From Jeff Bush The views and opinions expressed in this presentation are those of the author and presenter and do not necessarily reflect the views and opinions of the sponsoring companies or their affiliates. Disclosure Neither Andrew Friedman, Jeff Bush, nor any law firm with which he may be associated, is providing legal or tax advice as to the matters discussed herein. The discussion herein is general in nature and is provided for informational purposes only. There is no guarantee as to its accuracy or completeness. It is not intended and may not be regarded as legal or tax advice, and financial advisors and other recipients of this information may not rely upon it (including for purposes of avoiding tax penalties imposed by the IRS or state and local tax authorities). Financial Advisors should consult with their firm s legal and tax counsel as to matters discussed herein. Clients should consult their own legal and tax counsel before entering into any investment, annuity, estate planning, or trust arrangement, and financial advisors should advise their clients to do so. Copyright Andrew H. Friedman 2011. Printed by permission. All rights reserved. 1
Value of Advice is Temporal Clarity of Purpose 2
Agenda Critical Period of Clarity Current Discussions Advice Today For Client Solutions Critical Period of Clarity Clarity of Purpose 3
2010 Election Net effect, more polarized Washington D.C.. Consensus required to move any legislation. - Republicans control the House and have votes to block action in the Senate. - Democrats hold majority of the Senate and have the veto power of the White House. Deficit Outlook (in billions of dollars) 2008 budget deficit $ 455 2009 budget deficit $ 1,400 2010 budget deficit $ 1,300 2011 budget deficit (estimate) $ 1,300 2011 deficit is almost 9% of GDP Source: Budget of the U.S. Government, Mid-Session Review, Fiscal Year 2012, Office of Management & Budget (Aug. 2011) 4
Deficit Reduction Our nation is on an unsustainable fiscal path. Even after the economy recovers, federal spending is projected to increase faster than revenues. The Moment of Truth Report of the National Commission on Fiscal Responsibility (December 2010) 2011 Federal Spending ($3.6T) (in billions of dollars) Domestic $477 (13%) Defense $835 (23%) Mandatory Programs (Entitlements) $2,102 (58%) Interest $216 (6%) Source: Budget of the U.S. Government, Fiscal Year 2012 5
Mandatory Spending Programs (Entitlements and Interest) Mandatory spending (2011): $3.6T total federal expenditures x 64% = $2.3 trillion Federal tax revenues (2011): $3.6T federal expenditures - $1.3T deficit = $2.3 trillion Source: Budget of the U.S. Government, Fiscal Year 2012 Political Impediments Obama pledge not to increase taxes on families earning < 250K Republican pledge not to increase taxes on anyone Democrat unwillingness to cut retiree benefits 6
Deficit Reduction Panel Report Large debt will put America at risk by exposing it to foreign creditors. In a worst-case scenario, investors could lose confidence that our nation is able or willing to repay its loans possibly triggering a debt crisis that would force the government to implement the most stringent of austerity measures. The contagion of debt that began in Greece and continues to sweep through Europe shows us clearly that no economy will be immune. If the U.S. does not put its house in order, the reckoning will be sure and the devastation severe. The Moment of Truth Report of the National Commission on Fiscal Responsibility (December 2010) Standard & Poor s We believe there is at least a one-in-three likelihood that we could lower our long-term rating on the U.S. within two years. Standard & Poor s Research Update (April 18, 2011) There is at least a one-in-two likelihood that we could lower the long-term rating on the U.S. within the next 90 days. Standard & Poor s Research Update (July 14, 2011) 7
Current Discussions We have entered into a new phase of the crisis that I would term the political phase, where hard political decisions need to be made because the window for substantial policy action is closing. Time is of the essence. IMF Spokesperson June 16, 2011 2011 Decision Points 2011 federal budget - Government shut-down averted with agreement on $38B of spending cuts 8
Borrowing Limit (Final Plan) Permits President ultimately to increase debt limit by $2.1T, sufficient for borrowing through 2012. Enacts $900B in spending cuts over ten years, beginning i in 2012. Includes $350B in defense cuts. Forms 12 member bipartisan, bicameral Congressional committee to identify at least $1.2T in additional cuts. - Committee must produce plan by mid-november 2011. Congress would vote on plan in up-or-down vote by year-end. Borrowing Limit (Final Plan) If committee fails to identify at least $1.2T of cuts, acrossthe-board spending cuts of $1.2T would be imposed automatically, beginning in 2013 ( sequestration ). - Cuts split equally between national security and domestic programs. - No cuts in Social Security or Medicaid. - Medicare cuts may only affect supplier reimbursements, not recipient benefits. 9
Borrowing Limit (Final Plan) No meaningful changes to entitlements or taxes, unless committee agrees. - Spending cuts would take effect in 2013, when the Bush tax cuts are slated to expire. Expiration of Bush cuts would raise $3.5T. (Expiration of cuts for families with income > 250K would raise $1.8T.) Savings $210B per year. Standard & Poor s The downgrade reflects our opinion that the [debt limit] plan falls short of what [is] necessary to stabilize the government's medium-term debt dynamics. The effectiveness, stability, and predictability of American policymaking and political institutions have weakened at a time of ongoing fiscal and economic challenges. Elected officials remain wary of tackling the structural issues required to effectively address the rising U.S. public debt burden in a manner consistent with a 'AAA' rating. Republicans and Democrats have only been able to agree to relatively modest savings on discretionary spending. New revenues have dropped down on the menu of policy options [and] the plan envisions little change in entitlements, the containment of which [are] key to long- term fiscal sustainability. Standard & Poor s Research Update (August 5, 2011) 10
China s Reaction China, the largest creditor of the world's sole superpower, has every right now to demand the United States to address its structural debt problems and ensure the safety of China's dollar assets. The U.S. government has to come to terms with the painful fact that the good old days when it could just borrow its way out of messes of its own making are finally gone. Chinese Government News Agency (Xinhua) August 5, 2011 Jobs Short Term vs. Long Term Dilemma: Deficit cutting is anti-jobs in short & intermediate term. Long term- smaller government absorbs less resources which could foster economic growth. Stimulus is pro-jobs in short & intermediate term. Long term- higher debt, exposed to higher (normalized) interest rates puts further pressure on economic growth. 2009 stimulus worked only as long as it continued. 11
Jobs Obama proposal ($450B): Senate proposal- 5.6% Millionaires tax Spending on infrastructure, state aid, and expanded unemployment benefits. Reducing the 2012 Social Security tax rate for both employers and employees to 3.1%. Cost of reduction in 2012 exceeds savings from debt ceiling deal. Republican proposal: reduce government regulation and spending. Republicans won t agree to additional spending Republicans may agree to temporary reduction in Social Security taxes. Taxes The Bush tax cuts expire as of 1/1/2013, the same date that the spending sequester would go into effect. These two events together will force balanced deficit reduction. Absent a balanced deal, it would enable the President to use his veto pen to ensure nearly $1 trillion in additional deficit reduction by not extending the high-income tax cuts. White House Fact Sheet, July 31, 2011 12
Taxes Bush tax cuts expire by their terms at the end of 2012. Heath Care Reform law imposes new 3.8% tax on taxable investment income (interest, dividends, capital gains, etc) for families with AGI > $250K, beginning in 2013. Estate tax rate (35%) and exemption ($5M) expire by their terms at the end of 2012. Taxes If Congress does not act, tax rates increase across the board. - The top tax rate on ordinary income rises from 35% to almost 44% -- an increase of almost 25%. - The top tax rate on capital gains rises from 15% to almost 24% -- an increase of almost 60%. - Top dividend tax rate increases from 15% to almost 44% -- an increase of almost 300%. - Estate tax exemption drops to $1M and rate rises to 55% -- an increase of over 55%. Increase has reduced effect on AMT taxpayers. 13
Advice Today for Client Solutions Investment Planning Consequences of High Federal Deficit Slower U.S. growth Greater inflation Decline in value of U.S. dollar against currencies of stronger countries Possible increase in interest rates Higher taxes Curtailment t of Social Security and Medicare benefits for recipients currently under or about age 55 See Federal Reserve Chairman Ben S. Bernanke testimony before the Senate Budget Committee (Jan. 2011) 14
Investment Planning Possible Concepts Emerging market equities U.S. multinationals with significant emerging market operations Emerging market debt as hedge against declining dollar Investments that take advantage of or hedge against rising interest rates and inflation Investment Planning Possible Concepts Prepare for higher taxes - Dissolve concentrated positions - Municipal bonds - Equities - Gifting Investments that provide retirement income guarantees 15
Retirement Planning Retirees are losing access to guaranteed lifetime income from traditional sources their employers and the government. Employers have eliminated defined benefit plans, particularly in the wake of a 2006 law that required them to fully fund the plans. Entitlement reform may reduce or eliminate Social Security benefits, particularly for affluent investors. Goal is to provide many 401(k) and IRA holders with a defined benefit-type type arrangement to help alleviate concern about asset value decline and longevity. Source: Washington Post, Oct. 8, 2008 Potential Action Step Purchase annuity to simulate defined benefit plan by providing lifetime income. - Annuity with guaranteed income rider can provide downside protection, potential equity upside, and death benefit for next generation. - Annuity guaranteed income rider can provide floor on retirement income notwithstanding poor investment performance. Note: All guarantees are based on the financial strength and claims paying ability of the issuing insurance company, which is solely responsible for all obligations under its policies. Purchasing an annuity within a tax-deferred account such as an IRA provides no additional tax savings. Therefore, IRA funds should be used only if the investor can benefit from annuity features other than tax deferral. 16
Gifting to Irrevocable Trust In 2011 and 2012, individual may transfer up to $5M aggregate to irrevocable trust without gift tax. - $5M limit is reduced by gifts made in prior years. - Estate tax exemption is reduced by amount of lifetime gifts. Trust pays discretionary income to spouse or to children during life. Corpus (principal) then passes to children or grandchildren. Removes future asset appreciation from estates of transferor and income recipient. Irrevocable Trusts Income Taxation Trust pays tax annually on undistributed income at highest rates (currently 35% on ordinary income, 15% on long-term capital gains and qualified dividend id d income). Important to invest trust assets in a tax-efficient manner. - Examples: Tax-exempt bonds, equities, life insurance, annuities. 17
Irrevocable Trust - Investing Spouse needs income - Annuity with guaranteed income rider Spouse does not need income - Life insurance - Annuity with enhanced death benefit rider Spouse sometimes needs income - Annuity - Life insurance You Are Your Client s Financial Pilot 18
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