Monthly Archives: February 2012
How President Obama’s 2013 Budget Could Affect You
President Barack Obama's fiscal year 2013 budget released Monday doesn't contain any big surprises on the tax front. The president has talked about many of the proposals in recent months and included some of them in previous budget proposals.
The president did, however, take a few new approaches to reach his long-held, but not yet accomplished, tax goal of increasing taxes on wealthier individuals.
Alternative tax replaced by Buffett Rule: The alternative minimum tax, for example, has long been a Washington, D.C., target. Many lawmakers in both parties have urged elimination of this parallel tax, which Congress must tweak each year so that it won't hit middle-class taxpayers because it is not indexed for inflation.
Obama would replace the alternative minimum tax with the Buffett Rule. This proposal, named after billionaire businessman Warren Buffett who got a lot of attention when he said his secretary faced a higher income tax rate than he did, would impose a 30 percent minimum tax on individuals with an annual income of at least $1 million.
Higher taxes on some investments: Another budget target is earnings of private equity fund managers.
This occupation was in the spotlight when Republican presidential candidate Mitt Romney revealed that he paid around 14 percent in taxes on the millions he earned as a fund manager because that money was taxed at the lower capital gains tax rates. Obama wants to tax such profit-based compensation at ordinary income tax rates.
As for the investment income of others, Obama's budget would hike the current 15 percent capital gains tax rate to its previous 20 percent level. It also would treat certain dividends earned by individuals making more than $200,000 annually and married couples making more than $250,000 a year as ordinary income rather than as lower-taxed capital gains.
However, investment earnings of taxpayers in the 10 percent and 15 percent income tax brackets would remain untaxed under this budget proposal. And those taxpayers in the current 20 percent, 25 percent and 28 percent tax brackets still would pay capital gains at the 15 percent tax rate.
Ending top Bush tax cuts: The president renewed his annual call for ending the Bush-era tax rates on higher ordinary income.
The two current top tax rates, now at 33 percent and 35 percent, would increase to 36 percent and 39.6 percent. The remaining tax rates -- 10 percent, 15 percent, 25 percent and 28 percent -- would remain on the books.
If the Bush-era rates are allowed to expire as scheduled on Jan. 1, 2013, the top rates would increase and the lowest 10 percent rate would disappear.
Reducing some deductions: In addition to facing higher taxes on all types of earnings, wealthier taxpayers would see the value of their itemized deductions reduced.
They also would face phased-in limits on foreign excluded income, tax-exempt interest, employer-sponsored health insurance, retirement contributions and selected above-the-line deductions.
Permanent American opportunity: The American opportunity credit, worth $2,500 for college costs, is a temporary replacement of the Hope education credit. It is set to expire at the end of 2012, with the lower $1,800 Hope amount to return. The president wants the more generous American opportunity tax credit to be a permanent part of the tax code.
Estate tax limits: One area where Obama might find some broader Congressional support is his estate tax proposal. The current estate tax is set to expire at the end of 2012 and revert to pre-Bush tax levels of a $1 million exemption and top rate of 55 percent. Obama wants to keep the exemption level at the current $3.5 million with a 45 percent tax on the excess.
Obama's tax proposal | |
| The proposal | How it would work |
| Buffett Rule. | People making more than $1 million would pay a minimum of 30% in federal taxes, but it's unclear what counts as income or if the proposal creates a income tax bracket. |
| Keep Bush tax cuts for almost all. | The top 2 income tax brackets would increase from 33% and 35% to 36% and 39.6% -- what they were under Bill Clinton. In other words, single filers making more than $178,650, married-jointly folks making more than $217,450 and head-of-household filers making more than $198,050 would get a tax increase. |
| Change estate tax. | The estate tax would jump by 10 percentage points from 35% to 45% with a $3.5 million exemption. |
| Limit itemized deductions for the rich. | Taxpayers in the top two income tax brackets would see their itemized deductions drop from 33% or 35% to 28%. |
| Raise taxes on investment fund managers. | Currently, managers of private equities and hedge funds pay 15% on capital gains (aka "carried interest"). This proposal would tax capital gains at regular income levels, instead of a flat tax. |
| Make the American opportunity credit permanent. | Allows college filers to get up to $2,500 a year in tax credit for college expenses. |
Source: Bankrate, Inc.
Benefits of Diversification
“Don’t put all your eggs in one basket” is a common expression that most people have heard in their lifetime. It means don’t risk losing everything by putting all your hard work or money into any one place.To practice this in the context of investing means diversification—the strategy of holding more than one type of investment, such as stocks, bonds, or cash, in a portfolio to reduce the risk. In addition, an investor can diversify among their stock holdings by buying a combination of large, small, or international stocks, and among their bond holdings by buying short-term and long-term bonds, government bonds, or high- and low-quality bonds.
A diversification strategy reduces risk because stocks, bonds, and cash generally do not react identically in changing economic or market conditions. Diversification does not eliminate the risk of experiencing investment losses; however, by investing in a mix of these investments, investors may be able to insulate their portfolios from major downswings in any one investment.
Over the long run, it is common for a more risky investment (such as stocks) to outperform a less risky diversified portfolio of stocks, bonds, and cash. However, one of the main advantages of diversification is reducing risk, not necessarily increasing return. The benefits of diversification become more apparent over a shorter time period, such as the 2007–2009 banking and credit crisis. Investors who had portfolios composed only of stocks suffered large losses, while those who had bonds or cash in their portfolios experienced less severe fluctuations in value.
Source: Morningstar, Inc.
A Quick Guide to Home Equity Loans
If you as a consumer need an additional line of credit, a home equity loan, also known as a second mortgage where your home serves as collateral, is one of several options that you can choose from. There are two major advantages of home equity loans. First, the interest rate on home equity loans is usually lower than credit cards and other consumer loans. Second, you can usually deduct the interest on home equity loans, unlike other loans. There are two types of home equity loans — fixed-rate loans and lines of credit.A fixed-rate loan provides a single, lump-sum payment to the borrower, and is repaid over a fixed period of time at a pre-determined interest rate. This is useful if you know how much you would need and when you would be able to pay off the loan.
A home equity line of credit (HELOC) is a variable rate loan that works like a credit card. Borrowers are pre-approved for a specific spending limit and can withdraw money when needed via a credit card or special checks. Similar to a fixed-rate loan, the outstanding loan amount must be repaid in full at the end of the term. However, unlike a fixed-rate loan, HELOC interest rates float up or down, generally adjusted based on the current prime rate. A HELOC is a convenient way to cover short-term, recurring costs, such as quarterly tuition for a four-year college degree.
Although home equity loans do provide attractive rates of financing, we caution consumers to think twice about the reasons why one would need an additional line of credit. If you are thinking about using a home equity loan for day-to-day expenses, one should examine whether you are overspending and possibly sinking deeper into debt. If you end up taking out more money than your house is worth, the interest paid on the loan above the value of the home is not tax deductible.
Source: Morningstar, Inc.
Common Investing Mistakes
Almost all of us have made investing mistakes. The key is not to make the same mistake twice. These mistakes can directly affect whether or not you achieve your desired goals. By repeating even just one mistake, individual investors can quickly become their own worst enemy. Below are some common mistakes that many fall prey to and some suggestions on how to sidestep them.Starting Too Late
The first mistake a large number of investors make is waiting too long to initiate a long-term investment plan. The earlier you can start the investment process, the more likely it is that the plan will succeed. For example, let’s consider two investors—Bill and Tim. Bill began investing $5,000 per year 30 years ago. Tim began investing $10,000 per year 20 years ago. Assuming a hypothetical return of 10% per year, Bill’s ending wealth value was $822,470 compared to $572,750 for Tim. Thanks to the power of compounding, a small amount of money, wisely invested early on, can turn into a large sum over time. Avoid procrastinating; start investing today.
Lack of Diversification
By investing all of your money into just one asset class, industry, or company, you are placing all of your eggs into one basket—and this can be extremely risky. It is better to combine a variety of investments, such as stocks, bonds, and cash, which are unlikely to move in the same direction. Your risk exposure should be lessened as a result.
Chasing Past Performance
Yesterday’s hot stocks or mutual funds may not be today’s best investments. A good number of investors purchase assets when they have already reached their peak, only to watch their performance subsequently suffer. It may be a good idea to choose investments with a history of good performance as well as quality management.
Lack of Research
No matter what type of investment you plan to make, be sure to conduct the proper research. It is unwise to allocate your money to an investment you do not understand. There are a number of helpful resources that you can explore—ranging from public information to professional advice. Take advantage of these when possible.
Unrealistic Expectations
Many investments require time to grow. Investors often become frustrated with the early performance of their investments, decide to sell too quickly, and move the proceeds into other investments. This will result in too much trading, which is not only expensive, but also usually unnecessary. It is important to maintain a long-term view and to not be distracted by short-term results.
Overconfidence
Confidence is a good thing, but overconfidence can cause investors to improperly select investments. Too much assurance in one’s knowledge and ability can lead investors to focus on the upside and deemphasize the potential downside of investments. Instead, a solid financial plan constructed by a professional can go a long way.
Source: Morningstar, Inc.
