Avoiding The Tax Time Bomb
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As a subscriber you can listen to articles at work, in the car, or while you work out. Subscribe Now"Read my lips: no new taxes" is an iconic moment in our nation’s history. George H.W. Bush famously uttered the line in a speech at the 1988 Republican National Convention after accepting his party’s nomination. Many political historians believe those words clinched the election for him. Ah, but such bold promises can be hard to keep. Once elected, the Democrat-controlled Congress proposed a tax hike to reduce the national budget deficit. President Bush initially tried to fight it, but ended up reaching a compromise that raised several existing taxes. He was reminded of the outcome very unsubtly during his bid for re-election, which he lost to Democrat Bill Clinton. This is only one example of how taxes affect elections and vice versa.
There was the New Deal, Stagflation, Reaganomics; the list goes on. Now, another election is upon us and boy, has it been contentious, to say the least. It’s easy to see why many people are anxious about what’s going to happen come November 8. One of my clients recently told me he wasn’t going to touch his finances until after the election. I advised him that it doesn’t really matter who ends up sitting in the Oval Office, there are some things you can do to help yourself when it comes to investments and paying taxes.
Your strategy depends largely on your age. If you’re in the accumulation phase of your wealth, your money should go into growth products. Start with your employer. Does your company offer a match with its 401(k) plan? If so, take it. It’s free money. Don’t put a dime more into it after what’s matched, unless it’s a Roth 401(k). Otherwise, you’re creating a tax time bomb. A Roth 401(k) allows you to pay taxes as you go, sparing you from paying them at retirement. Traditional 401(k)s, on the other hand, accumulate money tax-deferred and then are taxed like regular income when the funds are withdrawn. If you think our taxes are high now, imagine what they’ll be like when you’re ready to retire. Roth is the way to go when it comes to IRAs as well, although you can’t participate if you have an income north of $194,000. A lot of my high-net-worth clients utilize indexed universal live insurance instead. It’s called “overfunding.” You buy the least amount of life insurance and invest the most amount of money. When you’re ready for the money at retirement, if structured properly, you can pull it out on a tax-free basis. It’s a misconception that life insurance is simply a death benefit. It can make for a solid retirement strategy for the living.
If you’re ready to retire or getting close to it, it’s time to switch gears from growth products to fixed income ones, such as annuities. An annuity is a contract with an insurance company in which you pay premiums and then systematically receive payments over time or in a lump sum. They’re fixed income because they’re unaffected by market volatility. Fixed annuities offer guaranteed rates of interest, whereas variable annuities do not. You pay regular income taxes when you make a withdrawal, hopefully after age 59½. Otherwise, you’ll pay a 10 percent penalty. No investment is perfect, but with a fixed annuity, you at least have peace of mind that you won’t lose a penny of your principal.
Regardless if Hillary Clinton or Donald Trump gets elected, we’ve got a problem in this country and it’s a math problem. We have too many entitlements and not enough money to pay for them. We have three workers for every social security retiree. In 1945, the ratio was 42 to one. The U.S. Debt Clock says we have a gross national debt of $19 trillion, but consider the following fact. Income tax rates for the top brackets peaked in the 1940s at 94 percent and have steadily fallen ever since to around 40 percent. Yet, if you ask people what they think of taxes, you’re likely to hear “They’re high!” or “They’re terrible!” But in reality, they’re not. I am predicting whoever gets into the White House in January will eventually raise taxes at some point. He or she will simply have to find some revenue to relieve the deficit. My advice is to learn how to protect your income as much as possible. Familiarize yourself with the tax code or consult with a professional. Don’t wait for the government to tell you how to keep more of your money because you’ll be waiting a long time.
Bill Demaree is president of Demaree Retirement Services.