Why You Must Urgently Plan for Rising Taxes

Today’s article is about something that I consider urgent. I don’t use that word often in these articles because most of the steps we take are steps that will yield measurable and predictable results in the future if done consistently. But this topic is urgent, and it’s something that you need to address right now. I’m referring to the critical topic of the inevitable rise of taxes. You need to urgently plan for raising taxes.

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Why do I say that rising taxes are inevitable? I regularly ask people which direction they think tax rates will go in the future. The answer to that question is that tax rates will rise over time. We currently live in historically low brackets, but that will change. Tax rates were much higher before the Tax Cuts and Jobs Act of 2017 was passed. We currently enjoy some of the lowest tax brackets in a generation. At Lord and Richards, we call that a window of opportunity: the opportunity to get ahead of the expiration of these tax cuts.

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There are several reasons why rising taxes are inevitable, but before I get to them, I want to clarify that I'm not talking about deferring taxes. Deferring taxes means not paying them now and paying them back later. Putting money in your tax-deferred IRA, your 401K, your 457, or your 403B are all ways of deferring taxes. All these plans were created and codified into law under the assumption that when you retire, you will be in a lower tax bracket than you are now and that you’ll live far below the standard of living you enjoy today. But that assumption does not have to be true. There is no reason you can’t enjoy the retirement that you deserve if you plan for it now, including planning for higher tax rates.

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One of the reasons why taxes will rise is that after the Tax Cuts and Jobs Act expires, we will revert to our previous rates, which were much higher, less generous, and had fewer deductions built into them. That will happen even if the government does nothing to raise taxes more. Since 2018, the government has tried several times to repeal the Act to increase taxes, so I don't have much hope that they’ll be eager to give us back our low brackets after the Act expires. Historically, when Congress passes a law that people really like, such as lowering tax brackets to gain political capital, that capital is spent and gone with the generation that passed the law. The next generation of representatives won't receive the same benefit by extending something already in place. We will likely have a new set of tax brackets that depend entirely on who is in power and how they vote.

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Additionally, because we have a divided government, our representatives must make deals and find compromises. We’re all familiar with the annual shoot-out between parties over the debt ceiling, and during that squabble, tax increases always end up on the table as a dealing chip.

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Another reason I believe you will be liable to pay higher taxes in retirement is that some additional taxes are not uncommon for retirees to have to pay. That’s just a reality of that phase of your life. We call some of these extra taxes “stealth taxes,” because they might not even be listed as a tax. For example, if you’re drawing money out of an IRA, all that money is taxable because it’s been deferred. And the more money you pull out of the IRA, the higher your Medicare premium increases.

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You might be thinking, “Wait, what? What do you mean my Medicare premium will increase? Isn’t Medicare my health insurance during retirement? What does that have to do with my income?” Quite a bit, unfortunately. Even though you paid into the Medicare program, the government looks at your income to test your means. Based on your income, not your total portfolio, your Medicare premium could rise from as low as $243 to as high as $643. That’s a difference of up to $400! And it all depends on how much taxable income you have in retirement. This is one of the “stealth taxes” you may have never considered.

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How do you plan for stealth taxes? We’ll cover that in another article and tell you how to prepare in advance so you can have zero taxes in retirement. For right now, I want to make you aware of these things so that when you invest in your IRA and defer taxes down the road, you might stop and consider whether there’s a better way or whether there are more surprise taxes that you need to plan for as you retire.

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The money you pull out of your IRA could even impact the taxation of your Social Security checking. The security itself will attack you. The government views Social Security the same as any other income source, and the IRS will want to tax you as soon as you start taking those checks. Depending on your provisional income (how much you make over and above your Social Security), you could pay tax rates of anywhere from 50-85% on your Social Security.

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Another “stealth tax” is the widow penalty. Becoming a widow or a widower means you move into a new, single-filing tax bracket, a bracket that is less generous with your income and taxes you at a higher rate. You are penalized for being single. Very rarely have I seen folks accounting for this in their financial planning. You’ll also find that when your loved one passes on, more of your income becomes taxable and at a higher rate. Your Medicare surcharges can also increase, and you may qualify more easily for the net investment income tax, which is 3.8%.

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Finally, you will also lose deductions in retirement. If you’re still in a home with children, those children will eventually move away, and you will lose those deductions. You will lose the mortgage interest deduction when you pay off your home. These are all considerations you need to be educated on because the government will try to pull all this money from you, whether they call it a tax, a penalty, an adjustment, or any other kind of “stealth tax.”

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If you haven’t built a written plan to prepare for the inevitability of rising taxes, I would urge you to do so as soon as possible. Rising rates, “stealth taxes,” and income are all things that we account for when we walk you through our financial independence review, which we offer completely free for you. We offer this free because we want you to be able to reduce your taxes, not your lifestyle, when you retire. We want to help you build a written plan that covers every aspect of your retirement and ensures you’re set up for success. It all begins with the financial independence review. Please give us a phone call or see us in our beautiful offices at zero cost to you. We would love to take the time to help you prepare for the rising taxes that are on the horizon.