On some level, this was inevitable. Higher taxes, that is. After all, when Congress passed the Tax Cuts & Jobs Act of 2017, they built in a safety net. On January 1, 2026, taxes are scheduled to automatically revert back to the higher 2017 levels. However, President-elect Biden and others in government are staring at a $27.5 trillion National Debt, the scheduled insolvencies for Medicare (2026) and Social Security (2034), and expected trillion dollar budget deficits as far as the eye can see. Our country needs revenue now, and it comes largely from your taxes.
What does this mean for investors? You must take higher taxes seriously when it comes to planning for retirement. Whether retirement is 2 years or 20 years away, what ultimately matters is after-tax income. It does not matter how much you have saved, but how much you have left after state and federal taxation. If tax rates rise steadily over time, as expected, it could be more damaging than inflation to your retirement spending power.
There are specific ways to reduce your exposure to future higher tax rates and one of the best methods of doing so is converting existing IRA assets to Roth IRAs. Doing so will result in paying income taxes on the conversions at today's historically low tax rates. But it will ensure that you can withdraw those funds in retirement tax-free when rates are much higher. Congress has given you an additional reason to consider Roth Conversions: the SECURE Act of 2019. As a result of this legislation, non-spouse beneficiaries of your IRAs will have to empty them within 10 years, resulting in massive taxable distributions during their highest earning years.
Another way to combat coming higher taxes is to contribute as much as you can to Roth IRAs and Roth 401(k)s. By forgoing a current tax deduction, and using after-tax dollars to fund these retirement accounts, you are ensuring that your savings will grow tax-free and can be withdrawn tax-free. While Roth IRAs, like Traditional IRAs, come with some restrictions, they are more than worth it if you believe that taxes will be on the rise. Americans love a sale. Today, you have a unique opportunity to make many smart financial planning decisions while tax rates are on sale.