Successful
Investing
New Tax Rules Will Help Most Of Us
by Andrew Leckey
It's
true that the $1.35 trillion tax law has more phase-ins and phase-outs
than the program schedule for a last-place television network.
But, despite the complexity
and negative impact on the government surplus, these tax changes
will put more money in everyone's pockets during a time of economic
weakness. An estimated $100 billion will be added to the disposable
income of Americans in the fourth quarter, half of which is likely
to be spent.
With an army of Baby
Boomers marching toward retirement, the new rules also made it
a priority to boost the use of retirement accounts and to permit
people to save more for their children's educations. While no
one should go overboard in exaggerating their role as a panacea
for all financial woes, the changes do look like a plus for the
stock market.
"These tax rules
will help the economy and profits while encouraging a bull market
strategy, which is good news for stocks," believes Hugh
Johnson, chief investment officer with First Albany Corp. In
Albany, N.Y. "On the other hand, the changes will reduce
the federal government surplus and possibly move us to deficit
position in 2005, which is bad news for bonds."
Consumer cyclical stocks
such as Harley-Davidson (HDI) and Home Depot (HD), industrials
such as General Electric (GE) and, a bit down the line, technology
stocks should benefit all from the tax cut, Johnson predicts.
Emphasize stocks that
will benefit from a new bullish sentiment, rather than the defensive
issues that have been popular lately.
"If you were waiting to buy stocks until the economy showed
evidence of turning around, the new tax rules mean you ought
to start investing now," added Alfred Goldman, chief investment
strategist with A.G. Edwards in St. Louis. "It's very basic
that you're going to have more money, which will help consumer
confidence and market psychology."
While Goldman expects
all stocks should benefit from the fact American consumers have
$200 to $600 more in their pockets, those of fast food restaurants
and retail stores companies will probably benefit first.
Meanwhile, due to lower
individual tax brackets, it's likely state and local governments
will have to start paying higher interest rates on municipal
bonds because the taxable bonds they compete with won't have
as heavy a tax burden as in the past.
"The most important
change in the new tax law is that Individual Retirement Account
contribution limits will go up, affecting everyone who has income,"
said Nick Kaster, senior analyst with the CCH Incorporated tax
information publisher in Riverwoods, IL. "However, this
also means people are going to have to regularly revisit their
financial plan because there are changes in the allowable IRA
amount every year."
Here are the important
changes in retirement savings:
- Traditional and Roth IRA contribution limits will increase to $3,000 for 2002 to 2004; $4,000 for 2005 to 2007; and $5,000 for 2008 and beyond, with increases for inflation. Those over 50 can contribute an additional $500 a year into either type of IRA starting next year, and $1,000 over the cap starting in 2006, putting the total then at $5,000.
- Limits for 401 (k) plans will increase to $11,000 for 2002; $12,000 for 2003; $13,000 for 2004; $14,000 for 2005; and $15,000 for 2006 and beyond, indexed for inflation. Employees over 50 years of age can make catch-up contributions by adding an extra $1,000 next year, an amount that gradually rises to an additional $5,000 a year in 2006.
- As of next year, 401(k) matching contributions made by an employer must become fully available to the account-holder after three years of service, or after six years if the employer contributions vest gradually. Current vesting rules specify five and seven years respectively. Good old-fashioned tax planning comes into play, as it always does when rules change.
"Because
tax rates are going down, we suggest that people accelerate their
deductions and defer their income," counseled Martin Nissenbaum,
national director of personal income tax planning for Ernst &
Young in New York. "That, for example, means prepayment
of investment expenses such as subscriptions this year, so you
get more bang for your buck while the tax rate is higher."
Education IRAs have become much more attractive, Nissenbaum noted,
with the ability to put aside $2,000 annually for each child
starting next year, rather than the current $500. These can now
also be used for primary and secondary school and to pay for
computers and Internet access. New rules cap the income level
that would qualify for this plan at $110,000 for a single parent
or $220,000 for a married couple, up from the current $95,000
and $190,000 respectively.
Another education plus:
Next year there will no longer be federal taxes on the state
tuition programs known 529 State Savings plans. Withdrawals are
currently free from state taxes but subject to federal tax at
the student's rate. Such plans have no income limit. It will
also be easier to switch from one state's plan to another, and
the concept has been extended to allow colleges to set up programs
themselves.
Editor: Andrew
Leckey's column, "Successful Investing" appears regularly
in the print version of The Bull & Bear Financial Report.
