newspapers and magazines. He was also vice president of communications for an insurance agents’ association. Steve can be reached at [email protected].

© Entire contents copyright 2020 by InsuranceNewsNet. All rights reserved. No part of this article may be reprinted without the expressed written consent from InsuranceNewsNet.