Struggling to plan for your future when there’s so much uncertainty about interest rates, future tax rules, and Social Security? You’re not alone.
One of the biggest concerns that comes up these days is whether savers can count on their Roth IRA withdrawals being tax-free (subject to the rules, of course) when they retire. Anyone who glances at the chart below senses that the only way to pay the cost of the national debt, in the long run, is by raising more revenue from the public–and the massive sums sitting in Roth IRA accounts would seem a perfect target.
Higher-income tax rates seem inevitable, too–and perhaps not far off, depending on who wins the 2020 presidential election. But it’s not just federal income taxes that are likely to increase. State and local budgets have been decimated by the Covid-19 pandemic, and even with federal relief funds, many places will have no choice but to raise income and/or property taxes and to impose other fees that will raise the cost of living.
So what are current and future retirees, who are often trying to maximize their income while lowering their cost of living, supposed to do? The answer to dealing with most unknowns is to hedge your bets, whenever possible. Doing so isn’t “copping out” of making a difficult choice; it’s acknowledging that the decisions to be made are beyond your control and you don’t want to lose your shirt.
Here are a couple of examples:
To Roth or not to Roth? Do both. It’s worth putting some of your retirement savings in a Roth 401(k) or IRA if you believe your income tax rate could be higher when you retire. You could leave your employer match amount (say if they match up to 3%) or whatever you’re currently contributing to your traditional 401(k) as-is, and then put the same amount (e.g. 3%) into a Roth.
Should I defer “recognizing” interest income to a later date assuming I’ll be in a lower tax bracket? Try using a different investment vehicle instead. A “Multi-Year Guaranteed Annuity,” for instance, provides a stipulated annual interest rate like 3% but pays the entire interest at the end of the contract period, say, after five years. Plus, you can roll the whole amount into another MYGA and continue to defer interest–perhaps even until you’re in a lower tax bracket, typically at retirement.
Should I move to a lower-tax state? Don’t count on current tax rates. Taxpayers in higher-tax states where “SALT” a.k.a state and local tax bills are no longer capped for federal tax purposes have been dismayed by the change, but it may not prove permanent. Local politicians are already campaigning to rescind it. And it’s currently scheduled to expire with the Tax Cut and Jobs Act at the end of 2025.
The bottom line is that we should try not to predicate all of our planning on the existing rules, especially ones that affect or benefit a narrow niche of taxpayers. You might be surprised by how much you can benefit from financial planning that incorporates a broad array of investment options even with all of these uncertainties.