Make money. That`s the bottom line for American investors with the new tax laws. Finding the best strategy to cope with a new investment world of lower tax brackets and fewer shelters has sent everyone from Wall Street to Main Street scurrying.
Brokerage firms are pushing high-yield choices and variations on one shelter that was mercifully spared, the tax-exempt municipal bond. Banks are trotting out advertising campaigns to let investors know the IRA isn`t really dead. Financial planners are shifting clients out of traditional partnerships that functioned as tax shelters. Bond houses are getting ready for the return of many investors to fixed-rate investments. Since the home remains one of the few tax breaks still around, everyone from real estate brokers to lenders pitching home equity loans is trying to figure all the angles.
Long before the new tax laws were signed by President Reagan in what he termed the World Series of tax reform, the word ”simplification” was dropped from the title. Good thing, too. Eighteen-hundred pages is definitely not simple.
But, complex as it all may appear, you can make money with the new tax laws. They`re part of a dramatic new investment climate in which instruments are packaged in fancy names and wrappers, with fees often slapped on when you`re not looking. More than a few investments are designed to look as though they were specifically designed to cope with the new tax laws, but not all of them may be right for you.
Making money requires understanding all the variables, selecting the right group of investments for your particular situation at each stage of your life, and being patient enough to wait for solid, long-term results.
The opportunities to make money aren`t just for big-buck folks who got theirs the ”old-fashioned way,” by inheriting it. Many highly profitable mutual funds require small minimum investments or, in some cases, set no minimums at all. The basics of making money are no different whether you`re a small investor scrimping to put aside a few extra dollars, or an executive aiming to be fat and sassy in retirement one day. People who earn the most money, after all, are not necessarily the people who wind up with the most money.
When Rep. Daniel Rostenkowski (D., Ill.) and Sen. Robert Packwood (R., Ore.) came down from the mountain with the tablets of reform, they considered Americans to have been kicking up their heels for decades in a ”lurid”
lifestyle of consumer debt and tax schemes. Once the White House signed off on this new morality of personal finance, it was a fresh start.
To begin preparing for these sweeping changes that installed the nation`s accountants, lawyers and financial planners as spiritual guides, here are the 10 commandments of the new tax laws:
— Pay off your consumer debt pronto.
The gradual, five-year phaseout of the deduction for consumer interest makes carrying around a lot a debt at high interest charges a real burden. Attempt to pay your monthly credit card bills in a timely fashion, too.
— Don`t take anything, such as tax brackets, for granted.
A lot of taxpayers seem to think they`re immediately in low tax brackets, but 1987 is a transition period. Even in 1988 a lot of Americans will be in tax brackets higher than that highly advertised 28 percent. Figure what your actual bracket will be before you make any big personal financial moves.
— Look into tax-exempt vehicles such as municipal bonds and bond funds, as well as tax-exempt money market funds.
These remain free of federal taxation under the new tax laws. In addition, yields on tax-exempts are currently at historically high levels when compared to taxables. As soon as President Reagan signed the tax bill, big Wall Street investment firms were racing to market with newly authorized stripped municipal bonds. These are zero-coupon securities one to eight years in maturity designed for investors who are saving for their children`s education or for their own retirement. Zero-coupon investments don`t pay interest, but are sold at a deep discount. The investor`s return comes from the difference between the discounted price and the face value, which he receives at maturity.
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— Consider single-premium whole life insurance policies, which accumulate tax-free and often permit borrowing without interest charges, and single-premium deferred annuities, which are sort of like an IRA with no deduction.
Another deferral tool is the Series EE U.S. savings bond. This still offers a competitive yield, despite the fact the Treasury Department lowered the guaranteed minimum on bonds held five years to 6 percent.
— Examine high-yield investments such as high-dividend stocks, high-yield bonds and bond funds and mortgage-backed Ginnie Mae funds in which interest and principal are guaranteed by Uncle Sam.
When tax changes are in full swing, a greater number of Americans will be in lower individual tax brackets, so high yields will make more sense for them. Bonds also look more competitive because stocks no longer enjoy an advantage in capital gains treatment. When looking at individual stocks and mutual funds, remember that some types of companies will be more blessed by the new tax laws than others.
— Realize how important your home is in financial planning.
Interest on it is still deductible. Furthermore, interest on home equity loans is deductible as long as the amount doesn`t exceed the purchase price of the home plus improvements. Many Americans will consolidate debts into these highly publicized home equity loans that permit them to borrow based on equity built up over the years. But realize that rates and terms on home equity loans vary considerably among institutions, and that adding additional debt to your home increases your chance of losing it one day.
— Take advantage of company 401(k) plans.
The contribution to these tax-deferral vehicles has been cut back to $7,000 annually under the new laws, but they are still a worthwhile means of socking money away for retirement. They permit an employee to contribute pretax dollars to a company pool invested in stocks, bonds or money-market funds, not reported for tax purposes until retirement or severance.
— Don`t automatically reject individual retirement accounts.
For many Americans they`ll still be deductible, and for others, it will still be possible to use them as deferral vehicles even without the deduction. Tax-deferred compounding is always worthwhile.
— Be cautious in considering partnerships.
The goal now is on economic sense, lots of cash and little debt, a reversal of tax shelter philosophies of the past. Also be careful when considering the new shelters designed to have ”passive” income to offset present income. Always look closely at the logic behind them. Study the track record of the company offering the shelter.
— Don`t expect children to be the tax shelter they were in the past.
Children`s investment income over $1,000 gets taxed in the parents`
bracket until age 14. So there will be less emphasis upon high-income investments in the child`s name, but, instead, growth investments such as stock funds and also tax-exempt instruments.
That just scratches the surface, of course. Just figuring out the complex transitional rules is enough to wear out a calculator battery. For 1987, there are five individual tax rates ranging from 11 percent to 38.5 percent, while in 1988 there are three rates of 15, 28 and 33 percent. Expect your 1987 tax form and new W-4 employee withholding form to be much more difficult.
For someone in a lower tax bracket, the opportunities to save should be better than ever. But ”running the numbers” on competing yields at banks and investment firms and structuring the finances required to own a first home are more difficult than ever.
The new tax laws require planning geared more to the individual`s circumstances. There are plenty of people just waiting to offer that financial advice–at a price. Don`t panic. You can do a lot of your homework yourself and the decisions you make can be your own. In all the confusion, avoid mistakes such as setting up unnecessary trusts or buying municipal bonds that aren`t tax-exempt rather than those that are.
Next: Expert Advice. The Wall Street pundits share their advice about the new tax laws and give individual investors tips on how to make money through sound investments that conform to the new rules of the tax game.