Merrill Lynch warns of post-election double whammy

A post-election stalemate over taxes and spending could lead Washington lawmakers to bring the country to the brink of recession, Merrill Lynch Wealth Management warns.

The double whammy of increased taxes for those with incomes above $250,000 and cuts in mandated federal spending (also known as sequestration) may be too potent for the Federal Reserve to manage with monetary policy, according to Merrill's "After the Election" report published after President Obama won a second term in office.

"If no compromise is reached by the end of this year, the bipartisan Committee for a Responsible Federal Budget predicts that the nation could face a second recession from the combined spending cuts and tax increases," the report said. "Federal Reserve Chairman Ben Bernanke warned Congress in September that the tools at the central bank's disposal may not be 'strong enough to offset' the effects of such a combination."

Compromise likely in Washington

However, the report quotes Merrill Lynch Global Wealth Management Chief Investment Officer Lisa Shalett as saying that lawmakers have a vested interest in preventing another recession. That will likely lead to a compromise that includes both spending cuts and tax hikes.

"We think that odds of a kick-it-down-the-road compromise are now rising," Shalett said. "There is no political party that wants to drive the economy into a recession,"

For advisors, this is a good time to help clients formulate year-end tax strategies that offset rising tax rates, such as selected tax-free municipal bonds.

"For some, moving more money into 401(k)s and IRAs offers a tax-deferred alternative that not only helps them prepare for retirement, but which also reduces their tax bill today," Shalett said.

With changes in Medicare in mind, advisors should keep an eye on health care sector companies — particularly those offering Medicaid managed-care plans, pharmaceutical companies and pharmacy benefits managers, all of which should prosper under the Democratic president, according to the report. Defense companies, on the other hand, are likely to experience cuts.

3 client-advisor talking points

Merrill Lynch Wealth Management suggests that clients keep these three talking points for clients and their financial advisors and tax professionals:

Clients should review their portfolios to make sure they're diversified and consult with a tax advisor about what potential tax hikes could mean for their finances. Clients want to be well-positioned to protect investment returns in a rising tax environment for both individuals and corporations.
Clients might want to consider moving money into 401(k)s, IRAs and other tax-deferred accounts that let them postpone taxes until retirement and look into increasing their holdings in tax-free municipal finance bonds.
Clients should be alert for rising interest rates that may slow growth in corporate profits and make fixed income investments more attractive.

For more on estate planning, see:

12 key personnel implications of the election

Tax increases depend on definition of "wealthy"

Avoiding the fiscal cliff