As we enter what may well be a period of transition, effective planning will become increasingly important. As highlighted in the attached piece from Schwab, one of our two recommended custodians, three planning trends will likely dominate the near term—rising inflation, taxes, and the changing landscape of a post-COVID world. In sum, Schwab’s position, and ours—successful investors always start with a plan.

2021 has been a boom year for equity markets, while inflation expectations have shifted, and many workers in the emerging post-COVID world have reconsidered what their work, finances, time, and health mean to them. As always, we believe that successful investors start with a plan—whether it’s to start saving and investing, or to manage, protect, and use wealth they already have. Heading into 2022, we see three trends that could have implications for financial planning and wealth management:

·   Inflation rising

·   Tax debate shifting

·   Embracing change post-COVID

Here’s an overview, with takeaways to navigate the year ahead.

Inflation is rising

Inflation measures rose sharply at the end of 2021 to over 6% for the consumer price index for urban consumers (CPI-U) and just over 4% from CPI-U less food and energy, the highest year-over-year increase since 1991. Inflation above the Federal Reserve’s 2% targeted annual rate may persist, but we don’t expect 1970s-style inflation or inflation levels.

A modest amount of inflation is healthy. An unplanned for, unexpected, or prolonged inflationary spike is more concerning; however, we don’t think a prolonged inflation increase is occurring now. Keep an eye on market commentary from Schwab strategists for the latest on inflation.

Whether higher overall inflation persists or not, it’s key to have a plan. Here are steps to consider now:

Embrace diversity

A portfolio includes many pieces, and each piece plays a role. As part of a diversified portfolio, stocks (in particular small cap stocks), real estate investment trusts, and non-US international investments have historically provided returns that keep pace with or exceed inflation and economic growth. Cash, as well as traditional bonds, provide little-to-no inflation protection, but they still play an important role in a portfolio for diversification and liquidity. Adding Treasury Inflation Protected Securities (TIPS), which are US Treasury bonds whose principal value increases with inflation, can provide an inflation hedge as well.

Consider all income and assets

A comprehensive financial plan focused on retirement includes various income sources and assets, including Social Security, a pension (for some), a home and perhaps other real estate, an opportunity for part-time work, and other assets. Some of these income sources and assets provide more protection against unexpectedly high inflation than others. Home prices, for example, have already appreciated dramatically in many areas, and Social Security recipients will see a 5.9% cost of living increase to their payments starting in 2022. Consider all income and assets, including Social Security, when considering your exposure to inflation risk.

Test your financial plan

A proper financial plan is neither a “success” nor a “failure.” It’s a projection of what we expect could happen based on today’s assumptions and financial goals, and a tool to help with the what-ifs in life. For example, what if your investments are better or worse than projected? What if there’s a spike in inflation? What if you live shorter or longer than anticipated? Testing your financial plan with different scenarios can help you be prepared.

Tax-awareness is still important

After inflation, taxes have been the top wealth management topic in our 2021 client conversations. As of this writing, the Build Back Better bill includes almost no major tax increases for individuals with the exception of a 5% surtax on adjusted gross income over $10 million, and an additional 3% surtax over $25 million. Proposals in the bill passed by the House in mid-November could change before being voted on in the Senate, but, unless the direction of negotiation shifts suddenly, we aren’t currently expecting major changes in tax law for 2022.

Regardless of what happens in Washington, investors should plan and invest in a tax-aware manner. Here are strategies to consider now:

Take tax-advantaged accounts seriously

Investors can take relatively simple steps to cut taxes on their investments. First, maximize every opportunity for tax-advantaged saving and investing in employer-sponsored retirement accounts, IRAs, Roth IRAs, and Health Savings Accounts (HSAs). All tax-advantaged accounts can help boost wealth, but HSAs (if used for qualified medical expenses*) and Roth accounts are extremely helpful to fund now if you believe your taxes will be higher in the future or want diversification of accounts based on tax treatment to provide flexibility to manage taxes in retirement. Whatever tax-advantaged account you select, make sure to receive the full employer match in employer-sponsored accounts, such as a 401(k), if available to you.

Cut taxes in brokerage accounts

Every dollar from interest or dividends earned in taxable brokerage accounts is taxed when earned, with some exceptions, including interest earned on tax-exempt municipal bonds. And, any trade, sale, or investment that results in a gain—or loss—potentially results in a taxable event. Attention to tax-smart investing can have a sizable impact on after-tax wealth over time. Consider these strategies:

·   Reduce turnover in brokerage accounts. When you sell and “realize” a gain in a taxable brokerage tax, you may owe tax on the gain. If you trade actively and don’t hold the investment for more than a year, you’ll pay short-term capital gain tax rates, which are the same as the ordinary income tax rates. Long-term capital gains on investments held longer than a year are taxed at a lower, preferential tax rate. These transactions create tax drag. If you trade actively, consider doing so in tax-advantaged accounts such as an IRA or Roth.

·   Hold high-income investments that generate current tax-year liabilities in retirement accounts. Interest earned on high-yield bonds and other higher yielding investments, as well as dividends paid from REITs held in taxable accounts, are taxed when interest or dividends are paid. To reduce tax drag, consider holding higher income earning investments, especially those not taxed at preferred tax rates (e.g., qualified dividends paid by most dividend-paying stocks held for longer than 60 days and dividend-paying stock funds) in retirement accounts.

·   Consider both tax-loss and tax-gain harvesting. Tax-loss harvesting is a common technique to sell investments in a taxable account with unrealized capital losses to realize that loss and use it to offset realized capital gains, if any. And with tax-gain harvesting, by selling some of your winners you could actually help reduce future taxes and create a more balanced portfolio.
Plan for current tax laws to sunset by 2026

Tax changes implemented via the Tax Cuts and Jobs Act (TCJA) will expire at the end of 2025. At that time, absent a new law, ordinary income tax brackets will increase to pre-TCJA rates, and the estate tax exemption will decrease to pre-TCJA levels. Consider the strategies below if your estate is at or close to $5 million or above:

·   Annual exclusion gifting. Individuals can give up to $15,000 tax-free to an unlimited number of donees without utilizing any of their lifetime gift tax exemption (currently $11.7 million per individual, scheduled to fall after the TCJA sunsets). Those who do not wish to gift outright to their intended donees could consider an irrevocable trust that would allow them to make annual exclusion gifts while controlling how the gifts are later dispersed.

·   Spousal lifetime access trusts (SLATs). These remain a popular method for married couples to lock in the “bonus” lifetime exemption allowed under the TCJA. SLATs allow the donor spouse to have indirect access to gifted assets by means of the beneficiary spouse. Investors with $20 million or more should consider using a SLAT to lock in the current lifetime exemption while maintaining some access to the gifted assets.

·   Charitable lead trusts (CLTs). Those who are charitably minded and are facing an abnormally large income tax bill in 2021 due to a large Roth conversion, sale of a business, or the sale of other highly appreciated assets should consider the use of a charitable lead trust in combination with a donor advised fund (DAF) to help mitigate their income tax liability.
Embracing change post-COVID

COVID has led many people to reconsider what their work, finances, time, and health mean to them. Reflect on these issues for you, your family, and your personal goals and priorities. Having a financial plan helps you have a foundation in place to manage risks if conditions change.

Leaving the workforce

Every year you earn a wage is one less year you’ll need to tap other income sources, such as Social Security or retirement savings. If you decide to leave a job or retire earlier than planned, keep in mind that the longer you wait to claim Social Security beyond age 62 (up to age 70), the higher the “pay raise” you’ll receive in inflation-adjusted income thereafter for the rest of your life and, if applicable, your spouse’s life. Full- or part-time work may help manage inflation, as wages in this cycle have been rising as some workers have left the workforce.

Health and healthcare costs are a factor

Anxiety tends to arise from the unknown or unbounded. And for many, current and future health and healthcare costs are likely a source of anxiety. A solution to that anxiety is to plan for healthcare costs. Another is to broaden your notion of financial health to also include physical health. Lack of attention to basic healthcare is tightly correlated with potential future costs. No one can accurately predict future healthcare events, but they can take simple steps to lower the probabilities of those events and plan, including saving for healthcare and understanding health insurance (in particular Medicare while transitioning into and living in retirement).

Be prepared for tides to shift

Market volatility comes at any time. If you don’t feel you can stomach it, or know you’ll need money from your portfolio soon, prepare for it. The important difference between financial planning and wealth management versus institutional investing (such as pensions, endowments, and mutual funds) is that individuals may not have the time or tolerance (how much risk can you stomach) to work through market corrections like an institution does. For anyone who needs money from investments soon, we recommend allocating that sum to cash or high-quality shorter-duration bonds or bond funds. Then continue the rest based on your time horizon and risk tolerance.

What to do now

Navigating trends versus responding reactively or emotionally is best done in the context of a comprehensive financial, investment, or wealth management plan. Financial planning, investing, and wealth management can work to manage risks, prioritize and achieve goals, and then manage, protect, and distribute wealth. Use these trends and their possible implications as the starting point for a conversation about your financial, investing, or wealth management plan this year.

 

*HSA withdrawals that are not used for qualified medical expenses are subject to ordinary income tax, and prior to age 65, may be subject to a 20% federal tax penalty.

 

 

Source: https://www.schwab.com/resource-center/insights/content/2022-financial-planning-outlook-3-trends-and-implications