New Paradigm for Deferring Taxes

If someone were to ask if you thought taxes would be higher or lower in the future many people would say higher and they would most likely be right.

Our government needs a significant increase in revenue going forward to meet all of its entitlement program promises and other obligations such as the interest and principal on our country’s ever-growing National Debt.  Here are the debt numbers in real time. 

Currently, our tax rates are considered to be low especially, some might even go as far as to say they are on sale when compared to where they were from about 1936 to 1964. During that 29 year period, the top marginal tax bracket in this country was well above 75%, peaking for two years 1944-45 at an astonishing 94%.

Just look at the historical marginal tax rates below.

Historical Marginal Tax Rates

Granted, very few people paid any tax at that marginal tax bracket rate because of the deductions that were available at that time and because there were not that many people whose income after those deductions was high enough to push them into that marginal tax bracket.

Starting in 1965 the top marginal tax bracket came down to 70% and stayed there (except for a brief three-year period from 1968-70 where they spiked again to around 75%) for 17 years until 1982 at which time the top marginal tax rate dropped to 50%.

Introduction of Deferred Taxation

It was during this time period that the deferred taxation theory for retirement plans really began to be promoted.

The 401(k) was created in 1978 when Congress passed The Revenue Act of 1978 in which Section 401(k) established defined contribution plans.

The idea was to place some of your current income into a qualified retirement plan pretax, let it grow tax-deferred until you retired, at which time you would theoretically be in a lower tax bracket.

That was a perfect recommendation and financial planning solution for someone who’s working lifetime and contribution period was in the 30 to 40-year period leading up to 1982.

The problem we have here is that no one is questioning the old way of thinking and that we are just accepting the “story” the way it has been told for decades.

This reminds me of the story where the son-in-law asks his wife a question while cooking for Christmas dinner.  He asks, “Why do you cut the end of the ham off before you put it in the roasting pan?” 

His wife says, I don’t actually know that is how my mother always did it, let me ask her.  The mother replies, I don’t actuall know let me ask Grandmama.  When Grandmama is asked she simply replies “I had to that is the only way that the ham would fit in the pan.

So, what does this all mean for those of us planning for retirement today.

Are low income tax rates an opportunity?

First, we need to understand that the current marginal tax brackets are very low in contrast to historical norms.

Second, the current tax brackets are set to expire on December 31, 2025 which is just a little over six years from now.

Third, it is highly likely the new marginal tax brackets will be higher, very possibly much higher.

With that information in hand, would it not make sense to reconsider the current practice of deferring some of our current income into a future in which we will very likely be taxed at a rate higher than that which we are in today?

Some of you may be thinking, I won’t be in a higher tax bracket when I retire because my income will be lower than it was while I was working. That may be true, but there are a couple of problems with that thought process.

One might be that you most likely will not have as many deductions as you do now. Another problem may be that if you are planning on retiring on less income than you make today you may not have saved enough for your retirement.

It also may not be safe to assume that just because you have paid off your house and have no consumer debt that you won’t need as much monthly income to live on.

Consider that inflation is low today but what about in the future? What will the cost of healthcare be in the future? What if you or your spouse need long-term care in an assisted living facility?

Its time to take action

We cannot assume that just because retirement has worked out for our parents or grandparents over the last 30 years that, by using some of the same financial planning processes, it will work out for us.

We are not living into the economic conditions of the last 30-40 years, we are living into the economic conditions of the next 30 or 40 year period.

We are living into an entirely new economic future and a new financial paradigm that requires a whole new way of thinking.

Now is the perfect time to consider positioning your assets and retirement plan dollars to avoid taxes now and in the years ahead.

If you are interested in learning how you can design a tax-free retirement, call our office at 801-545-9494 or email us.

Because tax rates are so low now it really is the perfect time to design and implement a retirement plan that prevents Uncle Sam from intruding upon your retirement years, but you need to act now to take advantage of this incredible, tax saving window before the tax laws change.

Scott