Morningstar Advisor - Fall 2008 - (Page 39)

their ordinary income-tax rate. Starting in 2010, the $100,000 income limitation is lifted. Plus, there is an added benefit. Taxpayers making Roth conversions in 2010 can spread the tax bite over two years, paying half in 2011 and half in 2012. The downside is that tax rates are likely to be higher by 2010. Still, planners expect a boom in Roth conversions as clients look to take advantage of lower tax rates. The major attraction of a Roth is that the investor pays no federal tax when the money is withdrawn upon retirement. A client aged 60 in the 35% tax bracket has a break-even point of about 15 years on a Roth conversion, earning 3% compounded annually. (At 5%, the break-even is even less--nine years.) In other words, it will take at least that much time to make back the tax paid, says Janet Briaud, CEO of Briaud Financial Planning in Bryan, Texas. “If your tax rate remains the same, over the time it makes sense to make the conversion,” Briaud says. Briaud, who has a lot of clients who are professors at Texas A&M, says taxes are a concern but she is more worried about deflation, given the current economy. “We are seeing housing prices falling and wages aren’t going up,” Briaud says. “The airlines are cutting prices because they can’t fill enough seats. Individuals are going through a period where they need to deleverage their balance sheets. Right now is a good place to be in cash and fixed income.” Briaud says that the portfolios she manages are 10% in gold, 10% in oil and gas, 10% (down from 20% recently) in Treasury Inflation-Protected Securities, and 60% in fixed income. “I am bearish,” she says. “We are in a ‘winter’ market, and when you have profits, you need to take them.” K Mark W. Tatge, a former bureau chief and editor at Forbes, teaches at Ohio University’s EW Scripps School of Journalism. Our $53 Trillion Problem By Mark W. Tatge Just how big a drag on the economy is a federal budget deficit of $500 million or even $1 trillion when the U.S. economy measures $14.2 trillion? Twenty years ago, the United States racked up record deficits only to see surpluses and economic prosperity a decade later. The White House budget office recently estimated the federal deficit for fiscal 2009 at $482 billion, or 3.3% of gross domestic product. The deficit would be a record in absolute terms. But when accounting for the overall size of the economy, the 2009 deficit will be significantly below the 1983 record when the deficit accounted for 6% of GDP. Former U.S. comptroller general David Walker says that those looking at the federal debt in that context are missing the severity of the problem. “The U.S. is $53 trillion in the hole,” Walker says. What’s Walker talking about? A $53 trillion federal debt that increases by about $3 trillion annually because of the interest costs—obligations Walker says are seldom talked about in Washington, where the focus is more on annual budget deficits. “We are looking at about drawing an awareness to this problem,” says Walker, who now runs the nonprofit Peterson Foundation and is crusading for government financial responsibility. Walker offers this breakdown of the federal debt: $34 trillion in unfunded Medicare obligations, of which $8 trillion is the new prescription drug benefit that was supposed to save money, another $11 trillion in liabilities and public debt, and $8 trillion in unfunded Social Security obligations. “The government is totally irresponsible, and it is a setting a terrible example for Americans,” he says. Walker says that if the government wants to fund “off-balance-sheet liabilities” like Social Security, perform financial bailouts, and keep spending at the current rate (20% of GDP) without running deficits, taxes will have to double in the next 25 years. Without spending cuts, higher taxes, or both, the biggest challenge for the president will be figuring out how to pay for commitments that the government has made to Social Security and Medicare recipients without running up huge deficits. The impending retirement of 76 million baby boomers, who account for 25% of the U.S. population, threatens to sink Social Security and Medicare on several fronts. As baby boomers retire, they stop paying Social Security wage taxes, and that system is already underfunded. Once they begin drawing Social Security, Medicare, and Medicaid, the systems will face financial strain. The three programs already account for 42% of the federal budget, a figure that is expected to rise as this demographic wave moves through the retirement system. Assuming that the growth rate of health-care costs does not slow, Medicare and Medicaid will grow by nearly four times as a share of the economy (GDP) by 2050, according to the bipartisan Concord Coalition in a report it headlined, “A Fiscal Wake-Up Call.” If retirement and health-care programs are allowed to grow on autopilot, federal spending will rise to 30% of GDP or higher. Couple that with Americans’ reluctance to pay taxes above 20% of GDP—federal tax receipts have averaged 18.2% of GDP over the past 40 years—and you have a recipe for fiscal disaster, the Concord Coalition report says. A deficit equaling 10% of GDP is equivalent to $1.4 trillion, or roughly half of today’s federal government spending, or more than eight times the size of 2007 federal deficit (1.2% of GDP). “It would be impossible to carry that level of debt year after year without stifling the economy,” the report says. MorningstarAdvisor.com 39 http://www.MorningstarAdvisor.com

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Morningstar Advisor - Fall 2008 Contents New on MorningstarAdvisor.com Letter from the Editor Contributors Inbox Are You Preparing for Higher Taxes? State of Financials Oracles of Alabama Investment Briefs Managers’ Investment Secrets Revealed Conformity Becomes a Growing Concern at American Gimme Shelter Location, Location, Location Rooted in Buffett, Going for Growth Keeping Little Company Away from the Numbers Consumer Confidence What about Natural Gas? TIPS to Beat Back Inflation Investing in Hidden Assets Funds That Have an Edge Come Tax Time Mutual Fund Analyst Picks 50 Most Popular Equity ETFs Undervalued Stocks Most Popular Variable Annuities New at Morningstar One for You, 19 for Me

Morningstar Advisor - Fall 2008

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