I am a strong advocate of making a number of small adjustments in my financial strategy, over a long period of time to create sustainable change. However, with just mere weeks left before we experience possibly one of the largest economic tsunamis this country has ever seen, there is not a great deal of time left to plan. With this in mind, the question that you have to ask yourself is “What are the threats and what do I absolutely need to react to right now?”
As I see it, there are four primary threats that will have an impact on how you do business as a family in the future. First, there is the tax issue. Marginal rates are set to increase. The pinch on the average married wage earner is where the greatest impact will be felt. For the current tax year (2012), if you are married filing jointly making under $70,700 annually you are in the 15% tax bracket. However, if you are married filing jointly, and you make between $70,700 and $142,700 your marginal rate is 28%. If nothing is done by January 2013, the 15% rate will apply to wage earners, who are married filing jointly, only up to $58,900 and the 28% rate will kick in at $58,900.
This in effect widens the 28% bracket by $11,800, on the lower end of the wage group, for wage earners who are married filing jointly. Let’s assume that you make an annual salary of $69,000. For the 2012 tax year you will be paying 15% federal income tax. However, on January 1, 2013 you your marginal rate will become 28% without you even earning a single dollar more. That significant change results in roughly a $2,828 tax liability that you will have to absorb. If you are paid bi-weekly that’s an additional $108.77 out of every paycheck.
I would at least recommend that for the month of December you find a way to cut your budget by the amount of tax liability you plan on incurring beginning in January. If you can do this you will be ahead of the game. “But what if a deal is made and my taxes do not go up?” you might ask. I would suggest to you that if you can make this strategic move now and the tax rates do not go up, you have proven to yourself that you can live on less than you previously thought you could. In that case, bank the extra money each paycheck or pay down the debt you currently have.
Of course marginal rates are not exclusive in this tax increase event. Capital gains and dividend tax rates will also be increasing. There are a number of moves you could make to reduce the impact of these rate increases including contributing more towards your company sponsored 401k. Even if this contribution would be above the match threshold, doing this protects income from tax increases as well as shelters your growth from the current increases. In taxable brokerage accounts, you can sell off big gainers and pay the current 15% rate before the end of the year. You should also focus your growth efforts in any tax preferred account such as the Roth or traditional IRA.
The second threat is the amount of regulation and bureaucracy associated with the Affordable Care Act. While the bi-weekly premiums taken from my paycheck have not increased from this year to the next, my costs have increased significantly. This is primarily due to the cost shifting that happened when my employer moved to a high deductable plan. Although the full impact of the ACA will not be realized until 2014 and beyond, you might find yourself having to make major adjustments for the foreseeable future. Absorbing the impact of regulations that have yet to be written and revealed is difficult.
There is no real adjustment you can make other than to cut your budget in areas that are associated with wants and desires. Unless you can increase your own revenues, you are left to tighten how you use the resources you earn. If you are relatively healthy, you might not feel an immediate impact of the cost shifts. The best move you can make is to take full advantage of the Health Savings Account. If your family is relatively healthy, use the HSA as a health emergency fund. That means that you build up the funds balance each year and don’t touch it.
As long as you can afford the deductibles and out of pocket maximums from your spendable income, reserve the HSA funds for major medical emergencies. Funding the HSA should be done with pretax dollars if you can. However, there is a way to fund it with post tax dollars, which allows you to write off the contributions on your taxes. If you have an emergency fund in place, and you are not beholden to any secured or unsecured debt, you can use your emergency fund to fund the HSA with post tax dollars. This allows you to shelter up to the maximum contribution amounts, gives you a $6,250 write off on your 2012 tax return, and allows you to invest the contributions in a HSA investment account.
If you generate $6,250 a year in taxable dividends or capital gains in a taxable brokerage account, you can use that money to fund the HSA. Therefore you get the tax advantages and funding the HSA does not reduce your take home pay. I recommend thinking in terms of using dividends and capital gains realized in a taxable account to fully fund your HSA and your traditional IRAs if possible. A family earning $20,000 in dividends and capital gains could reduce their tax burden by $16,250 by fully funding these accounts (since contributions to the HSA and the traditional IRA’s are currently tax favored accounts ). This concept should be part of a broader based strategy of income modeling. I teach a class on income modeling for individuals, couples, and families. If you are interested, contact me by visiting my website http://kenrupert.com.
Third, there is a threat for the planned spending cuts associated with the Sequestration Transparency Act of 2012. The scheduled cuts that will have the greatest impact will be those cuts that directly impact the economic activity of employment. When budget cuts impact employment numbers, it directly impacts the sustainability of economic activity of the free markets. If you work for a company that relies on some level of government spending, such as defense or bio-tech research, then you need to be thinking about potential employment impacts.
As long as you remain employed, you should begin to shore up your reserves through debt reduction, personal spending controls, and increased savings and investments. If the cuts are not made, adjustments that are implemented today could become the positive financial behaviors of tomorrow. I still believe that spending cuts are less likely to be enacted over top of tax increases. I also believe that the current administration will continue to try to use the Keynesian economic policies to move the economy forward. These policies, instituted after the Great Depression, caused a prolonged period of slow economic recovery. If it were not for WWII, the economic malaise might have continued into the 1950s.
The other side of the spending cuts coin is the entitlement programs that have increased exponentially during this current administration’s watch. Part of this is due to the aging population. However, I just want to focus in on one specific area of entitlements: food stamps. The Department of Agriculture – Food and Nutrition Service provides the following statistics on the growth of the food stamp entitlement program. The total number of people receiving food stamps has increased from just under 3 million (2,878,000) in 1969 to just under 45 million (44,709,000) in 2011. The average monthly benefit paid out has increased from $6.63 to $133.85 respectively.
As of September 5, 2012 the annual cost of the food stamp program is $71.8 billion. The number of beneficiaries is a incredible 46.67 million, which is 14% of the population. The broader picture of entitlement spending is that a number of beneficiaries receiving food stamps are likely to be receiving other forms of government assistance including housing and unemployment benefits. Spending cuts cannot simply be focused on defense and bio-tech research. It also has to be focused on entitlements. And the best thing that you can do is to avoid putting yourself in the position of having to depend upon the government. I have a special needs child and I refuse to apply for government programs so long as I am blessed enough to be able to physically work and provide for my family. And that means that if I needed to work two or three jobs, I would do it.
Finally, the last threat is the current national debt. The current mentality is that a “balanced approach” of tax increases and spending cuts will result in enough free cash flow to pay down the debt. It is an historical fact that raising taxes has a suppression effect on economic growth. It is also an historical fact that spending cuts, which are really nothing more than a smaller increase than the recommended increase, is still an increase and still adds to the annual deficit. Thus, the national debt might not increase as fast as it would have, but it will still increase. It basically comes down to this. The debt cannot be fixed with spending cuts and tax increases alone. Taxes increases without spending cuts will lead to more debt. Spending cuts with tax increases will have a suppression effect on any economic growth, thus resulting in a growing national debt. Spending cuts without tax increases provide little to no economic advantage because cuts to budget that is nothing more than a reduced level of increased spending still adds to the deficits and thus to the national debt.
So what is the answer? For starter, a four legged stool does not stand evenly when one of the four legs is shorter than the others. It can stand, however, if the burden it is supporting shifts in the wrong direction, then the stool will buckle under the weight. The answer to the fiscal fiasco is as complex as the problems that need to be solved. If you are going to shorten one leg of the stool in the attempt to stimulate the economy then you have to shorten them all to maintain balance. Cut spending, cut regulations, and cut taxes. Ultimately you will reduce the debt. Unfortunately, this administration believes that they need to lengthen the legs of the stool. If one leg is lengthened more than the others the stool remains unbalanced. Lengthening one leg requires that you lengthen all to maintain balance. This administration believes that increased spending, increased taxes, and increased regulation will ultimately reduce the debt. That makes no mathematical sense at all.
In light of this economic environment, I suggest that you cut your spending and reduce your debt burden. Set a goal to save up to 25% of your income. You might have to say no to some good things. But saying no to some good things now allows you to say yes to some excellent things later. Adopt a long-term perspective and do not be shaken by day to day events except to measure the broader picture in relationship to the future. You need to make a number of little adjustments over a long period of time to achieve sustainable change. Achieving sustainable change will ultimately position you to live above the day to day economic challenges of the fiscal fiasco.