THE SEQUESTER LOOMS

If federal budget cuts occur March 1, how might they be felt economically?

On March 1, $85 billion in federal budget cuts are supposed to take place - and it doesn't look like they will be delayed any longer. Congress went on recess last week, so there was no concerted legislative effort to stave them off (in the manner of the fiscal cliff deal).1

At this point, the cuts seem inescapable. How might they impact Main Street and Wall Street?

Is Main Street all that worried about the cuts? A February Pew Research Center poll found that 29% of Americans didn't even know about the sequester, while 40% said that they should be allowed to happen. Eyeing the poll results a bit more, a big picture emerges - 70% of those polled indicated that legislation to significantly reduce the deficit should be a federal priority.2

Will the cuts damage the economy as deeply as some fear? In the White House Budget Office projection, defense programs will take a 13% cut, with $34 billion in belt-tightening by the Army, Navy and Air Force resulting in layoffs or furloughs for at least 450,000 people. USA TODAY research forecasts nearly 35,000 jobs being lost in Texas, and Maryland, Virginia and Alabama each suffering between 20,000-30,000 job losses.3,4

In addition, the White House projects a 9% reduction in spending for other federal programs, with job cuts or furloughs anticipated for INS, FDA, TSA and FAA employees (and myriad other federal workers), reduced jobless benefits for the long-term unemployed, and layoffs of 10,000 teachers and school employees, including some with the Head Start program.1,3

Less abstractly, what could this hit to growth mean for the business and housing sectors? In a February 21 New York Times article, George Mason University School of Public Policy professor Stephen Fuller estimated that 1.4 million private sector jobs might disappear in the wake of the cuts. Fuller, who testified before the House Small Business Committee on the possible effects of the sequester, thinks that small businesses could let over 700,000 employees go and absorb 34% of the job losses projected for federal contractors. He reminded the Times that suppliers and vendors to those contractors could also be hit hard.5

HUD Secretary Shaun Donovan believes the sequester would be "deeply destructive" to the real estate market. If FHA staff is reduced by 9%, that could hurt the agency's ability to originate loans, process refis and sell foreclosed homes in its possession. (By the way, the average interest rate on a conventional home loan was 3.78% last week, according to the Mortgage Bankers Association. That's a high unseen since August 2012.)6

Or will the cuts have less economic impact than commonly believed? Some analysts think the fear is overblown. As CNBC columnist Larry Kudlow recently pointed out, the $85 billion haircut slated for March 1 is to budget authority, not budget outlays. Actual federal budget outlays, according to the Congressional Budget Office, will only shrink by $44 billion - which is but 0.25% of GDP and 1.25% of the $3.6 trillion federal budget.7

Kudlow notes that while the sequester would trim the growth of federal spending, "it's clear that it won't result in economic Armageddon." He argues that the sequester might actually have positive effects, for as "the government spending share of GDP declines, so does the true tax burden on the economy. As a result, more resources are left in the free-market private sector, which will promote real growth."7

As for the markets, opinion varies. If the cuts occur, Nomura thinks that they will be undone by Congress within weeks. A Wells Fargo analysis concludes that "in the end we are not looking for a significant cut in government spending this year." On the other hand, Credit Suisse sees a 0.5% reduction in U.S. GDP to 1.5%, and Macroeconomic Advisors thinks the jobless rate will creep up to 7.9% by the end of 2013 - a projection matching that of many economists, who see unemployment rising 0.2-0.3% this year with payrolls slimming by about 500,000 jobs.8

March 1 could be a very big day on Wall Street. If the sequestration happens as scheduled Friday, it won't be the only major economic news item on tap: the February jobs report, February's ISM manufacturing index, the January consumer spending report and the final February consumer sentiment index from the University of Michigan will all be out that day. If some of these reports surprise to the upside (or downside), there is a chance that they may pull focus from the (assumed) budget cuts. Or, if the cuts occur as slated, perhaps the market will price them in more than some analysts believe.

If the sequester delivers a serious economic punch, it could deter the Federal Reserve from any notions of phasing out QE3 this year or tinkering with interest rates in 2014. We shall see how the drama plays out in March and the months that follow.

Citations.
1 - online.wsj.com/article/SB10001424127887324449104578314113835559092.html [2/20/13]
2 - www.cbsnews.com/8301-250_162-57570484/poll-40-say-let-the-looming-budget-cuts-happen/ [2/21/13]
3 - www.cbsnews.com/8301-250_162-57570191/will-sequestration-really-be-that-bad/ [2/20/13]
4 - www.usatoday.com/story/news/nation/2013/02/19/army-state-by-state-sequester-details/1931051/ [2/19/13]
5 - boss.blogs.nytimes.com/2013/02/21/many-expect-budget-cuts-to-hit-small-businesses-hard-but-not-the-n-f-i-b/ [2/21/13]
6 - www.cnbc.com/id/100474955 [2/20/13]
7 - www.cnbc.com/id/100476675/The_ProGrowth_Sequester [2/21/13]
8 - www.cnbc.com/id/100475956 [2/20/13]

Sincerely,
William T. Morrissey and Tammy Prouty
Sound Financial Planning Inc.
wtmorrissey@soundfinancialplanning.net
Primary Office
425 Commercial Street, Suite 203
Mount Vernon, WA 98273
Phone: (360) 336-6527
Secondary Office
650 Mullis St., Suite 101
Friday Harbor, WA 98250
(360) 378-3022

PLEASE READ THIS WARNING: All e-mail sent to or from this address will be received or otherwise recorded by the Sound Financial Planning, Inc. corporate e-mail system and is subject to archival, monitoring and/or review, by and/or disclosure to, someone other than the recipient. This message is intended only for the use of the person(s) ("intended recipient") to whom it is addressed. It may contain information that is privileged and confidential. If you are not the intended recipient, please contact the sender as soon as possible and delete the message without reading it or making a copy. Any dissemination, distribution, copying, or other use of this message or any of its content by any person other than the intended recipient is strictly prohibited. Sound Financial Planning, Inc. has taken precautions to screen this message for viruses, but we cannot guarantee that it is virus free nor are we responsible for any damage that may be caused by this message. Sound Financial Planning, Inc. only transacts business in states where it is properly registered or notice filed, or excluded or exempted from registration requirements. Follow-up and individualized responses that involve either the effecting or attempting to effect transactions in securities or the rendering of personalized investment advice for compensation, as the case may be, will not be made absent compliance with state investment adviser and investment adviser representative registration requirements, or an applicable exemption or exclusion. This information should not be construed as investment advice. All information is believed to be from reliable sources; however, we make no representation as to its completeness or accuracy. WE WOULD LIKE TO CREDIT THIS ARTICLE'S CONTENT TO PETER MONTOYA.

THE SURPRISINGLY LARGE IMPACTS OF SMALL SAVINGS

There's an eternal debate about whether you should use an unexpected amount of free cash (bonus? inheritance?) to pay down your mortgage or put the money into a retirement investment account. The numbers on a spreadsheet tend to favor investing the money if the investment returns are higher than the mortgage interest rate (currently in the 3.5% range). But of course there is absolutely no guarantee that this will happen. And some people sleep better when they're debt-free. Can you put the value of THAT on a spreadsheet?


A more interesting discussion is whether you can use some of your lifestyle expenses to pay down your mortgage--and what the value of even small budget cuts would be over time. You can explore this surprisingly fascinating subject on a new website: www.mortgagenudge.com, which lets you look at relatively modest shifts from the expense side of your ledger to your mortgage, and see the long-term results.

As an example, suppose you have a $250,000 mortgage at a 4.5% interest rate. You enter this information into the website, along with your monthly principal and interest payment.

Then you move a little slider that determines how much extra you might be willing to put down on your mortgage each month. For instance, suppose you discover that you're spending $60 a month at Starbucks, when you could be brewing moderately decent coffee at home before your commute to work. Let's say you want to kick the habit gradually, so you start out putting $20.29 extra on your monthly mortgage payment. You agree to find an additional $20.29 a month the following year, which means a little over $40.50 will be paid monthly the next year. Your Starbucks habit will be gone in the third year, when you find those same additional savings to pay down your mortgage. If you get a raise the following year, some of that is added to this payment, and so forth.

When the slider moves, you discover that this modest diversion of lifestyle dollars, over time, pays off your mortgage 7 years and 9 months early, saving you $48,531 in total interest. If you want to be more aggressive, and start off with $26.29 a month--with graduated increases thereafter--your mortgage is paid off nine years and a month early, at an interest savings of $57,131. The slider takes you all the way up to an aggressive $64.29 additional monthly payment in the first year, with increasing payments thereafter. That cuts the 30 year mortgage almost in half, saving more than $92,000 in interest.

The key to making this interesting exercise work in the real world, of course, is discipline; making those additional payments each year like clockwork. You can take some money out of eating out, or the cost of an unnecessary cable TV premium channel that you never watch, or some other service you no longer use--or, instead, when you receive an increase in salary, you can put some of that on the monthly mortgage check. The point here is how substantial some of these smaller incremental adjustments can become over time; a few pennies saved can become big dollars later on.

Sincerely,
William T. Morrissey and Tammy Prouty
Sound Financial Planning Inc.
wtmorrissey@soundfinancialplanning.net
Primary Office
425 Commercial Street, Suite 203
Mount Vernon, WA 98273
Phone: (360) 336-6527
Secondary Office
650 Mullis St., Suite 101
Friday Harbor, WA 98250
(360) 378-3022

PLEASE READ THIS WARNING: All e-mail sent to or from this address will be received or otherwise recorded by the Sound Financial Planning, Inc. corporate e-mail system and is subject to archival, monitoring and/or review, by and/or disclosure to, someone other than the recipient. This message is intended only for the use of the person(s) ("intended recipient") to whom it is addressed. It may contain information that is privileged and confidential. If you are not the intended recipient, please contact the sender as soon as possible and delete the message without reading it or making a copy. Any dissemination, distribution, copying, or other use of this message or any of its content by any person other than the intended recipient is strictly prohibited. Sound Financial Planning, Inc. has taken precautions to screen this message for viruses, but we cannot guarantee that it is virus free nor are we responsible for any damage that may be caused by this message. Sound Financial Planning, Inc. only transacts business in states where it is properly registered or notice filed, or excluded or exempted from registration requirements. Follow-up and individualized responses that involve either the effecting or attempting to effect transactions in securities or the rendering of personalized investment advice for compensation, as the case may be, will not be made absent compliance with state investment adviser and investment adviser representative registration requirements, or an applicable exemption or exclusion. This information should not be construed as investment advice. All information is believed to be from reliable sources; however, we make no representation as to its completeness or accuracy. WE WOULD LIKE TO CREDIT THIS ARTICLE'S CONTENT TO BOB VERES.

TURNING A POT OF MONEY INTO A LIFETIME PAYCHECK

An estimated 10,000 people are retiring every day, and this unprecedented surge of new retirees is expected to last for the next 17 years. Many, perhaps most, will roll their retirement plan assets into an IRA account, and that money--plus Social Security and any taxable retirement accounts they may have--will provide their living expenses for the rest of their lives.


This is different from retirees in the past, who often received regular payments from their defined benefit plans--their equivalent of a retirement paycheck. Millions of new retirees are being required to make a new kind of calculation: how do I translate a lump sum retirement account into sustainable income over the rest of my retirement? For those of us who are accustomed to receiving income throughout our lives, this is not an easy calculation to make.

Suppose, for example, a 65-year-old couple retires, and when their pension assets are rolled into the IRA, they have a total of $4 million between the IRA and their retirement accounts. They can start receiving $1,750 a month from Social Security. With so much money in the bank, they feel comfortable joining an expensive country club, traveling around the globe, and before long, a large recreational vehicle is parked in their driveway. They remodel the kitchen. By age 68, they still have $2.5 million in the bank and back down to spending $170,000 a year. Are they all right, or not?

This is the kind of calculation that financial planners who serve retiree couples wrestle with all day long, and there are few definitive answers. Some of the pioneering research into safe spending in retirement, most notably by Bill Bengen in La Quinta, CA, take into account what is called "sequence risk"--meaning that some unlucky retirees will experience a severe market drop in their early years, which will make it more likely that they'll run out of money before they die. The research assumes that the retired couple wants to raise spending, each year, at exactly the inflation rate, so they maintain spending power. Then it looks at the historical market returns, and identifies a spending level that would have survived even the worst sequence risk scenarios. The answer is between 4% and 4.5% of the retirement portfolio in the first year, with that dollar amount rising with the inflation rate each year.

In our hypothetical retiree example, Social Security is paying for $21,000 of the couple's living expenses, meaning the portfolio has to come up with an additional $149,000, indexed to inflation, for the next 30 or so years. That comes to almost exactly 6% of the remaining portfolio. The couple feels financially solvent, but they are really highly at risk if the market turns down in the next few years.

Other research, notably by Jon Guyton in Minneapolis, MN, has factored in the possibility that a retired couple will be willing to forego inflation increases in years when their retirement portfolio has lost money. This so-called "adaptive withdrawal" strategy allows a retiree couple to raise spending to 4.8% of the initial portfolio. Once again, under this other scenario, our hypothetical couple is in the spending danger zone. And this only covers a 30-year period. People who live longer would need to live on somewhat less--but how do you know how long you'll live?

Others, including Jim Shambo in Colorado Springs, have looked at the Bureau of Labor Statistics research on actual spending in retirement, and found data that questions the assumption that people in retirement only increase their yearly spending by the inflation rate. Shambo found that the government-calculated Consumer Price Index appears to understate actual yearly increases in retirement spending by as much as one and a half percentage points a year--meaning if the CPI goes up by 3%, actual spending may rise by anywhere from 3.25% to 4.5%. Using a more complex calculation, Shambo found that people age 75 and older were spending between 13.2% and 22.07% more than the inflation statistics would indicate.

Of course, all of this research focuses on surviving the worst-case scenario--the times when the markets are least favorable to a comfortable retirement. If the market climate is, instead, sunny during the early years of retirement, if our hypothetical couple happened to retire in the early years of a bull market, then their current spending won't be a problem, and they may actually be able to increase their lifestyle expenditures.

The only way to stay in the safety zone is to have a professional run the numbers every year in light of recent market activity and long-term guidelines, and help you chart a course through the income maze. Converting a portfolio into a paycheck is a surprisingly complex exercise. Ten years down the road, when a few million baby boomers are well into retirement, you may be reading about some of the simple, innocent, tragic mistakes they made with their spending decisions when it felt as if they were flush with cash.

Sources:
http://www.fpanet.org/journal/HowtoAchieveaHigherSafeWithdrawalRate/
http://bit.ly/USWtDF

Sincerely,
William T. Morrissey and Tammy Prouty
Sound Financial Planning Inc.
wtmorrissey@soundfinancialplanning.net
Primary Office
425 Commercial Street, Suite 203
Mount Vernon, WA 98273
Phone: (360) 336-6527
Secondary Office
650 Mullis St., Suite 101
Friday Harbor, WA 98250
(360) 378-3022

PLEASE READ THIS WARNING: All e-mail sent to or from this address will be received or otherwise recorded by the Sound Financial Planning, Inc. corporate e-mail system and is subject to archival, monitoring and/or review, by and/or disclosure to, someone other than the recipient. This message is intended only for the use of the person(s) ("intended recipient") to whom it is addressed. It may contain information that is privileged and confidential. If you are not the intended recipient, please contact the sender as soon as possible and delete the message without reading it or making a copy. Any dissemination, distribution, copying, or other use of this message or any of its content by any person other than the intended recipient is strictly prohibited. Sound Financial Planning, Inc. has taken precautions to screen this message for viruses, but we cannot guarantee that it is virus free nor are we responsible for any damage that may be caused by this message. Sound Financial Planning, Inc. only transacts business in states where it is properly registered or notice filed, or excluded or exempted from registration requirements. Follow-up and individualized responses that involve either the effecting or attempting to effect transactions in securities or the rendering of personalized investment advice for compensation, as the case may be, will not be made absent compliance with state investment adviser and investment adviser representative registration requirements, or an applicable exemption or exclusion. This information should not be construed as investment advice. All information is believed to be from reliable sources; however, we make no representation as to its completeness or accuracy. WE WOULD LIKE TO CREDIT THIS ARTICLE'S CONTENT TO BOB VERES.

WAYS TO SAVE FOR COLLEGE

Comparing & contrasting the potential of some popular vehicles.

How expensive will college be tomorrow? The Department of Education projects that by 2030, the tuition cost of obtaining a four-year degree at a public university will surpass $200,000. Staggering? Indeed, but college is plenty expensive already. In 2012, tuition averaged $15,100 a year at public colleges and $32,900 a year at private colleges.1

A Sallie Mae study finds that today's students, on average, can only pay for 24% of their college expenses. It is little wonder that student loan debt exceeds credit card debt today.1

How can you start saving to meet those costs today? With interest rates being what they are, don't look to a garden-variety savings account. Even if current interest rates soon ascend to 2% or 3%, you would be at a disadvantage even if the bank account was large as tuition costs are climbing more significantly than inflation.

The message is pretty clear: to meet college costs, you need either a prepaid tuition plan or a savings vehicle that taps into the power of equity investing. Let's look at some options.

Prepaid 529 plans. Offered by states and public colleges, these plans let you buy tomorrow's tuition with today's dollars. You purchase X dollars of tuition today, and that is guaranteed to pay for an equivalent amount of tuition in the future.

You can do this in two different ways. Some of these prepaid plans are unit plans, in which you pay for X number of college credits or units now with a promise that the same amount of credits will be covered in the future. In other words, you're locking in tuition at current rates.

As an example, let's say a year of college at Hypothetical State University requires 36 units. Mom and Dad use a unit plan to pay $7,500 for those 36 units now for their 6-year-old daughter. In turn, the plan promises to pay whatever those 36 units cost when she starts her first semester at Hypothetical State 12 years from now, even though it might be much more.2

The other prepaid 529 plan variant is the contract plan, or guaranteed interest plan. In these prepaid plans, you make a lump sum contribution (or arrange recurring contributions), essentially buying X number of years of tuition. In turn, the plan guarantees to cover this predetermined amount of tuition expenses in the future.2

Usually, beneficiaries of prepaid tuition plans must be residents of the state offering the plan, or prospective students of the college offering the plan. In the wake of the recession, some of these plans are not accepting new investors as some states are worried about underfunding.2,3

529 college savings plans. These state savings plans allow you to invest to build college savings rather than simply prepay them. Plan contributions are typically allocated among funds, and possibly other investment classes; the plan's earnings grow without being taxed. The withdrawals aren't taxed by the IRS either, as long they pay for qualified education expenses.2

You can contribute up to six-figure sums to these 529 plans - there's a lifetime contribution limit that varies per state. Most of them are open to out-of-state residents. If the market does well, you can harness the power of equity investing through these plans and potentially make a big dent in college costs.2

There are two caveats about 529 plans. Should you elect to withdraw money from a 529 plan and use it for non-approved purposes, that money will be taxed by the IRS as regular income - and you will pay a penalty equal to 10% of the withdrawal amount. 529 balances can also negatively affect a student's chances for need-based financial aid. In a given school year, that eligibility can be reduced by up 5.64% of your college savings.3

Coverdell ESAs. Originally called Education IRAs, Coverdell Education Savings Accounts offer families some added flexibility: the withdrawals may be used to pay for elementary and secondary school expenses, not just college costs. These are tax-deferred investment accounts, like 529 savings plans. Unfortunately, the current annual contribution limit for a Coverdell is $2,000. Any remaining account balance must generally be withdrawn within 30 days after the beneficiary's 30th birthday, with the earnings portion of the balance being taxable.3,4,5

Roth IRAs. Yes, it is possible to use a Roth IRA as a college savings vehicle. While the IRA's earnings will be taxed, withdrawals used to pay for qualified college expenses will not be taxed and will face no IRS penalty. Additionally, if your son or daughter doesn't go to college or comes into some kind of windfall that pays for everything, you end up with a retirement account. While Roth IRA balances don't whittle away at a student's chances to get need-based financial aid, the withdrawal amounts do come under the category of untaxed income on the FAFSA.3

Life insurance. Some households look into so-called "cash-rich" life insurance - whole or universal life policies - as a means to fund a college education. This requires a big head start, as when you buy one of these policies the bulk of your premiums go toward the life insurance part of the contract for several years and you have yet to build up much cash value. The big feature here is that most colleges don't consider life insurance when evaluating financial aid applications.3

Would a trust be worth the expense? Rarely, families set up tax-advantaged trusts for the purpose of college savings. In the classic model, the family is incredibly wealthy and the kids are "trust-fund babies" bound for elite and very expensive schools. Unless you have many children or your family is looking at potentially exorbitant college costs, a trust is probably overdoing it. The college savings vehicles mentioned above may help you save for education expenses just as effectively, all without the administrative bother associated with trusts and the costs of trust creation.

Citations.
1 - money.usnews.com/money/blogs/my-money/2012/07/25/how-much-will-you-need-to-send-your-child-to-college-in-2030 [7/25/12]
2 - www.axa-equitable.com/plan/education/529-plans/529-vs-prepaid-tuition.html [2011]
3 - money.cnn.com/101/college-101/savings-plan.moneymag/index.html [1/10/13]
4 - money.msn.com/tax-tips/post.aspx?post=9dba01a0-b233-4e6e-97ef-aecbc62188e3 [1/9/13]
5 - www.irs.gov/uac/Coverdell-Education-Savings-Accounts [9/11/12]

Sincerely,
William T. Morrissey and Tammy Prouty
Sound Financial Planning Inc.
wtmorrissey@soundfinancialplanning.net
Primary Office
425 Commercial Street, Suite 203
Mount Vernon, WA 98273
Phone: (360) 336-6527
Secondary Office
650 Mullis St., Suite 101
Friday Harbor, WA 98250
(360) 378-3022

PLEASE READ THIS WARNING: All e-mail sent to or from this address will be received or otherwise recorded by the Sound Financial Planning, Inc. corporate e-mail system and is subject to archival, monitoring and/or review, by and/or disclosure to, someone other than the recipient. This message is intended only for the use of the person(s) ("intended recipient") to whom it is addressed. It may contain information that is privileged and confidential. If you are not the intended recipient, please contact the sender as soon as possible and delete the message without reading it or making a copy. Any dissemination, distribution, copying, or other use of this message or any of its content by any person other than the intended recipient is strictly prohibited. Sound Financial Planning, Inc. has taken precautions to screen this message for viruses, but we cannot guarantee that it is virus free nor are we responsible for any damage that may be caused by this message. Sound Financial Planning, Inc. only transacts business in states where it is properly registered or notice filed, or excluded or exempted from registration requirements. Follow-up and individualized responses that involve either the effecting or attempting to effect transactions in securities or the rendering of personalized investment advice for compensation, as the case may be, will not be made absent compliance with state investment adviser and investment adviser representative registration requirements, or an applicable exemption or exclusion. This information should not be construed as investment advice. All information is believed to be from reliable sources; however, we make no representation as to its completeness or accuracy. WE WOULD LIKE TO CREDIT THIS ARTICLE'S CONTENT TO PETER MONTOYA.

A GUIDE TO 2013 TAX LAW CHANGES

When President Obama signed the fiscal cliff bill into law on January 2, a host of major federal tax changes ensued. Some were long planned, and others occurred to a greater or lesser degree than anticipated. Here are the details on those tax changes and many others - the details taxpayers absolutely need to know for 2013.

The bad news is that Americans are going to see significant tax increases this year. The good news is that some of the tax breaks from 2010-12 were preserved, and a couple of expired tax perks have even been brought back. Estate and tax planning professionals will also be able to assist their clients with more certainty, as some provisions that were once temporary are now permanent.

Reminder: you should consult with a qualified tax or financial professional before making short-term or long-term changes to your tax or financial strategy.

The Major Changes for 2013

1 - The payroll tax holiday is over.
Taxes are going up for most Americans - including the middle class.

In 2013, the payroll tax rate returns to its old level and employees will pay 6.2% in Social Security taxes rather than the 4.2% they paid in 2011-12. This year, individual wages up until $113,700 will be subject to the tax, so the maximum payroll taxes that an individual worker could pay in 2013 top out at $7,049.40.1

2 - The top marginal income tax rate is now 39.6%.
A sixth bracket is back for 2013.

The highest earners will find themselves in it, facing a 4.6% hike from 2012. The IRS has announced the income thresholds delineating the 2013 federal income tax brackets:

Bracket    Single Filers    Married Filing Jointly Married    Married Filing     Heald of Household
                                      or Qualifying Widower               Separately

10%     Up to $8,925             Up to $17,850                      Up to $8,925           Up to $12,750
15%     $8,926-$36,250        $17,851-$72,500                 $8,926-$36,250       $12,751-$48,600
25%     $36,251-$87,850      $72,501-$146,400               $36,251-$73,200     $48,601-$125,450
28%     $87,851-$183,250    $146,401-$223,050             $73,201-$111,525   $125,451-$203,150
33%     $183,251-$398,350  $223,051-$398,350             $111,526-$199,175 $203,151-$398,350
35%     $398,351-$400,000  $398,351-$450,000             $199,176-$225,000 $398,351-$425,000
39.6%  $400,001 or more     $450,001 or more                 $225,001 or more     $425,001 or more

It is possible - albeit remotely possible - that some filers may owe hundreds less in federal taxes for 2013 if this year's COLAs put them the next lowest bracket.2

3 - Estate taxes top out at 40% with a $5.25 million individual exemption.
The less-publicized news: the individual exemption is still portable.

Congress gave families a great estate planning break in the fiscal cliff deal. The portable individual estate tax exemption is no longer a temporary thing; it has been made permanent. This means that an unused portion of a $5.25 million individual exemption may be transferred to the surviving spouse at the death of the first deceased spouse.

You may have read earlier that the individual exemption would be set at $5 million this year. The estate tax exemption is subject to indexing for inflation, and in the fiscal cliff bill, Congress chose to keep and continue the indexing off of the $5 million base from 2011. Thus, we have the $5.25 million exemption amount.

Also, the estate and gift tax remain unified; if you choose, you can use up the whole $5.25 million individual exemption on gifts made during your lifetime.2,3

4 - Investment income taxes are slightly altered.
Dividends will not be taxed as ordinary income.

While that is a huge relief for top earners, their dividends and long-term capital gains will still be taxed more in 2013. Here are the newly adjusted tax rates on both of these forms of investment income.3

10% & 15% brackets                              0%
25%, 28%, 33% & 35% brackets           15%
39.6% bracket                                         20%

5 - Upper-income Americans face two healthcare surtaxes in 2013.
Be mindful of your MAGI this year.

Should your modified adjusted gross income (MAGI) exceed certain thresholds in 2013, you will contend with a new Medicare surtax and an increase in any Medicare payroll tax you pay (which is actually a form of withholding).

* A 3.8% Medicare surtax will be levied on the lesser of either a) net investment income or b) the amount of MAGI exceeding $200,000 for single filers, $250,000 for couples filing jointly, and $125,000 for spouses filing separately.

* While all wage earners routinely pay a 1.45% Medicare payroll tax on earned income, the Medicare payroll tax rises 0.9% for employees after their MAGI exceeds the $200,000 individual threshold this year. Your employer will deduct 1.45% in Medicare payroll taxes from your paycheck up until that threshold, and 0.9% more from your paycheck once your wages surpass it.

If you are married and file jointly, this could get complicated. While your individual MAGI may be $200,000 or less (and therefore below the individual threshold), your joint MAGI might top the applicable $250,000 threshold and that could make the 0.9% surtax kick in.

In regard to these thresholds, remember that the definition of MAGI encompasses many different forms of income: your salary, your adjusted gross income (AGI), RMDs from a 401(k), 403(b) or traditional IRA, "unearned" net investment income (such as net capital gains from the sale of real estate or passive income from a partnership), and any foreign wages eligible for the foreign earned income exclusion.4

6 - The AMT has been permanently patched.
Credit the fiscal cliff deal.

The Alternative Minimum Tax has at last been indexed to inflation due to the American Taxpayer Relief Act of 2012. The fix is retroactive to the beginning of last year, which will spare about 34 million taxpayers from the sting of the AMT as they file 2012 federal returns. The 2013 AMT exemption amounts are:

Single filers                                                    $51,900
Married filing separately                                 $40,400
Married filing jointly/qualifying widower          $80,800

Future AMT exemption amounts will be higher, of course.2,5

7 - Phase-outs of itemized deductions & personal exemptions are back.
A clever method of raising marginal tax rates for high earners.

The Pease limitation and the personal exemption phase-out (PEP) are back permanently; high-income taxpayers haven't seen them since 2010.

For single filers, the threshold for both the PEP and the Pease limitation kicks in at $250,000 of AGI; for married joint filers, the threshold is $300,000 of AGI.

Reinstalling the Pease limitation effectively adds about 1% to the top tax rate. Under the Pease provision, taxpayers with AGI surpassing the above thresholds lose 3 cents of itemized deductions for every dollar of income that exceeds them. So if a single CEO should earn $400,000 in 2013, that CEO's itemized deductions will be reduced by $4,500 this year (3% of the $150,000 of income above the $250,000 phase-out start). For the record, the phase-out is limited to 80% of deductions (a detail irrelevant for almost all taxpayers).

The personal exemption phase-out (PEP) reduces the value of the personal exemption for taxpayers above certain income thresholds. (Last year, the personal exemption was $3,800 for most taxpayers.) This year, the PEP will phase out totally at about $420,000 of AGI for married joint filers.3,6

8 - More employees can go Roth with their workplace retirement plans.
A little-noticed byproduct of the fiscal cliff agreement.

Thanks to the American Taxpayer Relief Act, employer-sponsored retirement plans can now permit plan participants to convert a balance in a non-Roth 401(k), 403(b) or 457 account to an account within the retirement plan that offers a Roth option.

The conversion is permissible at any age and may include all pre-tax salary deferrals. Any account balance so converted must be included in the income of the taxpayer in the year of the Roth conversion.

If an employer-sponsored retirement plan lacks a Roth option, it must add one before any of these in-plan Roth conversions can take place.7,8

Tax Breaks Extended or Reinstated for 2013

9 - Bonus depreciation is still around for 2013.
The Section 179 deduction amount has also increased.

In 2012, businesses could deduct as much as 50% of the cost of their investments in so-called "qualified property" placed into service. "Qualified property" does not include real estate, but it does encompass many forms of new business equipment. (Only new property is eligible for bonus depreciation.) In 2013, businesses can again write off such investments at this accelerated rate thanks to the fiscal cliff bill passed at the start of the year. This may or may not apply in 2014.

The bill also raised the maximum Section 179 deduction amount to $500,000 for both the 2012 and 2013 tax years, with the dollar-for-dollar phase-out kicking in above $2 million.3,7

10 - Short-sale tax relief is again available.
Congress renews the popular deduction for struggling homeowners.

Are you underwater? If you are, you should know that any forgiveness of mortgage debt linked to a short sale (or some other means) won't be considered taxable income this year. This tax break emerged from the fiscal cliff deal. This tax break has also been made retroactively available for 2012.3,7

11 - Marriage penalty relief is permanently extended.
No sunset for this EGTRRA provision.

The American Taxpayer Relief Act of 2012 preserves the doubling of the standard deduction for married couples who file jointly and the enlargement of the 15% income tax bracket for such filers.7

12 - Taxpayers may still (optionally) deduct state & local sales taxes.
Congress has extended this alternative for another year.

This is useful for people who live in Florida and other states that refrain from collecting state income tax. Taxpayers residing in such states can still claim an itemized deduction for state and local sales taxes this year. This tax break is also available for the 2012 tax year.7

13 - The IRA charitable rollover is back.
It may not be too late to arrange one for 2012.

Many charities and donors would like to see this opportunity made permanent. It isn't yet, but IRA owners who are 70½ or older may arrange IRA charitable rollovers this year by asking their IRA custodians to send the amount of the donation directly to a charity or non-profit organization. While you can't get a tax deduction this way, the sum going to charity will not be included in your adjusted gross income. (Don't just take a distribution from your IRA and give the money to charity yourself - then the money will be taxed as regular income.)

According to Forbes, the fiscal cliff deal (which brought back this opportunity) also made it possible for a few IRA owners to make an IRA charitable rollover for 2012 and have it count as part (or even all) of their 2012 RMD. How? This is only possible if a) you delayed taking an IRA distribution until December and b) you donate cash to charity between now and January 31. Be sure to see a qualified tax advisor about this if you are interested.3,9

14 - The Child Tax Credit is preserved at current level.
The same goes for the adoption tax credit & dependent care credit.

These extensions are permanent. EGTRRA altered the CTC in 2001, boosting it to $1,000; it will remain at that amount in 2013. The limit on the dependent care credit this year remains at $3,000 for one child or disabled dependent and $6,000 for two or more, with a phase-out of the applicable credit rate of 35% beginning at $15,000 AGI; there is a 20% applicable credit rate for taxpayers with an AGI exceeding $43,000. The adoption credit (indexed for inflation) is capped at $10,000 in 2013, as is the income exclusion for employer-provided adoption benefits.7

15 - American Opportunity Tax Credit preserved as is.
The valuable education credit is now available through 2017.

This annual credit of up to $2,500 is available to half-time and full-time students for the first four years of college. Had the fiscal cliff deal not happened, it would have had a $1,900 ceiling in 2013 and been available only for two years of post-secondary education. The phase-out range for single filers is between $80,000-90,000, and from $160,000-180,000 for joint filers.10,11

16 - Coverdell contribution limits not reduced.
It may be a shot in the arm for these underutilized college savings vehicles.

The fiscal cliff bill permanently extended the present $2,000 yearly contribution limit on Coverdell Education Savings Accounts. Families have recently used these tax-advantaged investment accounts to save for qualified elementary and secondary school expenses as well as qualified college expenses; it will be that way from now on. The phase-out threshold on these accounts rises to $190,000 this year for joint filers; it remains at $95,000 for single filers.

Without the fiscal cliff deal, Coverdell account assets could have only been used to meet college expenses and the annual contribution limit would have been $500.11

17 - Three other key education tax incentives have been retained.
More tax perks to help students & families.

Taxpayers may take an above-the-line deduction for qualified tuition and related expenses for the 2013 (and 2012) tax years, subject to phase-outs. The deduction limit is $4,000 for households with incomes of $65,000 or less ($130,000 for joint filers). The deduction is retroactively available for 2012.

Second, taxpayers may exclude up to $5,250 of employer-provided education assistance from gross income in 2013 and subsequent years.

Third, the EGTRRA expansion of the student loan interest deduction is now permanent. Individuals who have paid interest on education loans may claim an above-the-line deduction of up to $2,500. The phase-out ranges for this deduction are $60,000 for single filers and heads of household, $120,000 for joint filers.3,7,11

18 - Teachers may again deduct classroom expenses.
A nice break for K-12 educators.

The fiscal cliff bill extended the above-the-line deduction for classroom expenses of elementary and secondary school teachers; it is set at $250 for 2013. The deduction may also be claimed for 2012.3,12

19 - Limit on the Earned Income Tax Credit is higher.
Low-wage tax filers may qualify for this break.

Married couples filing jointly with three or more children may qualify for the maximum EITC for 2013, which is $6,044 (it was $5,891 for 2012). (See a tax professional for full details.)3,5,12

20 - Mortgage insurance premiums are potentially deductible.
This tax break is now scheduled to sunset at the end of 2013.

In 2013, middle-income and lower-income homeowners required to pay for mortgage insurance as a condition of a home loan may be eligible to deduct such premiums.7

21 - Deductions for conservation donations return.
Real property donations to non-profits might qualify for deductions.

In 2011, charitable contributions of real property for conservation purposes could be deducted if the contribution amounted to 50% or less of the donor's total charitable contribution base. This deduction opportunity is available for another year and is retroactively available for 2012. (Some forms of partial interest in real property may also qualify.)3,7

22 - The R&E credit sticks around.
This 32-year-old tax perk gets yet another reprieve.

The American Taxpayer Relief Act extends the R&E credit through the end of 2013. Could it one day be extended permanently? That is anyone's guess.7

23 - Green tax incentives are still available.
Energy efficiency could be rewarded with a federal tax credit.

The ATRA also temporarily extended (through 2013) the $500 credit for taxpayers making energy efficiency improvements, as well as credits for manufacturers of energy-efficient homes and appliances.7

24 - Favorable rules remain for small business stock gains.
These rules will be in place for another year.

For any taxpayer besides a corporation, any gain from the sale or exchange of qualified small business stock held for more than 5 years is 100% excluded from income if the shares are acquired between September 28, 2010 and January 1, 2014.7

25 - Two tax breaks pertaining to S corporations have been extended.
One involves donated property; the other involves the recognition period.

As a result of the ATRA, a shareholder's basis in an S corporation may again be decreased by the shareholder's pro rata share of the adjusted basis of property donated by that S corporation to a qualified non-profit. This tax break is set to sunset at the end of 2013.

The recognition period for built-in gains tax for S corps that were formerly C corps was previously shortened from ten years to seven years with regard to sales of assets in 2009 and 2010, and shortened to five years with regard to sales of assets in 2011. Thanks to the ATRA, a five-year recognition period also applies for sales of assets in 2012 and 2013.7

26 - Employment-based credits have been extended.
They will be available for at least another year.

The Work Opportunity Credit (and the Returning Heroes and Wounded Warriors Work Opportunity Tax Credits) may still be claimed in 2013.7

27 - Baseline for medical expenses deduction rises.
This change doesn't yet affect taxpayers 65 & older.

In 2012, you could claim a tax deduction if your total medical expenses exceeded 7.5% of taxable earned income (minus deductions and exceptions). In 2013, you can only claim the medical expenses deduction if those expenses exceed 10% of your taxable earned income. The good news: if you will be age 65 or older by the end of this year, the 7.5% baseline still applies for you through 2016.13,14

28 - New tax on the price of some medical devices.
Corrective lenses & hearing aids are exempt from it.

This year, a 2.3% federal tax will be added to the price of certain medical devices, including pacemakers, defibrillators, artificial joints and other substantial medical equipment. Basic hearing and vision aids will not be hit with this tax.13

29 - FSA contributions are limited to $2,500 in 2013.
This is the first federally mandated cap for these accounts.

In past years, there was no official limit on Flexible Spending Account contributions, although most employers capped them at $5,000. The new $2,500 yearly limit is per individual, so a married couple can contribute a total of $5,000 to a pair of FSAs this year. FSAs remain use-it-or-lose-it accounts.13,14

Key COLAs for 2013

30 - Standard deduction amounts rise about 2%.

For those who don't want to itemize, the 2013 standard deduction exemption amounts are:

Single filers/married filing separately                      $6,100
Heads of household                                             $8,950
Married filing jointly/qualifying widower                $12,2002

31 - Certain special deduction amounts adjusted.

In 2013, the standard federal income tax deduction for an individual who can be claimed as a dependent is either a) $1,000 or b) the sum of $350 and that dependent's earned income, whichever is greater.

The additional standard deduction amount for the aged or the blind is $1,200 this year, $1,500 if that individual is single and not a surviving spouse.2

32 - Personal exemption amount has risen by $100.

It was $3,800 last year; it will be $3,900 this year. On the downside, it is now subject to phase-outs (refer to item #7 in this guide). The phase-out range (adjusted gross income) runs between $250,000-372,500 for single filers and $300,000-422,500 for joint filers.5

33 - Higher contribution limits for IRAs, 401(k)s, 403(b)s & 457 plans.

The federal government has made the following cost-of-living adjustments (COLAs) to popular qualified retirement plans, increasing the limit on the amount of money an individual taxpayer can contribute to these plans in 2013.15

Traditional & Roth IRAs       $5,500 (up $500 from 2012), $6,500 if 50 or older in 2013

401(k)s, 403(b)s,                 $17,500 (up $500 from 2012), $23,000 if 50 or older in 2013
                                            most 457 plans & the Thrift Savings Plan

34 - Higher phase-outs regarding Roth IRA contributions.

Q: How much money can you make and still contribute to a Roth IRA?

Single filers and heads of household can make a full Roth IRA contribution for 2013 if their MAGI is less than $112,000; the phase-out range is from $112,000-127,000.

For married joint filers, the MAGI phase-out occurs at $178,000-188,000 in 2013; married couples with MAGI of less than $178,000 can make a full contribution.16

35 - New COLAs affect deductions on traditional IRA contributions.

Q: How much money can you make and still deduct some or all of your contribution to a traditional IRA?

Single filers and heads of household who contribute to both a workplace retirement plan and a traditional IRA in 2013 can deduct 100% of their IRA contributions if their MAGI is $59,000 or less. A partial deduction is available to such filers with MAGI between $59,001-69,000.

As for married couples filing jointly, if the spouse making the IRA contribution participates in a workplace retirement plan, the traditional IRA contribution is fully deductible if the couple's MAGI is $95,000 or less. A partial deduction may be claimed if the couple's MAGI is between $95,001-115,000.

If the spouse making a 2013 IRA contribution doesn't participate in a workplace retirement plan but the other spouse does, the IRA contribution may be wholly deducted if the couple's MAGI is $178,000 or less, with the phase-out range from $178,001-188,000.17,18

36 - COLAs for SEPs, SIMPLE plans, & ESOPs.

The IRS has made 2013 adjustments to contribution, compensation and distribution thresholds specific to these plans.19


SEPs                     Maximum compensation of $255,000 (up $5,000 from 2012)

SIMPLE plans     Maximum contribution of $12,000 (up $500 from 2012)
                              (Catch-up contributions remain capped @ $2,500)

ESOPs                  5-year distribution threshold of $1,035,000 (up $20,000 from 2012)
                              Additional year threshold of $205,000 (up $5,000 from 2012)

37 - Limit on annual gift tax exclusion has increased.

After several years at $13,000, it rises to $14,000 for 2013. So this year, individuals may gift up to $14,000 each to as many different people as desired, tax-free.

Gifts that surpass the $14,000 limit may be subject to federal gift tax of up to 40% and count against the lifetime gift tax exclusion, which has increased to $5.12 million in 2012.3,20

38 - "Kiddie tax" exemption amount is $50 higher.

If net unearned income reported on a child's tax return exceeds $1,000 in 2013, the "kiddie tax" will kick in. The exemption was $950 in 2012.

As for the "nanny tax" exemption, it remains at $1,800 in 2013. Any cash remuneration paid by an employer for domestic service in said employer's private home becomes FICA wages above that level. If you pay a maid, au pair, or other domestic employee more than $1,800 this year, you are defined as an employer by the IRS. You are looking at the "nanny tax" and you should read IRS Publication 926 (the Household Employer's Tax Guide) and consult a tax advisor.21,22

39 - More pre-tax salary can be used to pay for commuting costs.

In 2013, the monthly cap on the amount of pre-tax salary that can be assigned to this rises to $245. Take note: the ATRA also retroactively raised the 2012 monthly cap from $125 all the way up to $240.2

40 - Social Security has adjusted its retirement earnings test amounts.

This is no change in tax law, but Social Security recipients need to know about this COLA.

If you receive Social Security benefits and you will be younger than full retirement age at the end of 2013, $1 of your benefits will be withheld for every $2 that you earn above $15,120 (the 2012 limit was $14,640).

If you receive Social Security benefits and reach full retirement age during 2013, $1 of your benefits will be withheld for every $3 that you earn above $40,080 - but that restriction applies only to earnings in the months prior to attaining full retirement age. (The applicable 2012 threshold was $38,880.) There is no limit on earnings starting the month an individual attains full retirement age.

Now, how much of your Social Security income might be taxable in 2013? It depends on your "combined income", which Social Security measures with the following formula:

Adjusted gross income + non-taxable interest + 50% of Social Security benefits = combined income

If your combined income is between the following amounts, you may have to pay federal income tax on up to 50% of your benefits:

Single filers ("individuals")                   $25,000-34,000
Joint filers                                           $32,000-44,000

If it exceeds the following amounts, you may have to pay federal income tax on up to 85% of your benefits:

Single filers ("individuals")                   $34,000
Joint filers                                          $44,000

Those who are married and file separately will "probably" have their Social Security benefits taxed, according to the program's website. The above thresholds are never indexed for inflation; they are the same year after year.1,23,24

As you can see, a number of changes have occurred, some major. If you have any questions or concerns on your mind in the coming year, please contact us.

Citations.
1 - www.ssa.gov/pressoffice/factsheets/colafacts2013.htm [10/16/12]
2 - www.irs.gov/pub/irs-drop/rp-13-15.pdf [1/11/13]
3 - blogs.wsj.com/totalreturn/2013/01/02/what-the-new-law-means-for-taxpayers/ [1/2/13]
4 - www.fidelity.com/viewpoints/personal-finance/new-medicare-taxes [1/4/13]
5 - www.irs.gov/uac/Newsroom/Annual-Inflation-Adjustments-for-2013 [1/11/13]
6 - www.csmonitor.com/Business/Tax-VOX/2013/0108/Why-the-fiscal-cliff-deal-is-an-incentive-to-give-to-charity [1/8/13]
7 - www.jdsupra.com/legalnews/summary-of-income-tax-provisions-in-the-48632/ [1/8/13]
8 - www.jdsupra.com/legalnews/new-law-expands-in-plan-roth-401k-co-03075/ [1/10/13]
9 - www.forbes.com/sites/deborahljacobs/2013/01/02/fiscal-cliff-deal-allows-giving-ira-assets-to-charity/ [1/2/13]
10 - www.clasp.org/issues/in_focus_print?type=postsecondary_and_economic_success&id=0074 [1/4/13]
11 - money.msn.com/tax-tips/post.aspx?post=9dba01a0-b233-4e6e-97ef-aecbc62188e3 [1/9/13]
12 - money.usnews.com/money/blogs/my-money/2013/01/07/fiscal-cliff-averted-what-that-means-for-you-and-your-taxes [1/7/13]
13 - www.cnn.com/2013/01/04/health/obamacare-2013/index.html [1/4/13]
14 - www.forbes.com/sites/kellyphillipserb/2012/11/26/tax-breaks-for-medical-expenses-under-obamacare/ [11/26/12]
15 - www.kiplinger.com/columns/ask/archive/2013-retirement-account-contribution-limits.html [10/23/12]
16 - www.irs.gov/Retirement-Plans/Amount-of-Roth-IRA-Contributions-That-You-Can-Make-For-2013 [11/27/12]
17 - www.irs.gov/Retirement-Plans/2013-IRA-Deduction-Limits-Effect-of-Modified-AGI-on-Deduction-if-You-Are-Covered-by-a-Retirement-Plan-at-Work [11/26/12]
18 - www.irs.gov/Retirement-Plans/2013-IRA-Deduction-Limits-Effect-of-Modified-AGI-on-Deduction-if-You-Are-NOT-Covered-by-a-Retirement-Plan-at-Work [11/26/12]
19 - www.irs.gov/uac/2013-Pension-Plan-Limitations [10/18/12]
20 - www.forbes.com/sites/deborahljacobs/2012/10/18/irs-raises-yearly-limit-for-tax-free-gifts/ [10/18/12]
21 - blogs.wsj.com/totalreturn/2012/10/18/irs-announces-2013-inflation-adjustments/ [10/18/12]
22 - www.frrcpas.com/news-events/news/2012/nanny-tax-threshold-remains-at-$1,800-for-2013.aspx [10/18/12]
23 - www.ssa.gov/planners/taxes.htm [1/14/13]
24 - www.investmentnews.com/article/20121216/REG/312169988 [12/16/12]

Sincerely,

William T. Morrissey and Tammy Prouty
Sound Financial Planning Inc.
wtmorrissey@soundfinancialplanning.net
Primary Office
425 Commercial Street, Suite 203
Mount Vernon, WA 98273
Phone: (360) 336-6527
Secondary Office
650 Mullis St., Suite 101
Friday Harbor, WA 98250
(360) 378-3022

PLEASE READ THIS WARNING: All e-mail sent to or from this address will be received or otherwise recorded by the Sound Financial Planning, Inc. corporate e-mail system and is subject to archival, monitoring and/or review, by and/or disclosure to, someone other than the recipient.  This message is intended only for the use of the person(s) ("intended recipient") to whom it is addressed.  It may contain information that is privileged and confidential.  If you are not the intended recipient, please contact the sender as soon as possible and delete the message without reading it or making a copy.  Any dissemination, distribution, copying, or other use of this message or any of its content by any person other than the intended recipient is strictly prohibited.  Sound Financial Planning, Inc. has taken precautions to screen this message for viruses, but we cannot guarantee that it is virus free nor are we responsible for any damage that may be caused by this message.  Sound Financial Planning, Inc. only transacts business in states where it is properly registered or notice filed, or excluded or exempted from registration requirements.  Follow-up and individualized responses that involve either the effecting or attempting to effect transactions in securities or the rendering of personalized investment advice for compensation, as the case may be, will not be made absent compliance with state investment adviser and investment adviser representative registration requirements, or an applicable exemption or exclusion.  This information should not be construed as investment advice. All information is believed to be from reliable sources; however, we make no representation as to its completeness or accuracy. WE WOULD LIKE TO CREDIT THIS ARTICLE'S CONTENT TO PETER MONTOYA.



THE DEBT CEILING DILEMMA

Tension eases for the moment, but contention remains.

Global investors watch America anxiously. In late December, the U.S. technically reached its debt ceiling of approximately $16.4 trillion, with the federal government taking what Treasury Secretary Timothy Geithner called "extraordinary measures" to avert a default.1

Even as House GOP leaders announced plans Friday to approve a three-month increase in the federal debt limit, tension remains - and that tension could provoke a debt ceiling battle on Capitol Hill reminiscent of the impasse of 2011 later this year.2

President Obama has again presented a debt ceiling hike as an essential move needed to pay America's bills. House Republicans do not want to see a long-term increase in the debt limit without corresponding spending cuts, and some conservatives have characterized the Obama administration's warnings as more posturing than fact.

A new plan to deal with critical fiscal deadlines. Sometime between February 15 and March 15, the federal government's borrowing capacity will (in theory) be exhausted. March 1 now represents the start of the "sequester" - the automatic spending cuts detailed in the 2011 deficit accord. On March 27, a six-month measure passed to fund federal government operations expires.3

Last week, House Majority Leader Eric Cantor (R-VA) unveiled a plan for a three-month extension of the debt limit, which would offer Congress additional time to pass a budget. Under the plan, Senators and Representatives would work without pay if Congress failed to approve a budget within the three-month window. Any further extension of the debt ceiling window would be contingent on Democrats approving significant federal spending cuts.2

Will an extended battle be averted? Hopefully so - prolonging the debt ceiling fight into spring could do far more economic damage than that threatened by the fiscal cliff. In a recent Wall Street Journal commentary, Princeton University economist Alan Blinder envisioned a 6% GDP contraction "if the government hits the debt ceiling at full speed" in 2013, as a forced 26% cut in federal outlays would result. An outright drop off the fiscal cliff, in Blinder's view, would have reduced U.S. growth by 4.5%.4

A true default could invite a harsh recession - jobless benefits could be reduced or curtailed, and Social Security checks and pay to soldiers could even be delayed. Consumer spending could decrease along with federal tax revenues.4

The risk of an outright default may be overblown. Addressing the media on January 14, the President seemed to hint that the government would prioritize interest payments on Treasuries over other debt obligations in a worst-case scenario. Some congressional Republicans have called for such prioritization in a crisis - that is, the Treasury simply making selective payments on what America owes first, with other debts to be addressed later. The question is, would that be enough to preclude another downgrade by the major credit ratings firms? (Beyond that question, there is an issue of legality: President Obama lacks a distinct legal authority to prioritize certain debt payments over others.)5

Is the White House overstating the threat? Some conservatives believe so. As Cato Institute fellow Michael D. Tanner recently noted, the federal government will owe somewhere around $38.1 billion in interest payments between February 15 and March 15. If it doesn't pay them, it will default. Almost unpublicized, however, is the federal government's projected receipt of $277 billion in taxes and other revenue within that same interval.6

That isn't enough to fuel the $452 billion in federal spending stipulated between February 15 and March 15, but it would be enough to pay the interest on the debt and keep Medicare, Social Security and servicemember payments on track. About $500 billion in debt will mature between February 15 and March 15 - but the federal government routinely rolls over such debt rather than paying it off, swapping new debt for maturing debt.6

Multiple solutions have been suggested. In addition to the GOP proposal, some "quick fixes" for the issue have been suggested, some bordering on the sensational.

House Minority Leader Nancy Pelosi (D-CA) would like to see the President invoke the 14th Amendment to the Constitution to raise the debt limit - specifically Section 4, which reads "The validity of the public debt of the United States...shall not be questioned." The White House has rejected that idea.7

Citing a clause in the Coinage Act of 1996, a Georgia lawyer named Carlos Mucha has proposed that the Treasury Secretary authorize the U.S. Mint to make a $1 trillion platinum coin which could be deposited at the Federal Reserve. Mucha claims that the Fed could credit the account of the U.S. government for that $1 trillion and solve the whole problem in one fell swoop. The Treasury has rejected the idea.8

The GOP proposal announced on January 18 could be a step toward a bipartisan compromise on the debt limit - which hopefully will occur before summer arrives.

Citations.
1 - www.latimes.com/business/money/la-fi-mo-debt-limit-geithner-treasury-boehner-obama-20130114,0,5318272.story [1/13/13]
2 - www.latimes.com/news/politics/la-pn-house-leaders-debt-increase-20130118,0,4453098.story [1/18/13]
3 - www.reuters.com/article/2013/01/17/us-usa-fiscal-ryan-idUSBRE90G13520130117 [1/17/13]
4 - www.cnbc.com/id/100381526 [1/15/13]
5 - www.cnbc.com/id/100377700 [1/14/13]
6 - www.ocregister.com/opinion/debt-383518-payments-government.html [1/16/13]
7 - thehill.com/homenews/house/275663-pelosi-urges-use-of-14th-amendment-to-avoid-debt-ceiling-crisis [1/4/13]
8 - www.nytimes.com/roomfordebate/2013/01/13/proposing-the-unprecedented-to-avoid-default/platinum-coin-would-create-a-trillion-dollar-in-funds [1/13/13]

Sincerely,
William T. Morrissey and Tammy Prouty
Sound Financial Planning Inc.
wtmorrissey@soundfinancialplanning.net
Primary Office
425 Commercial Street, Suite 203
Mount Vernon, WA 98273
Phone: (360) 336-6527
Secondary Office
650 Mullis St., Suite 101
Friday Harbor, WA 98250
(360) 378-3022

PLEASE READ THIS WARNING: All e-mail sent to or from this address will be received or otherwise recorded by the Sound Financial Planning, Inc. corporate e-mail system and is subject to archival, monitoring and/or review, by and/or disclosure to, someone other than the recipient. This message is intended only for the use of the person(s) ("intended recipient") to whom it is addressed. It may contain information that is privileged and confidential. If you are not the intended recipient, please contact the sender as soon as possible and delete the message without reading it or making a copy. Any dissemination, distribution, copying, or other use of this message or any of its content by any person other than the intended recipient is strictly prohibited. Sound Financial Planning, Inc. has taken precautions to screen this message for viruses, but we cannot guarantee that it is virus free nor are we responsible for any damage that may be caused by this message. Sound Financial Planning, Inc. only transacts business in states where it is properly registered or notice filed, or excluded or exempted from registration requirements. Follow-up and individualized responses that involve either the effecting or attempting to effect transactions in securities or the rendering of personalized investment advice for compensation, as the case may be, will not be made absent compliance with state investment adviser and investment adviser representative registration requirements, or an applicable exemption or exclusion. This information should not be construed as investment advice. All information is believed to be from reliable sources; however, we make no representation as to its completeness or accuracy. WE WOULD LIKE TO CREDIT THIS ARTICLE'S CONTENT TO PETER MONTOYA.