The Elephant in the Room

“Elephant in the room,” “ticking time bomb”…whatever you wish to call it, there is an issue currently present but not talked about nearly enough. The issue hits a nerve with nearly everyone – investor/saver or not. The issue is taxes – more specifically future taxes on retirement savings. Unfortunately, the issue has become so politicized that its true impact has almost been forgotten.

 Tax rates and total taxes paid may be higher or the same as today for lots of savers in retirement.

Back in 2016, I discussed part of this topic in TGIF 2 Minutes. (Click Death & Taxes to read.) At that time, the focus was soaring healthcare costs.

Today, the gist of the rising taxes issue is that on several fronts, taxes will be going up sooner or later – and there is not enough unbiased, non-politicized advice and information being given to investors and savers – of ALL AGES.

Recall that saving for retirement traditionally – and gaining current tax deductions that accompany that saving in IRA and 401k accounts – has been thought to be the “Rule of Thumb.” Get a tax deduction today and then remove the money later in retirement at a lower tax rate – because income may likely be less in retirement. Fast forward to today’s relatively lower tax bracket world overall (1980’s and 1990’s saw higher tax brackets and Alternative Minimum Tax creep) and it is almost certain that tax rates and total taxes paid may be higher or the same as today for lots of savers in retirement. What will that do to after-tax income in retirement? And what happened that created this “tax elephant” standing in the room?

First, if you are reading and saying, “retirement does not matter to me” or “I am too young for this discussion” then simply think of this issue from the perspective that aging is inevitable. At some point in the future at age 72 or earlier in the case of inherited assets, the tax-deferred (pre-tax) savings in 401k accounts and IRAs will become mandatorily taxed in the form of Required Minimum Distributions, or RMDs. In addition, social security which is already partially taxable will be increasingly taxable (as it is today for those who make more than approximately $44,000 in retirement). After-tax income and the ability to spend will potentially be much lower than expected.

Current tax rates are set to increase as soon as late 2025 and thereafter social security is set to come under pressure (not be eliminated but rather come under pressure) with far less workers currently contributing per social security recipient. Conversations about 2025 and beyond often get boring and wonky – and that is the door where the elephant has entered the room.

There are ways to confront the elephant and create or increase tax-free vehicles today – no matter how young a person is (in fact, the younger the better) and no matter how high or low a person’s level of income.

  • Roth 401k
  • Roth IRA
  • Roth IRA conversions
  • Health Savings Accounts (HSAs)
  • Other more complex strategies such as cash value life insurance and even certain types of long-term care insurance.

Ignoring this elephant will be dangerous to a saver’s long-term financial independence – and potentially extremely expensive. In several of the above examples a taxpayer may pay greater taxes today – in order to reduce future taxes. Thus, adding greater certainty to a well-laid out financial plan and expectations for lifestyle sooner or later in life.

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