The Inflation Reduction Act is a great reminder of the Legislative Risk that faces retirees. When thinking about retirement risk, many focus on portfolio or market risk, but have you considered the impact of government risk on your retirement? Today, most of the retirement income comes from saving in qualified retirement plans. These are 401(k), 403(b), 457, and IRAs. The money was mostly saved with pretax dollars and is taxed when the money is taken out. This strategy has benefited many retirees who saved during high-tax earning years to withdraw at lower rates.
What happens if/when the government changes the rules? This is legislative risk. The impact is that by these changes you will have less net money. The reality is that you have a business partner in all your qualified retirement accounts. The government owns a portion of each of them. How much they own can be changed through legislative actions such as changing tax brackets, or removing tax credits or deductions. For most retirees,’ taxes are the silent assassin of their retirement income. For example, let’s assume that you have one million dollars in your IRA. All the money is not yours. The government is entitled to part of that and there is a minimum tax you will pay for having had the option to save pre-tax.
There are two ways to look at this. A micro view focuses on minimizing taxes each year, while a macro view aims to minimize taxes over a lifetime. The micro view assumes taxes will stay the same or decrease over time, whereas the macro view anticipates higher future taxes. I lean towards the latter due to two reasons: the country’s significant debt and the structure of our tax system.
When a spouse passes away, filing status changes from married to single, resulting in more condensed tax brackets and potentially higher taxes. Depending on your current tax and income situation, it may be beneficial to pay taxes on retirement accounts now to mitigate future tax burdens. I offer this analysis to my clients to weigh the cost versus the benefit of paying taxes upfront. Understanding the risks and costs is crucial for crafting a plan to meet tax obligations.
During my seminars, I delve into various case studies illustrating mandatory and voluntary taxes. Additionally, I provide a free calculator on my website to estimate your total tax liability.
I started this article with the Inflation Reduction Act and wanted to close with a reminder that the act proposes an additional 87,000 new IRS agents. The proposed bill suggests targeting individuals earning over $400,000, although independent organizations dispute this claim. However, even if accurate, the $400,000 threshold currently serves as a placeholder, creating the impression that only the wealthy would face additional taxes. It is relatively easy in the future to change that number to $200,000 or $100,000 if you were single. At some point, it could affect everyone and that is my point of legislative risk. You should have a plan to address it, and if you want to discuss it further, please let me know. I love helping people minimize legislative risk in retirement.