Do you recall the movie Thelma and Louise? Believing that they have only one option in front of them, the two friends drive off a cliff. Not the way I would choose to depart, yet the popular press keeps pushing maximization of tax postponed accounts (i.e., 401k or IRAs) or Self-Employed Plans (SEP).[i][ii] Why?
Well, the logic is that you “save” taxes today, but is that really true? It might feel like it but the IRS eventually will get their money when you access the funds. What they do not tell you is how much the tax bill will be when you make withdrawals at a later date—your postponed tax bill.
Now into my sixth decade of advising folks, here are a couple of observations about the direction of taxes. When I entered the business in the 1960s, the top tax rates hit 70%. As my clients retired in the mid-1980s, Reagan’s tax law was passed, effectively giving taxpayers a flat tax of 28% (a 60% reduction from the 70% rate). Today, that would require a top rate of under 15% in retirement years. What do you believe might be the chance of that happening? A 15% top rate?
But there is more to consider:
- We are currently about 21% below the average top tax bracket of 57.69%, according to IRS.gov. Income tax was established as a temporary tax in 1913 to fund World War I, and yet it is still here after more than 100 years. I have a T-shirt that says, “Teach your kids about taxes: Eat 1/3 of their ice cream first.” That’s what happens when the IRS requires withholdings from your paycheck. Their share comes off the top before you receive what is left.
- The deficit is really taxes spent, but not yet collected. We are, at the time of this writing, approaching a deficit of 22 trillion, according to usdebtclock.org. That is 22, followed by twelve zeroes and four commas.
- Amazon is forecast to have top line revenues of $235 billion this year.[iii] During the financial year that just ended, our government overspent (that is, borrowed) $804 billion, according to the Congressional Budget Office (CBO). That is almost three and a half times all of Amazon’s top line revenue.
So, I present my case: Be cautious with how much income you defer. You may currently be in the lowest tax bracket you will ever face. I came across the site www.thebalance.com that said: “and you think you will be in a lower tax bracket in future when you start taking withdrawals.”[iv] Sounds nice. Generally, if you are in a “lower tax bracket” you have less income to spend. Is that the plan you want? More free time, less income to do things?
What might the future hold? If Bernie and his crowd take control, we could have “BernieCare” – single payer medical insurance. The Wall Street Journal[v] recently ran a piece that laid out the following:
- “All care would be ‘free’ in the Venezuelan sense of the word. Government would dramatically cut the reimbursement rates doctors receive for providing services. All this would lower administrative costs and make health care more efficient, or so we’re told. And we’re not supposed to call this ‘government-run health care,’ although who do you think would make the payment decisions?”
- “The plan would cost the federal government $32.6 trillion over 10 years. That figure is from an analysis by the Mercatus Center’s Charles Blahous, a respected researcher and former Social Security and Medicare trustee. His findings are in the ballpark of every serious analysis.”
- “Brace yourself: Doubling all currently projected federal individual and corporate income tax collections would be insufficient to finance the added costs of the plan.”
Want to explore your balance between the postponed dollars and tax-paid dollars today? If you’d like to have a discussion about taxes and deferral, simply reply to this article. We can help you with some modeling of the impact of taxes on your strategy. Not only today, but also in the future! Don’t end up like Thelma and Louise, flying off the tax cliff and making the IRS both happy and rich.
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Neither SMART Group Houston nor World Equity Group, Inc. provide tax or legal advice.