The Importance of Why You Need a Plan For a Lower Tax Bracket in Retirement:
You've probably worked for years developing your career maybe at one job, but these days more than likely at multiple jobs building an impressive resume. One thing that sticks out to everyone is the paycheck you receive each week or month seems to always dwindle more and more than you anticipate from so many taxes and other benefits being deducted prior to being deposited in your checking account. Then each spring, we all join forces to file our taxes to Uncle Sam. If you've done proper planning throughout the previous year, you may be one the lucky ones to even receive a refund check! Many people pride themselves on getting this money and there are countless businesses waiting this time to market their products and services to you, the consumer with a little newfound cash in their pocket.
Many advisors and financial gurus constantly recommend taxpayers not to overpay throughout the year because you are giving the IRS an interest free loan with your hard earned income that they will pay you back next year when they get around to processing your return. This is very true, but I have found that many average consumers disregard that advice for many reasons. Maybe it's the sheer joy of receiving a lump sum surprise each spring to go car shopping or do some home renovating. I've had others tell me they would rather use that as a form of saving rather than trying to do it on their own. Having said all that imagine going into retirement and not ever having to worry about paying a dime in income taxes. Sounds impossible, right? It most certainly isn't and can be done with the right planning even if you have saved hundreds of thousands or more in your 401k plans and IRA's.
Many people have been fortunate enough to save for retirement, but once they get there, find that since they are withdrawing their funds for an income, their social security income could end up also being taxed. Outrageous! Now all of a sudden you're paying a tax on something that was basically a tax on you to begin with! But, it happens every day. People follow the herd's advice and contribute as much as they can to their companies retirement plans and then get a huge tax bill throughout the many years of retirement. Don't you think there's a good reason that the IRS came up with these plans and then put so much stress on people to use them?
Let's take a brief look at Social Security. Most people know the basics of this program, which was enacted by congress in 1935 under Roosevelt's "New Deal" to help provide needed funds to the American people as an insurance against living too long. It was never initially designed for the massive government retirement plan that it has become today. This same program has also now built up a reputation with negative connotations and warnings of deficits and depletion. If you take a look at the statement that you receive each year in the mail or online, most people only glance at the second page with the estimated future income at age 62 and the age at full retirement.
Unfortunately, our government has put together a plan that over promises and under delivers to the American people. I say this because on the other pages of that same statement quotes that soon, the program will be running a deficit (losing money) each year and that by 2031, the program currently will be only able to pay out an estimated 70% of the estimated income listed. How can this be so poorly managed? Well, it has little to do with management of the trust fund and more to do with the economic factors of our society over the past century. When social security was first enacted there were approximately 42 workers to pay for each retiree’s income. The life expectancy for the average person was also 62! After the baby boomer generation came along, they had fewer children than their parents did, thus creating a big problem even bigger. So to reiterate, the program was set up expecting people to use social security as a last resort and it was likely of those that qualified, they would be on it for no longer than two to three years. A lot has changed since then; the problem is the social security rules have not.
Currently, the fastest growing segment of our population is age 85 and older, with many of the baby boomer generation on the way. The program that once had 42 workers to each retiree now has 3 and in a several years will be 2. A program that was written for people to use for a couple years is now being used by in many cases 25 - 30 years, while our biggest segment of the population is entering retirement. It's simple math that it is unsustainable, yet nothing has been done to alter it even though it has been obvious for decades. A married couple that is age 65 today has a 50% chance of one spouse living to 92 and a 25% chance of living to age 97! Someone that is drawing social security income at age 62 today will, on average live to age 85. In this business, this is referred to as longevity risk. This unfunded obligation program is costing our country more and more and now takes up approximately 20% of our federal budget, or over $700 billion annually.
Then there are other government unfunded liabilities like this one that you know of that have resulted in similar situations. Medicare is a great example. Because of our scientific and medical advances over the past few generations, people are living longer than ever. Lyndon Johnson proposed Medicare as part of his programs of the 1960's and has led much of the same path as social security. It now costs the taxpayers another $500 billion annually. Out of Social Security, Medicare, Medicaid, and the interest on our national debt, we are paying approximately 76% of our national annual budget. This is projected to go to 92% by 2020. If this is news to you, I hope it is a rude awakening. If you are following along with me, you may guess that there are only a couple of remedies to these problems.
You guessed it! Higher taxes. While taxes are something that almost everyone can agree on that they would rather go down than up in some form or fashion, they, along with death, are the two guarantees we are given. Now let's take a brief look at income taxes. It can be said that it is hard to move into the future without understanding history and the past. The same is true with taxes.
Most people complain about income taxes and are always telling me how high taxes are. Consider this: from the early 1930's to 1980, the top marginal tax bracket did not fall below 60%! This is easily forgotten about in today's society where people constantly beg for lower taxes. If history has any way of repeating itself, which it commonly does, now is the time to start implementing some strategies to alleviate the threat of that future tax burden.
Along with your tax advisor, we can potentially help you with the proper planning to alleviate some of these concerns. Feel free to leave feedback and Contact Us on how to help you implement these strategies in some of the most effective ways possible.
*Chart above is of the U.S. Federal Budget for 2014