U.S. Election: Prepare Now for Potential Tax Shifts
Our analysis explores how potential post-election tax policy changes might impact dividends, capital gains, and municipal bonds and how investors might prepare for different election outcomes.
- Equity Insights
- Portfolio Construction
- Index Equity Strategy
- Tax Advantaged Equity Strategy
Key Points
What it is
We examine how potential post-election tax changes might influence dividends, capital gains, and the appeal of municipal bonds.
Why it matters
With election decisions on the horizon, investors may want to explore various tax-efficient options that support their long-term portfolio objectives no matter the election outcome.
Where it's going
Potential changes in tax policy after the U.S. election could reshape the investment landscape, highlighting the need for investors to review their portfolio strategies.
As the U.S. election nears, investors may want to consider potential tax policy scenarios based on different election outcomes, especially with the scheduled to end in 2025. The makeup of the White House and Congress will likely determine how tax and other policy decisions are resolved. To prepare, investors should evaluate the impact of different election outcomes relevant to their individual circumstances. Let’s take a closer look.
Higher tax rates lead to lower after-tax returns for taxable investors, assuming other factors remain constant. The impact can be directly seen in dividends, where a higher rate leads to a lower net dividend received. Increased capital gains taxes also impacts returns, but depends on variables like unrealized gains and losses, portfolio turnover, and market performance. However, taxes are just one part of a total return. Holding onto investments can defer gains but may introduce risks like tracking error against a benchmark or an overconcentrated portfolio. If capital gains taxes rise, selling assets becomes more costly while realizing losses becomes more beneficial. Carefully assessing these tradeoffs at the individual security, and the aggregate portfolio level, can help investors make strategic adjustments as needed.
While it may be premature to act before tax policies of the next administration are clear, investors may question if they should realize long-term gains prior to a potential increase in the capital gains tax. The answer depends on several variables and investor-specific details such as estimated market returns, time horizon, cash needs, and diversification needs. Historically, we’ve found that the results are highly dependent on inputs such as market rates of return and future cash flow needs. Because predicting these factors is challenging, we recommend a thorough analysis of each investor’s unique situation.
Since municipal bonds are exempt from federal taxes, an investor’s marginal tax rate plays an important role in their relative appeal. This rate directly determines the pretax yield a municipal bond would offer if it were taxable, making its yield comparable to taxable bonds. As a result, the tax-equivalent yields for municipal bonds are higher than their actual yields. This tax advantage means that all else being equal, a higher income tax rate actually increases the relative attractiveness of municipal bonds compared to taxable alternatives.
As the U.S. election decision approaches, potential tax changes could reshape after-tax returns, capital gains strategies, and the relative appeal of investments like municipal bonds. With uncertainty surrounding the tax landscape, we encourage investors to begin thinking about the impact of to tax law on their portfolios.
The Tax Cuts and Jobs Act, passed in 2017, reduced corporate taxes, increased individual deductions, and capped the state and local state deduction. Many of the individual tax cuts are set to expire in 2025, which could lead to future tax changes.
Main Point
How Potential Post-Election Tax Changes Could Impact Portfolio Strategies
Potential tax changes post-election could alter market dynamics. While the specifics are still uncertain, reviewing how possible tax shifts may impact dividends, capital gains, and municipal bonds can help investors navigate portfolio strategies going forward.
Mary Lukic, CFP
Head of Tax-Advantaged Equity
Mary Lukic heads the tax-advantaged equity portfolio management team, which is responsible for tax-managed, dividend, ESG (environmental, social and governance) and quantitative active strategies. She is also a senior portfolio manager on the global equities investment team. Mary has extensive experience providing custom equity solutions to high-net-worth families, nuclear decommissioning trusts, settlement trusts, insurance companies, and other taxable and tax-exempt investors.
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