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Sell Now or Wait? What Biden’s Tax Plan Could Mean for Your Investing Strategy

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Marcus by Goldman Sachs is excited to share this insight from our friends at Goldman Sachs Asset Management. You can read the original version of this article here.

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Tax season may be over, but taxes might still be top of mind for some investors. That’s because this spring, President Biden proposed a federal tax policy overhaul. Under the plan, certain investment income could be taxed at higher rates (some rates may nearly double). 

All of these changes may have investors wondering: Should you sell assets before these tax proposals become law, when there’s potential for them to be taxed at lower rates? As with many investment decisions, your answer will depend on your financial situation and money goals. But our colleagues at Goldman Sachs Asset Management have a few pointers on how to think about these potential tax changes – which can help you decide if you’d want to take action (aka sell) or wait. 

What are Biden’s proposed tax changes, exactly?

Let’s start by reviewing a few things on the (tax) table that could impact investors. President Biden’s proposed policy would increase federal taxes on both short-term and long-term capital gains, as well as qualified dividend income. If you need a refresher on those terms: 

  • A capital gain is the profit you make when you sell a capital asset – like stocks, bonds, real estate, jewelry, etc. – for more money than you bought it for. 
  • If you owned the asset for one year or less before you sold it, that would be a short-term capital gain; a long-term capital gain happens when you make a profit on an asset that you held for longer than a year. 
  • When you actually sell an investment for profit, that’s called a realized gain. An unrealized gain is a profit on an investment that hasn’t been sold yet – sometimes called a paper profit
  • Dividends are the payments from the earnings and profits of a company or corporation in which you’re a shareholder. Dividends are taxed but qualified dividends could be taxed at a lower rate if they meet certain requirements. 

Right now, the federal tax rate for short-term and long-term capital gains for people who earn above $1 million is 40.8% and 23.8%, respectively. Under Biden’s plan, the proposed federal tax rate for both these would jump to 43.4%. The federal tax rate on qualified dividend income would go from 23.8% to 43.4%. As you can see, the rate for long-term capital gains and qualified dividend income would nearly double.

The proposal would also make new capital gains rates retroactive to April 30, 2021. That means investors who haven’t already realized gains wouldn’t be able to do so at current rates. But it’s not clear if this provision will win approval from Congress. So for the purposes of this exercise, we’ll assume investors will retain the choice until the tax code is changed.

Last thing to keep in mind: This tax hike may not impact every investor – right now, it’s being considered for people with taxable income that’s $1 million or more. 

Taking action now vs. waiting

Whew! That was a lot of background, but hopefully it helps to put things in context. Now onto the burning question: Should you take action and sell profitable assets now? If the tax rates do change, investors who sell now at a profit could potentially pay less in taxes than those who wait. 

But there’s more to it, according to our colleagues in Goldman Sachs Asset Management. If investors cash out profitable assets now (aka realize gains), yes, they could pay less in taxes. But that would also mean paying taxes now, which would result in a smaller portfolio to reinvest. On the flipside, investors who don’t take action in their portfolio leave more money invested in the market, which could lead to more growth – but also a potentially bigger tax bill later.

Tip: Find the Break-even Point 

We know – that last part made it seem like there’s no clear answer here. And it’s true, the decision to sell or wait is a personal one and will depend on your financial situation and goals. 

But our colleagues in Goldman Sachs Asset Management point out three variables that could help investors make a decision: expected future tax rates, expected market returns and your time horizon. Let’s take a closer look at these factors.

  • Expected future tax rates: If higher taxes are expected, investors may benefit from realizing gains sooner and paying taxes now at a lower rate. 
  • Expected market returns: If higher market returns are expected, it might be more valuable to keep more of a portfolio invested (this gives assets the chance to potentially grow from a higher starting point). And if the expected return is high enough, it may be more valuable to wait to sell, assuming the portfolio liquidation or death is not expected to occur soon. 
  • Your time horizon: How long you plan on staying invested matters. If you don’t necessarily need portfolio funds for a while, it could be helpful to let the money sit. That’s because you’ll reap the benefits of compounding: the longer your money stays invested, the more money you could potentially earn. Goldman Sachs Asset Management analysts also add that in the case of a longer time horizon, the tax rate would have to be really high in order to justify selling profitable assets sooner. In the chart under Exhibit 4, you can see that if an investor does not expect to cash out a portfolio until year 25, the expected future tax rate would need to be nearly 70% before accelerating gains makes sense. 

Taken together, these factors can help you find a break-even point: the year in which a portfolio’s ending after-tax value is the same for both realizing gains at current tax rates and taking no action. If you look at the example below, you can see that the break-even year – the point at which a green line (returns) hits the blue dotted line (proposed tax rate) – can vary depending on the expected market return. So for example, under a 10% market return, the break-even year occurs at year 8. After that, it might make more sense for an investor to keep assets invested to give them a chance to grow. Compare that to a market return of 4%, which moves the break-even point to year 23. That essentially means that investors may have a longer time period when accelerating gains makes sense. 

On its own, the decision to sell now or wait can seem like a conundrum. It’s worth talking to your financial advisory and crunching some numbers – doing so can help you come to a decision that works for you. 

This article is for informational purposes only and is not a substitute for individualized professional tax advice. Individuals should consult their own tax advisor for matters specific to their own taxes. This article was prepared by and approved by Marcus by Goldman Sachs, but does not reflect the institutional opinions of The Goldman Sachs Group, Inc., Goldman Sachs Bank USA, Goldman Sachs & Co. LLC or any of their affiliates, subsidiaries or divisions. Goldman Sachs Bank USA and Goldman Sachs & Co. LLC are not providing any financial, economic, legal, accounting, tax or other recommendations in this article. Information and opinions expressed in this article are as of the date of this material only and subject to change without notice. Information contained in this article does not constitute the provision of investment advice by Goldman Sachs Bank USA, Goldman Sachs & Co. LLC or any of their affiliates. Neither Goldman Sachs Bank USA, Goldman Sachs & Co. LLC nor any of their affiliates makes any representations or warranties, express or implied, as to the accuracy or completeness of the statements of any information contained in this document and any liability therefore is expressly disclaimed.