Some financial advisers say savers who have relied on high interest rates over the past few years may be in for a shock.
Not only will their cash profits likely be lower following the Fed’s recent interest rate cuts, but the interest they earn could be taxed even more as the Trump tax cuts expire at the end of next year. There is sex.
“Raising income taxes means less money coming into your paycheck,” said Brian Large, a partner at Lennox Advisors. “Lower interest on cash means you lose out on profits, and in addition, (that lower) interest will be taxed at a higher rate. This will impact savers overall. ”
What is the Trump tax cut?
The Tax Cuts and Jobs Act of 2017 (TCJA), also known as the Trump tax cut, was the largest overhaul of the tax code in 30 years. This included extensive tax cuts for businesses and individuals. Many individual benefits expire at the end of 2025.
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One of the most important changes for most Americans is the reduction in income tax rates. The top tax rate decreased from 39.6% to 37%, 33% to 32%, 28% to 24%, 25% to 22%, and 15% to 12%. The minimum tax rate remained at 10% and the 35% tax rate remained unchanged.
If the income tax cuts are not extended, the affected classes will return to pre-TCJA levels.
“At the end of the day, almost everyone’s tax rate is going to go up,” said Mark Steber, chief tax officer at tax preparation firm Jackson Hewitt.
Why is the savings rate declining?
The Fed is focused on keeping the labor market strong as inflation continues to decline.
Job growth has slowed this year as 23 years of high interest rates have slowed the economy and slowed the pace of price rises. To stimulate the labor market, the Fed cut its benchmark short-term federal funds rate by 0.5 percentage points in September for the first time in more than four years.
Banks quickly followed suit, lowering the interest rates they pay customers who hold cash in savings accounts, money market accounts, and certificates of deposit (CDs).
As economists predict further interest rate cuts in the coming months, savers who have previously collected up to 5% interest on their cash risk-free will look elsewhere for similar returns. There will be a need, Raj said.
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How can Americans fight higher taxes and lower interest rates?
First, Americans should consider accelerating their income in 2024 and 2025, if possible, to take advantage of their current income tax rate before the potential tax increase in 2026. advisors said.
Nayan Rapshiwala, director of wealth management at Aspiriant, said retirees, for example, may have wanted to withdraw a little more than their required minimum distributions in recent years.
Others may consider converting to a Roth to save money by paying a lower tax rate now and not paying taxes later on when they withdraw from a Roth account, he said.
With yields on fixed-income holdings such as savings accounts, CDs, money market accounts and bonds declining, you should consider moving some cash into stocks, Raj said.
Advisers say stocks typically not only generate higher returns than holding bonds, but also lower taxes on those gains.
Fixed interest rates are taxed as income, but stock profits are taxed as capital gains. Income tax rates are already higher than capital gains tax rates and are likely to rise even higher after 2025, when the Trump tax cuts expire.
For assets held for at least one year, capital gains tax rates currently range from 0% to 20%, while income tax rates range from 10% to 37%.
While it’s true that stocks can carry more risk, advisers say that risk can be reduced by using mutual funds or exchange-traded funds (ETFS), which are made up of different companies and sectors, for example. said.
In the current declining interest rate environment, corporate borrowing costs will increase accordingly. This tends to favor smaller companies that have room to grow and may have greater financial benefits for investors than their larger peers. Raj said if companies can afford to borrow more to invest in their businesses, profits can rise and stock returns can be higher.
Additionally, money market funds hold a record $6.42 trillion, according to the latest data from the Investment Company Institute. Advisers said they expect stocks to benefit as investors seek better returns for their money as interest rates continue to fall.
The best way to invest in small businesses with lower risk is to buy an index like the Russell 2000, which includes companies from a variety of industries, Raj said.
However, this approach may not work for everyone, especially seniors who need regular income. In that case, buy high-quality, high-dividend growth stocks, said Daniel Millan, managing partner at Cornerstone Financial Services. Dividends provide regular income while the stock price increases.
“Dividend growth is the key,” he said. For a dividend to be worthwhile, “the annual dividend growth rate needs to be at least equal to inflation.” Dividends are taxed as income unless the shares are held for at least a specified minimum period (which can vary depending on the situation, but is usually several months). In that case, the dividends will be taxed at the lower capital gains tax rate.
Milan said he expects dividend growth of 7% to 10% per year from stocks with an average annual dividend yield of 3.5% to 4%.
Medora Lee is USA TODAY’s money, markets and personal finance reporter. Please contact mjlee@usatoday.com. Subscribe to our free Daily Money newsletter for personal finance tips and business news every Monday through Friday morning.
