- Why a Roth IRA is probably crucial to retirement plans
- A Roth IRA is a powerful tax defense tool
- Financial planners typically suggests having retirement funds in 3 buckets: taxable, tax-deferred and tax free (Roth IRA is considered tax free at time of withdrawal)
- Taxes will probably be higher in 10, 20 years and beyond
- Government programs such as Social Security, Medicare, etc. (that people love) are going to cost a lot more
“Wow, taxes are sure low nowadays! Yeah!”
This is an example of things you never hear people say. But if you did hear someone say it, they would actually be somewhat accurate. Now, I understand this depends on the State you live in and other ways of viewing this. Think about every time you buy something, you pay a tax, every time, down to the stick of gum.
But let’s focus in on Federal Taxes for a moment. The top tax rate since the 1980’s has never gone above 40%, historically low for very high income earners. This is for high income folks and sort of sets the ladder for how other incomes fare. Contrast this to tax rates from the 1930’s through the 70’s, when the top tax rate was from 60-90%.
Again, back in time not many people paid this high rate because it was reserved for very high income folks. But the point is that the rates now are in many ways historically low:
||Up to $19,050
||$19,051 to $77,400
||$77,401 to $165,000
||$165,001 to $315,000
||$315,001 to $400,000
||$400,001 to $600,000
||$600,001 or more
What is amazing is that rates are so low and our national debt and obligations are so scarily high. We have spent trillions on foreign adventures in the Middle East, have huge and growing Social Security/Medicare bills and crumbling infrastructure.
401K tax game
The 401k tax game is highly tied to the charts above. You see, any money you put in a 401k reduces your taxable income for that year. Many folks try to put in enough to get their income on paper to be in a lower tax bracket. For example, let’s say you make $90,000/year in income. Using the chart above you would want to invest at least over $13,000 in a 401k in order to get your “income on paper” to appear about $77,401 or lower. This bumps you down from the 22% tax bracket to the 12% tax bracket for tax purposes.
Taxes will go up
I am just going to come out and say it, taxes
will most likely go up. It is not politics, it is math. Simple math. In order to pay for all the stuff we have grown accustomed to, taxes will have to go up and I will explain why.
The old days
When social security was invented to fight abject poverty among the elderly (which was quite common), most people were able to collect at 65. Funny thing, life expectancy was 62. There were also something like 30 plus workers paying into the social system for every collector of social security. In other words, the system did not cost that much because people passed away early and many workers fed into the system to support older folks.
Contrast this with today. Today people live into their 80’s, drawing on the social system for decades. In addition, Congress and our country did nothing to shore the system up. Instead, as mentioned, we spent trillions on other stuff. To make matters worse, we are down to only 2-3 workers for every social security recipient. Population growth cannot keep up with the number of people living longer. Younger folks are not having kids (future workers).
The math does not work out and we are headed for a major crisis. And, as we can all see no matter your politics, we are not dealing with or planning for anything. We can’t even come to agreement to keep the Government open.
Taxes & death
There is an old saying that the only two things for certain are taxes and death. Ok, a bit too morbid and cynical, but it is supposed to be tongue in cheek. Although, given the current trajectory, the only conclusion we can come to is that folks will receive some combination of reduced benefits and be taxed more. In other words, high taxes will probably come. That is a real gut punch, pay more for less of something.
Rock out with your Roth…
There is some hope for someone trying to preserve their retirement cash flow, the Roth IRA. A Roth IRA (Individual Retirement Account) goes into the “tax free” withdrawal retirement income bucket. You can see where this is headed. In other words, when you obtain cash flow from a Roth IRA investment account, that money comes to you tax free.
The doomsday scenario I described above could result in significantly higher taxes in the future. Let’s say you work your tail off for 30 years and diligently socked money away in your 401k. That money grew at 6-7% and compounded for decades. You employed the “investing trifecta”
to increase your net worth and did what you were supposed to do.
When it comes time to withdraw that money, then suddenly we are in a crisis and the tax rates shoot up astronomically. Perhaps the government and Congress impose a tiered system with very high rates on one end. The bottomline is that all those years of investing in a 401k could be dramatically impacted and reduced by the higher taxes paid as the money is withdrawn…So…
TIME TO ROTH IT OUT!
I would put my Roth IRA in a Vanguard
account or Berkshire Forever Stock BRK-B
! This way I can enjoy tax free distributions from these accounts as taxes rise! See, the money I use in 2035 was taxed at that low 2018 rate.
Roth IRA Key Characteristics
- Money can be withdrawn starting at age 59 (and 1/2, don’t understand the 1/2 part).
- Money withdrawn is free from federal, state and capital gains taxes.
- IRA does not count as “provisional income” therefore doesn’t cause your Social Security to be further taxed.
- You do not get a tax deduction at the time you place the funds in the IRA. This is opposite the advantage of a 401k, that reduces your tax liability that year. But the 401k money is taxed when you withdraw it later.
- Under 50 years of age, Congress will only allow someone to contribute $5,500/year in a Roth IRA. Remember when something is a good thing, they have to put limits on it 😉
The bottomline in my humble opinion is that taxes will go up and that a Roth IRA makes for a good strategy to manage this expense in the future. Roth IRA is one of several “buckets” of money or strategies one can deploy to build a secure retirement.
- As always, this is not financial advice for any particular individual. These are personal opinions expressed here and only those of the author. See a tax professional for individual tax advice.