Taxes Are Going Up, Do You Have a Plan?

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I have been having more and more conversations recently with clients about tax planning. Depending on your desired overall retirement income, planning for taxes now and in the future is a crucial component in building a successful retirement income strategy.

After all, it is not how much you have, it is how much of that can you spend once you get to retirement.

Most Californians Fit Here

Let me put this another way. If you have $1,000,000 in your 401k or IRA and are in the 33% income tax bracket (most Californians are in this bracket or higher when adding state and federal taxes) and intend to draw $50,000 per year in income from the account, you will have a net after tax income of $33,500 not counting deductions and the graduated nature of our tax code. If tax rates went up by 20% (from combined state and federal; 33% to 39.6%) and applied that rate to the entire withdrawal, your spendable income would drop to $30,200!

That is like losing over one month’s entire income!!

What To Really Focus On

So, while most people and their advisors focus on “rate of return”, we focus on maximizing your “net spendable income”.

As an RICP® (Retirement Income Certified Professional), I understand that in retirement, security and peace of mind are based on the reliability of your income.

After all, when you are working, you pay bills from your paycheck. When you retire, it is your assets that become your income producer. Happiness is directly related to the confidence you have in your income being enough to support your desired lifestyle and that it will last for your lifetime. An increase in taxes can have a serious impact on both of these.

How Do We Know That Taxes Will Be Increasing?

There are only 3 things that can happen to taxes in the future:

1. They can go up
2. They can go down or
3. Stay the same.

Under the Tax Cuts and Jobs Act of 2017 (TCJA), the tax rates and rules for individuals will go back to what they were before the law was passed in December of that year. This expiration of the current tax backets will occur at the end of 2025. Corporate cuts will continue unless congress changes them.

During the campaign, now President Biden indicated that he would be looking at tax increases on folks with taxable incomes over $400,000 and he has already announced that they are looking to make changes in corporate taxes. This is necessary due to the unprecedented increases in our national debt since the TCJA and those debts increased even more rapidly in 2020.

In 2016 the reported total national debt was just over $20 trillion. It now stands at more than $28 trillion! That is an increase of nearly 40%. At some point this will need to be repaid. If additional stimulus occurs, this will become even more of a problem.

Clues From History

There is an old saying that “those who don’t learn from history are doomed to repeat it”. The last time tax rates were as low as they are now was in the 1920’s, known as the “Roaring 20’s”. To see what happened to those rates after the crash of 1929 see the chart below from USA Today:

You can see that tax rates increased dramatically during the Depression and into World War II.

Right now, do you think that tax rates will be going down or increasing over the coming years?

If you think they will stay the same or increase, then the rest of this post will be of value. If you think rates will be decreasing, you can stop here.

So, What Should I Be Doing Now?

Here are 4 things you might want to look into to protect yourself:

1. Am I saving in the 401k at work (or SEP or regular IRA)? If this is where most of your savings are, how will you deal with the taxes when you withdraw money in retirement?

1. Am I tax diversified? I try to make sure that clients understand the hierarchy of money. Here are the four types in order of value:
   1. Free money
   2. Tax free money
   3. Tax deferred money
   4. Taxable income

Capital gains are tax deferred money and currently are more advantageous from the amount you will pay in taxes standpoint than things like IRA’s and other retirement plans that are also tax deferred but will be taxed as “ordinary income” when withdrawn.

1. Will my retirement income trigger any “stealth taxes”? These are fees or surcharges that depend on what your taxable income is. I have a client who recently retired and said they were surprised that their Medicare part B premium increased by about $700 per month for the both of them due to how much they had earned prior to retirement.

This isn’t the only one. Things like taxation of your social security benefits, losing tax deductions (phase outs) and additional Medicare tax surcharges are some of these “stealth taxes” to consider.

1. Do I itemize or take the standard deduction? Will that change in 2026 when we go back to the old rules? Knowing this can help you plan when is best to pay.

Pay Now or Pay Later?

Sometimes it is better to bite the bullet and pay taxes now while they are low, in order to reposition investments into more tax friendly areas.

This can really help reduce your overall taxes.

Doing things like converting your regular IRA to a ROTH IRA can be a powerful strategy. Just drawing money from IRA’s now to raise cash can be a worthwhile activity.

If you would like to know how you can plan for your future tax liabilities, let’s set up a time to talk and see what strategies might be available to help you keep more of what you have saved.

This will give you added confidence to approach your Happy Retirement with greater confidence and control!
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