Beating the Tax Man
Remember that old saying—“The only thing you can count on is death and taxes.” Well, it’s not true. The only thing you can count on is death and higher taxes.
Just ask David Walker, U.S. Comptroller General and head of the General Office of Accountability. He refers to the federal government as sitting on “a burning platform” and predicts a doubling of tax rates unless we dramatically cut spending.
Don’t hold your breath. Uncle Sam now spends $30,000 per oldster on Social Security, Medicare, and Medicaid benefits. When the 77,000,000 boomers retire, the figure will be at least $50,000, after inflation. Multiply 77 million by $50,000, and you’re talking almost $4 trillion a year!
As for other spending, the leading Presidential candidates have lots of plans – all expensive, including healthcare subsidies, tuition tax credits, refundable Child Tax Credits, early Head Start, a larger military, . . . —you name it.
Add two and two together and you get very big tax hikes, and not just for the rich who can surely pay a lot more, but certainly can’t pay it all.
Is there a legal way to avoid future tax hikes? Yes. Contribute to a Roth IRA or a Roth 401(k). There is no immediate tax break for doing so, but there are no taxes levied on the interest, dividends, and capital gains earned on contributed funds. Once you hit age 59 ½, you can withdraw money from your Roth free of any penalty and free of any taxes. Whether Uncle Sam doubles, triples, or quadruples taxes, you’re Roth money won’t get hit. Putting money in the Roth is, thus, like buying an insurance policy against future tax hikes.
So what’s the skinny? How much does one gain by contributing to a Roth? The answer’s different for each household, but can be determined for any household using the economics-based software program, ESPlanner, that I’ve mentioned in prior columns and that’s marketed at www.esplanner.com.
Here’s one example that illustrates what’s at stake. Joe and Sue Roth are fifty year-old Texans with two teenagers who are heading to moderately expensive colleges. The Roths have a modest home and mortgage, $100,000 in annual earning, and $300,000 in regular assets. Thus far they’ve saved nothing in retirement accounts. They also expect taxes to be raised by 50 percent in 15 years when they reach retirement. Finally, Joe and Sue are in good health and could both make it to 100.
If Joe and Sue spend $53,369 when the kids are both home, $45,646 when the first heads to college, and $37,242 when the second takes off they’ll achieve a stable living standard of $23,276 per person year in and year out. This $23,276 is the amount Joe or Sue would need to spend as a single adult to enjoy the same living standard as they do within their marriage.
Now suppose Joe and Sue open up Roth IRAs and contribute $5,000 each through retirement at age 65. Doing so raises their sustainable living standard in each and every one of their possible future years to $24,417— a full 2.9 percent higher than it would otherwise be. Opening up their Roth account and setting up their contributions will take Joe and Sue a couple of hours. But they’d both have to work day in and day out for a full extra year to raise their living standard by the same amount.
How does contributing to the Roth compare with contributing to a regular IRA? Well, the regular IRA is better than nothing. The same $5k contribution translates into a 1.3 percent living standard gain. The reason is the tax hikes. With the regular IRA, Joe and Sue save taxes before retirement, but their retirement account withdrawals are taxed at the 50 percent higher rates.
If you’re single and your income is below $110,000 or married with income below $160,000 you can contribute up $4,000 to a Roth IRA. If you’re 50 and older, the limit is $5,000. If your income is above these limits, get your employer to start a supplemental Roth 401(k) plan if it has not already done so. Employers won’t be able to make matching contributions (the government doesn’t allow them), but you’ll be able to contribute up to $15,500 depending on the plan it has set up.