What investors need to know about the looming tax changes

[UNITED STATES] As the 2024 U.S. presidential election approaches, savvy investors are taking proactive steps to optimize their tax strategies, regardless of the outcome. With potential changes to tax policies on the horizon, it's crucial for investors to understand and prepare for various scenarios that could impact their financial future.

The upcoming election has brought tax policy to the forefront of many investors' minds. Regardless of who wins, significant changes are expected due to the scheduled expiration of key provisions in the Tax Cuts and Jobs Act (TCJA) at the end of 2025. This impending shift in the tax landscape is prompting investors to take action now to protect their wealth and optimize their tax positions.

"No matter who wins the 2024 elections, tax policy is likely to be a significant topic in 2025," says Greg Doyle, a vice president on Fidelity's Advanced Planning Team. This sentiment is echoed across the financial industry, as advisors and investors alike prepare for potential changes.

Strategies Investors Are Employing

1. Accelerating Income Recognition

Many high-income earners are considering ways to recognize income sooner rather than later. This strategy is based on the possibility of higher tax rates in the future, especially for those earning over $400,000 annually.

"We're telling clients to consider accelerating income into 2024 and 2025," says Robert Westley, a CPA and financial planner in New York. "This could mean exercising stock options or negotiating for bonuses to be paid out earlier."

2. Roth IRA Conversions

Roth IRA conversions have become increasingly popular among investors looking to take advantage of the current tax rates. By converting traditional IRAs to Roth IRAs now, investors can pay taxes at today's rates and potentially enjoy tax-free growth and withdrawals in the future.

"If you are likely to be affected by an increase in the highest marginal income tax rate, converting a traditional IRA to a Roth IRA now, when the rate is still relatively low, may make sense," advises Greg Doyle.

3. Estate Planning and Wealth Transfer

With the potential for changes to the estate tax exemption, many high-net-worth individuals are focusing on wealth transfer strategies. The current lifetime estate and gift tax exemption of $13.61 million per person (as of 2024) is set to revert to a much lower amount after 2025 unless Congress acts.

Estate planning attorneys are seeing a surge in clients looking to make large gifts before any potential changes take effect. "We're advising clients to consider using their full exemption amount now, while it's still available," says Sarah Wentz, a partner at Fox Rothschild LLP.

4. Tax-Loss Harvesting

Investors are increasingly turning to tax-loss harvesting as a way to offset potential capital gains. This strategy involves selling investments at a loss to offset gains in other parts of the portfolio.

"Tax-loss harvesting can be a powerful tool for managing your tax liability, especially in volatile markets," explains Michael Kitces, a financial planning expert. "It's something we're recommending to clients regardless of the election outcome."

5. Charitable Giving Strategies

Philanthropy-minded investors are exploring ways to optimize their charitable giving for tax purposes. One popular strategy is the use of donor-advised funds, which allow for an immediate tax deduction while providing flexibility in the timing of charitable distributions.

"We're seeing a lot of interest in bunching charitable deductions," notes Christine Benz, director of personal finance at Morningstar. "This can be particularly effective if you expect to be in a higher tax bracket in future years."

The Importance of Asset Location

Investors are paying closer attention to asset location strategies, which involve placing investments in the most tax-efficient accounts. For example, holding high-yield bonds in tax-advantaged accounts like IRAs, while keeping more tax-efficient investments like index funds in taxable accounts.

"Asset location can have a significant impact on after-tax returns," says Christine Benz. "It's a strategy that makes sense regardless of potential tax policy changes."

Preparing for Potential Capital Gains Tax Increases

With discussions of potential increases to capital gains tax rates, particularly for high-income earners, some investors are considering realizing gains now at current rates.

"If you have significant unrealized gains and fall into the highest tax brackets, it might be worth considering selling some positions and diversifying now," advises Robert Westley. "However, this decision should be made carefully and in the context of your overall financial plan."

The Role of Tax-Advantaged Accounts

Investors are increasingly maximizing contributions to tax-advantaged accounts such as 401(k)s, IRAs, and Health Savings Accounts (HSAs). These accounts offer tax benefits that can help shield income and investment gains from potential tax increases.

"Maximizing contributions to tax-advantaged accounts is a no-brainer," says Michael Kitces. "It's a strategy that works regardless of the tax environment."

Long-Term Perspective on Tax Planning

While the upcoming election and potential tax changes are driving many investors to action, financial experts emphasize the importance of maintaining a long-term perspective.

"It's important not to let tax considerations drive all of your investment decisions," cautions Christine Benz. "Your overall financial goals and risk tolerance should still be the primary factors in your investment strategy."

The Impact on Different Income Brackets

The potential tax changes could affect investors differently depending on their income level. Those in higher tax brackets may face more significant impacts and thus may need to be more proactive in their tax planning.

"High-income earners need to be particularly vigilant about tax planning in the coming years," notes Robert Westley. "But even middle-income investors should be aware of potential changes and how they might affect their financial plans."

Balancing Tax Efficiency with Investment Goals

While tax efficiency is important, financial advisors stress that it shouldn't come at the expense of sound investment principles. Diversification, risk management, and alignment with long-term financial goals should remain primary considerations3.

"Don't let the tax tail wag the investment dog," advises Greg Doyle. "Tax efficiency is important, but it should be part of a broader, well-rounded investment strategy."

The Importance of Professional Advice

Given the complexity of tax laws and the potential for significant changes, many investors are seeking professional advice to navigate these uncertain waters.

"The tax landscape is complex and ever-changing," says Sarah Wentz. "Working with a qualified tax professional or financial advisor can help ensure you're making informed decisions that align with your overall financial goals."

As the 2024 election approaches, investors are taking proactive steps to optimize their tax positions, regardless of the outcome. From Roth conversions and estate planning to tax-loss harvesting and charitable giving strategies, there are numerous ways to prepare for potential tax changes.

While the future of tax policy remains uncertain, one thing is clear: thoughtful tax planning can play a crucial role in preserving and growing wealth over the long term. By staying informed, working with professionals, and maintaining a long-term perspective, investors can position themselves for success in any tax environment.

Remember, while tax considerations are important, they should be part of a broader financial strategy that aligns with your overall goals and risk tolerance. As you navigate these complex waters, consider seeking professional advice to ensure your financial plan is robust and adaptable to potential changes in the tax landscape.