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Taxes: Mitigating the “Inconvenient & Unpleasant”

by Teri N. Benson, CDFA, October 28, 2019


In George Washington’s 1796 Farewell Address, he shared the following advice with the nation on debt and taxes:

“. . . towards the payment of debts, there must be revenue;
that to have revenue, there must be taxes;
that no taxes can be devised, which are not more or less inconvenient or unpleasant.”

Today, taxes remain the government’s main source of revenue and, as an individual, you can’t avoid the inconvenience or unpleasantness of paying yours. If you’re a high income earner, you already know it can be wise to maximize savings in tax-deferred accounts such as a 401(k), which can lower taxable income today. What you may not yet realize especially if you are currently in the top tax bracket is that there may be tremendous value in paying some tax today to build tax-free savings, which may reduce your taxes in the future.

Taxes on Sale. When viewed through the lens of history, a compelling case can be made that U.S. taxpayers face the prospect of higher future tax rates. With the passage of the 2017 Tax Cuts & Jobs Act, taxes are effectively “on sale” until 2026 when the current legislation is scheduled to sunset. Said another way, taxpayers especially those in the highest bracket today are paying among the lowest Federal tax rates since the Hoover Administration. See Chart 1.1.

chart 1

A Revenue Reckoning. Consulting history once more, when our national debt has exceeded the annual productivity of the entire U.S. economy (i.e. debt greater than 100% of GDP), the government has remedied this imbalance by collecting more revenue - a.k.a. higher taxes - in the ensuing years. Chart 2.1 illustrates that it has been decades since our lawmakers effectively addressed the ballooning national debt relative to tax revenues collected. What politician wants to deliver that inconvenient and unpleasant policy? Nonetheless, the reality depicted in Chart 2.1 makes a strong case for a period of revenue reckoning - higher rates across all tax brackets - in order to reduce the national debt and improve the country’s financial strength once again.

chart 2

Timing is Everything. While no one knows what tax rates will be in the future, there can be real advantages to building tax diversification among your assets today. As just one example, if your current income precludes you from directly funding a Roth IRA, a multi-year conversion strategy may be a valuable way to create a Roth IRA that will enjoy both tax-free compound growth and withdrawals. Further, such conversions can reduce the size of “required minimum distributions” that the IRS will ultimately mandate you withdraw from tax-deferred Traditional IRA and 401(k) accounts. These annual distributions must be taken whether or not you need to realize that much income and/or it pushes you into a higher tax bracket. By contrast, the IRS does not mandate withdrawals from tax-free accounts such as Roth IRAs, thereby affording you flexibility to help mitigate your future tax liabilities. From a legacy planning perspective, Roth accounts can also be an excellent way to leave money tax free to your heirs.

One final note on tax-free accounts such as Roth IRAs and/or Roth 401(k) accounts is the uncertainty regarding how long this potentially tax-efficient strategy will exist. The Roth provision is a highly debated item when Congress is negotiating tax law. Lawmakers may be realizing the folly in allowing taxpayers to pay tax on Roth contributions today, in lieu of taxing far larger balances in these accounts tomorrow. Since Roth accounts may not be available forever, there’s no time like the present to start planning for the future.

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Any opinions are those of Financial Advisors Catherine Trinder-Miller and Theresa N. Benson, CDFA and not necessarily those of Raymond James. The information contained in this article does not purport to be a complete description of the securities, markets, or developments referred to in this material. Any information is not a complete summary or statement of all available data necessary for making an investment decision and does not constitute a recommendation. Please note, changes in tax laws may occur at any time and could have a substantial impact upon each person's situation. While we are familiar with the tax provisions of the issues presented herein, as Financial Advisors of RJA, we are not qualified to render advice on tax or legal matters. You should discuss tax or legal matters with the appropriate professional. All opinions are as of this date and are subject to change without notice.

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