From the recent election to the start of a new year to the fast approaching filing date, taxes are on a lot of people’s minds right now. Lately in the news, we’ve heard just about every rumor, from raising taxes on the wealthy to tax cuts. Regardless of public opinion, many professionals agree that taxes will likely increase in the near future. And if this is the case, it’s important to review whether your plan is ready for the changes.
What Causes Taxes to Increase?
The government relies on taxes to get things done, and when they spend more, they need to raise taxes. Currently, one of our largest generations, the Baby Boomers, are accessing Social Security and Medicare at higher rates than ever. Combined with government programs like Obamacare and federally subsidized student loans, and interest on our national debt, our government is bound to require more resources in the coming years.
According to The Heritage Foundation, at current tax rates and expenditure levels, tax revenues will be fully consumed by 2030. (1) This is a sobering figure which will necessitate tax rate hikes.
However, keep in mind that tax rates are currently at an all-time low. Consider the fact that, in 1945 at the end of World War II, the highest tax bracket was 94%. Tax rates remained elevated, with a top rate of 70% the norm well into the 1980s. Our current 39.6% rate is incredibly low, which is why we can expect tax increases to come our way.
Preparing Your Plan for a Tax Increase
Even if we anticipate an increase approaching, we don’t know exactly when or how much change to expect. This makes it challenging to know how to protect your assets from a tax hike. However, even if you can’t predict with accuracy, you can strategize and take steps to prepare for an increase and reduce its impact.
1. Create a Plan
Rather than wait for a change to happen, create a plan now. Start by examining several areas of your financial life to see where a tax hike could affect you. Then, work with your financial advisor to evaluate strategies for minimizing their impact. By proactively planning ahead, the uncertainty won’t cause you as much stress and worry.
2. Max Out Your After-Tax Accounts
While you save income tax immediately when you contribute to pre-tax retirement accounts, you also end up paying taxes on the money when you withdraw it. Your income may be less when you are retired and draw on those savings, but taxes may also be even higher at that time.
Consider investing in a Roth IRA to achieve tax-free growth, which allows the taxpayer to prepay taxes and lock in current rates. This can shield you from future tax rate increases. However, keep in mind that if the tax system changes and new taxes are added, such as a consumption tax, the Roth tax vehicle does not protect against them.
3. Reevaluate Your Investments
You want your investments to grow, but some mutual funds do a better job than others when it comes to tax efficiency. Some tax-efficient options for you are index mutual funds and exchange-traded funds (ETFs). As taxes increase, make it a priority to focus on tax-efficient returns increases for your investments. You may also want to look at municipal bonds, which are tax-free investments that will ensure your income will not be affected if tax rates increase. While these bonds may not bring in as much income as taxable bonds, they offer more protection against tax hikes.
Reviewing Your Plan
In light of the recent election and historic tax rates, now is a great time to review your portfolio to see if it is prepared to weather a tax rate hike. We can help you identify any weaknesses in your portfolio and recommend any improvements that should be made. If you need someone to go analyze your portfolio to see how it will fare in different tax environments, send me an email at ernest_draper@fosterklima.com, or call my office at (612) 746-2272.
About Ernest Draper
Ernest Draper is a financial advisor with more than 18 years of experience in the financial services industry. Specializing in innovative investment strategies and wealth preservation products, he works with affluent professionals, executives, and business owners. Along with his many years of experience as an advisor, Ernest is also certified as a Chartered Life Underwriter®, Chartered Financial Consultant®, Chartered Advisor for Senior Living®, and CERTIFIED FINANCIAL PLANNER™ professional. With these designations, Ernest has the advanced training and knowledge to understand complex planning strategies and techniques facing many successful people and their families. Based in Minneapolis, he is licensed to work with clients in Minnesota, Illinois, Wisconsin, Maryland, Washington D.C., Missouri, Texas, and Connecticut. To learn more, connect with Ernest on LinkedIn, email him at ernest_draper@fosterklima.com, or call his office at (612) 746-2272.
Ernest Draper, Registered Representative and Financial Advisor of Park Avenue Securities LLC (PAS). Securities products and advisory services offered through PAS, member FINRA, SIPC. Financial Representative of The Guardian Life Insurance Company of America ® (Guardian), New York, NY. PAS is an indirect, wholly-owned subsidiary of Guardian. Foster Klima & Company, LLC is not an affiliate or subsidiary of PAS or Guardian.
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(1) https://www.nerdwallet.com/blog/finance/people-tax-rates-rise-future/