In my job, it is really not unusual to work with several generations from the same family. In fact, I just called a longtime client last week, I’ll call him George, who thought it was time for his daughter, I’ll call her Courtney, to start working with a guy like me. George is about 60 years old, grew up outside of Boston, married his high school girlfriend, and together they had three daughters. Courtney, who is the oldest, is 25 years old and recently engaged. George and his wife moved to East Sandwich about seven years ago, when we first met.
I told him I would be happy to talk to her, but you know, I also encouraged her to talk to other counselors to make sure she was right. George and I talked about how preparing for retirement is now a lot different for his daughter and how the world of retirement planning is changing from generation to generation. We both came from a generation that saw our parents work for the same company their entire careers and counted on a company-funded retirement plan as a cornerstone of their retirement plan. But over the course of our own working careers, direct contribution plans like 401 (k) and traditional self-funded IRAs have replaced pensions as one of the central sources of retirement income.
It is very likely that George’s daughters, like my three young ladies, will continue to use the 401 (k) and IRA, but many of them can take advantage of the benefits that Roth offers, and should. You see, the Roth IRA and Roth 401 (k) differ from their traditional predecessors in the way money is taxed and how it is taxed going out as income. Unlike traditional IRAs and 401 (k), Roth’s contributions are not tax deductible, but the benefit is that you don’t increase your income tax on money growth while making qualified distributions. People, with tax rates likely to increase in the very near future, Roth is paying close attention as an advanced retirement strategy for tax planning, so this week, along with our time together, I’d like to dive a little deeper into Roth’s details.
Roth was first created in 1997, and Roth has quickly gained popularity over the past decade, and current events make them more attractive only as a retirement vehicle. Over the past decade, Roth has seen a significant influx as people have decided to take advantage of their tax-friendly treatment in distribution. Roth invested $ 600 billion in assets in 2014, and by 2020 it had grown to more than $ 1 trillion. So why hurry for Roth then?
Well, folks, few of us like to pay more than our fair share of taxes, and we certainly don’t like taxes to go up. In fact, any politician who has demanded a tax increase in the last few decades has been on crazy business. However, that may change with the Democrats currently in power in the House of Representatives, the Senate and the White House. This political change in power, together with our significant government debt and recent significant stimulus payments, appears to indicate a larger future tax environment. And despite our grumbling about taxes, Americans are experiencing one of the lowest overall effective tax groups in the last century, at least for now.
President Biden recently unveiled the “American Business Plan,” which seeks to increase corporate taxes from the current 21 to 28 percent. The second phase of the plan will include increased taxes on Americans earning over $ 400,000 a year. It is still somewhat unclear as to whether his plan is to tax individuals or households. In addition, Biden’s plan plans to increase property taxes and impose higher capital gains taxes on individuals with greater wealth.
Other Democratic senators are also making their own proposals for tax increases. The one that should attract the most investor interest is the Step Act proposed by Senator Chris Van Hollen. Legislation would eliminate the heightened basis that heirs receive on many inherited investment instruments, including stocks. Instead, these gains would be realized and taxed by death. Currently, the proposal would exempt 401 (k) and those who have individual holdings of 11 million dollars and couples with holdings of 22 million dollars.
It is these expected tax increases, coupled with uncertainty, that will encourage many people to pay taxes at today’s relatively lower tax rates, and this further increases Roth’s appeal. Those who have already invested in traditional IRAs and 401s can also feel the move to turn those plans into Roth’s vehicles. Converting some or all of your traditional money from an IRA or 401 (k) now means a tax bill, but this will be weighed against the cost of paying potentially higher taxes later when the distribution happens in retirement. And many people are already making that move, with Roth’s conversions rising 22 percent in 2019 and 67 percent in 2020.
I ended the conversation with George and Courtney explaining that for younger people, like Courtney, who are in their lower years of earning, using Roths can be a great strategy as a supplement or alternative to a traditional 401 (k) or IRA, but we should consider their capabilities. For example, contributing 401 (k) often means winning a company match, and it’s basically free money you won’t want to lose. And for people like George, who are further in their careers, they should take care of proper tax analysis to see if it makes sense to switch to Roth.
And as always – be vigilant and be careful, because you deserve more!
Jeff Cutter, CPA / PFS, is president of Cutter Financial Group, LLC, a registered SEC investment advisor with offices in Falmouth, Duxbury, Mansfield. It is possible to reach it email@example.com.
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