U.S. Election 2024: An Analysis of the Tax Scenarios for Investors

EXHIBIT 1: WHERE DO CANDIDATES STAND ON POLICY RELEVANT TO INDIVIDUALS?

Both candidates have indicated their position on tax policy, meaning that investors can evaluate the impact on those areas relevant to their circumstances.

Equity Impact

Higher tax rates mean lower after-tax returns for taxable investors, all else equal. For example, if we assume an investor receives a dividend yield of 1.5%, then the change in tax policy highlighted in Exhibit 1 would decrease the after-tax return by 0.31% per year for the top tax bracket. There would also be an impact from an increase in capital gains taxes, although the degree of the impact depends on a number of variables including the existing unrealized gains and losses in the portfolio, portfolio turnover and market returns.

Of course, taxes are only one part of the equation as investors also balance risk and total return. While not trading avoids realizing any gains, it can also create significant risks to a portfolio such as tracking error to a capitalization-weighted benchmark or over-concentration. If the capital gains tax rate is higher, then realizing gains becomes more expensive and realizing losses becomes more beneficial. Investors can run a variety of scenarios through their portfolios to incorporate these dynamics to better understand the trade-offs and determine the optimal strategy.

Considerations for Realizing Long-Term Capital Gains

While portfolio action before clarity on tax policy would be premature, investors may ask based on the election results whether to realize long-term gains prior to a potential increase in the capital gains tax. In other words, they could realize capital gains during the lower-rate environment and increase their cost basis by reinvesting the proceeds, potentially lowering future capital gains if the tax rate rises.

The answer depends on several variables and investor-specific details. These include estimated market returns, details about the unrealized gains and losses, loss carry forwards time horizon, intentions for transferring assets, cash needs and diversification needs. When we have analyzed this question in the past, we found that the results are highly dependent on inputs such as market rates of return and future cash flow needs, which are both very difficult to predict. Therefore, a careful analysis of individual circumstances is required to determine the optimal approach.

What About Municipal Bonds?

Because municipal bonds are exempt from federal taxes, the marginal tax rate plays an important role for investors. This rate directly determines an important metric when evaluating comparable taxable bonds — the taxable equivalent yield. The taxable equivalent yield for a municipal bond is the pretax yield to investors if the municipal bond were taxable, making its yield comparable to taxable bonds. So tax-equivalent yields for municipal bonds are higher than their actual yields.

As shown in Exhibit 2, this tax-exempt benefit means that, all else being equal, a higher income tax rate increases the benefit of municipal bonds relative to taxable equivalents. For example, under the current tax rates, municipal bonds provide a taxable equivalent yield of 5.61%. If the TCJA expires, the top marginal rate reverts to 39.6%. Also, the net investment income tax could increase to 5% from 3.8%. In this scenario, the municipal bond taxable equivalent yield would increase to 5.99%, a 0.38% pickup.

EXHIBIT 2: POTENTIAL IMPACT TO MUNICIPAL BOND YIELDS

All else being equal, a higher income tax rate increases the benefit of municipal bonds relative to taxable equivalents.

Preparation for Tax Policy Uncertainty

With uncertainty surrounding the tax landscape, we think investors should be aware of and prepare for potential tax policy changes. Financial professionals, such as tax advisors and investment consultants, can help navigate through the various tax and investment issues. In addition, partnering with an experienced investment manager across asset classes can provide a tailored approach to meet client-specific objectives.

IMPORTANT INFORMATION

Northern Trust Asset Management (NTAM) is composed of Northern Trust Investments, Inc., Northern Trust Global Investments Limited, Northern Trust Fund Managers (Ireland) Limited, Northern Trust Global Investments Japan, K.K., NT Global Advisors, Inc., 50 South Capital Advisors, LLC, Northern Trust Asset Management Australia Pty Ltd, and investment personnel of The Northern Trust Company of Hong Kong Limited and The Northern Trust Company.

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For Asia-Pacific (APAC) and Europe, Middle East and Africa (EMEA) markets, this information is directed to institutional, professional and wholesale clients or investors only and should not be relied upon by retail clients or investors. This document may not be edited, altered, revised, paraphrased, or otherwise modified without the prior written permission of NTAM. The information is not intended for distribution or use by any person in any jurisdiction where such distribution would be contrary to local law or regulation. NTAM may have positions in and may effect transactions in the markets, contracts and related investments different than described in this information. This information is obtained from sources believed to be reliable, its accuracy and completeness are not guaranteed, and is subject to change. Information does not constitute a recommendation of any investment strategy, is not intended as investment advice and does not take into account all the circumstances of each investor.

This report is provided for informational purposes only and is not intended to be, and should not be construed as, an offer, solicitation or recommendation with respect to any transaction and should not be treated as legal advice, investment advice or tax advice. Recipients should not rely upon this information as a substitute for obtaining specific legal or tax advice from their own professional legal or tax advisors. References to specific securities and their issuers are for illustrative purposes only and are not intended and should not be interpreted as recommendations to purchase or sell such securities. Indices and trademarks are the property of their respective owners. Information is subject to change based on market or other conditions.

All securities investing and trading activities risk the loss of capital. Each portfolio is subject to substantial risks including market risks, strategy risks, advisor risk, and risks with respect to its investment in other structures. There can be no assurance that any portfolio investment objectives will be achieved, or that any investment will achieve profits or avoid incurring substantial losses. No investment strategy or risk management technique can guarantee returns or eliminate risk in any market environment. Risk controls and models do not promise any level of performance or guarantee against loss of principal. Any discussion of risk management is intended to describe NTAM’s efforts to monitor and manage risk but does not imply low risk.

Past performance is not a guarantee of future results. Performance returns and the principal value of an investment will fluctuate. Performance returns contained herein are subject to revision by NTAM. Comparative indices shown are provided as an indication of the performance of a particular segment of the capital markets and/or alternative strategies in general. Index performance returns do not reflect any management fees, transaction costs or expenses. It is not possible to invest directly in any index. Net performance returns are reduced by investment management fees and other expenses relating to the management of the account. Gross performance returns contained herein include reinvestment of dividends and other earnings, transaction costs, and all fees and expenses other than investment management fees, unless indicated otherwise. For U.S. NTI prospects or clients, please refer to Part 2a of the Form ADV or consult an NTI representative for additional information on fees.

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