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Farrell: Fear of fiscal cliff can be hazardous to your wealth

  • Article by: CHRIS FARRELL
  • December 8, 2012 - 3:23 PM

For much of the past week I've spent way too much time watching evening cable television news shows hyperventilate over the impending fiscal cliff. Don't get me wrong: It's a really bad idea to saddle a still-anemic economy with $500 billion to $700 billion in tax hikes and spending cuts starting next month.

The message in much of the frenzied commentary was that the average investor is going to get hammered -- deal or no deal. You have to do something to protect your money, right?

I don't think so. The tax situation for 2013 could change dramatically, or not. Yes, I've read stories with all kinds of scary arithmetic about deductions, capital gains and ordinary-income rates. Problem is, no one making those calculations knows what's going to happen.

That said, the lesson in the current frenzy is that the typical household and average investor shouldn't do much, if anything, in response. Despite the looming fiscal cliff, upheaval in the Middle East and the ongoing euro mess, the Standard & Poor's 500 index is down only 3.3 percent from its cyclical high reached in September, notes economist Ed Yardeni. For another, rash decisions made at moments like this usually don't pay off.

What should you do? Basically, what you did last year, the year before that, and so on: Traditional year-end tax preparation. For example, I'd make sure you've taken maximum advantage of any deductions available to you, like the deduction for charitable giving. Check to see if you've taken full advantage of your 401(k) and other employer-sponsored retirement savings plans. If you have taxable investment accounts, cull through your investments to see if there are positions you want to sell and reap capital gains, perhaps offsetting the gain with capital losses.

Higher-income individuals -- joint filers with an adjusted gross income of $250,000 ($200,000 for single filers) -- confront some more difficult questions. Odds are they'll end up paying more in taxes next year, especially since most will face a 3.8 percentage-point Medicare surtax on investment income.

Yet even here the uncertainty about the eventual fiscal cliff deal suggests sticking with business as usual. For example, high-income families often have to decide whether to accelerate or delay bonus-type payments or capital gains. The question about taking capital gains now (when rates are lower) vs. waiting (when rates will be higher) is a tougher one, especially for the truly wealthy who earn mostly investment income. Yet there's wisdom in an old tax adage: Judge an investment first by its underlying economics and only afterwards take taxes into account.

Also, I'd keep adding to your savings, even if that means cutting back on holiday spending. You can't control what Washington does or doesn't do. You can't predict the stock market or the business cycle. But you can control your spending.

Chris Farrell is economics editor for "Marketplace Money." His e-mail is cfarrell@mpr.org.

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