A bimodal retirement savings strategy can be a tax-wise strategy that doesn't predict the future of tax policy but merely prepares for it. (Photo: Shutterstock)
For as long as you can remember, you've heard the drums. This incessant beat has provided the backbone of every retirement savings article, every employee education meeting, and every policy-related discussion. It has become the axiom of retirement savings. “Save now and reduce your taxes!” came down in a thunderous voice for on high. “Obey or face the consequences!” was the implicit warning.
Of course, this adage was predicated on the belief your tax rate today is higher than your tax rate will be when you retire.
The 2017 Tax Cuts and Jobs Act changed all these assumptions (see “Tax Law Fallout Yields These Five Fiduciary Facts For Retirement Savings,” FiduciaryNews.com, April 23, 2019). As a result, our view of what is an appropriate retirement savings strategy has changed.
This change hasn't been abrupt. In fact, if we look at retirement savings statistics, millennials have been practicing it for quite some time. To understand the reason why helps explain how the new tax law has accelerated and expanded this evolution.
Remember the assumption that fueled the traditional consensus behind the supremacy of tax-deferred savings. For younger workers, with a lower salary that inhabited lower tax brackets, the idea that they'd be paying even lower taxes when they retired just didn't make sense. Where's the incentive to defer taxes?
What's more, they've seen how the power of compounding grew the size of earlier generations' retirement savings. Million-dollar (and more) IRAs yield higher required Minimum Distributions, in some cases much higher than the typical millennial's current salary. Why pay higher taxes in the future and save pre-tax when it makes more sense to pay lower taxes today and save after-tax?
These mathematics help explain why we see data suggesting millennials tend to save in Roth plans, not tax-deferred plans.
The new tax law has transformed the retirement savings calculus of older generations to one more like what millennials have experienced. We expected the new law to lower tax rates for most people. Experts have looked at the most recent filing data and have indicated this is precisely what has happened. Even The New York Times begrudgingly admits this is the case (although it adds most people may not believe this fact).
We're all millennials now. There's a strong suspicion a future non-Trump president will yield to those preaching economic nirvana is only a major tax hike away. Under this scenario, the RMD's being spewed from those multimillion dollar IRAs will get soaked by the Federal government at a rate much higher than today. The diligent savers who avoided paying tax rates in the mid-twenties on smaller levels of income will therefore be rewarded by paying tax rates in the mid-thirties on larger levels of post-retirement income.
There's a way out. Do what the millennials do.
For some time now, retirement industry thought leaders have spoke of the wisdom of a bimodal retirement savings strategy. This strategy includes a mix of tax-deferred retirement accounts (like traditional 401k and IRA plans) and after-tax retirement accounts (like Roth plans). With just a mix, retirees have the flexibility to take taxable income out at low rates and supplement that with tax-free Roth withdrawals.
This is a tax wise strategy that doesn't predict the future of tax policy. It merely prepares for it.
With most baby boomers and perhaps even some older Gen-Xers overweighted on the traditional tax-deferred retirement plan side of this ledger, the new tax law offers a great opportunity to begin fattening up the Roth portion of their retirement savings.
Do you think they can overcome their aversion to paying taxes today to act in their best interests for tomorrow?
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Christopher Carosa
Chris Carosa has been writing a weekly article and monthly column for BenefitsPRO online and BenefitsPRO Magazine since 2011 and is a nationally recognized award-winning writer, researcher and speaker. He’s written seven books, including From Cradle to Retire: The Child IRA; Hey! What’s My Number? – How to Increase the Odds You Will Retire in Comfort; A Pizza The Action: Everything I Ever Learned About Business I Learned By Working in a Pizza Stand at the Erie County Fair; and the widely acclaimed 401(k) Fiduciary Solutions. Carosa is also Chief Contributing Editor of the authoritative trade journal FiduciaryNews.com and publisher of the Mendon-Honeoye Falls-Lima Sentinel, a weekly community newspaper he founded in 1989. Currently serving as President of the National Society of Newspaper Columnists and with more than 1,000 articles published in various publications, he appears regularly in the national media. A “parallel” entrepreneur, he actively runs a handful of businesses, including a small boutique investment adviser, providing hands-on experience for his writing. A trained astrophysicist, he also holds an MBA and has been designated a Certified Trust and Financial Advisor. Share your thoughts and story ideas with him through Facebook (https://www.facebook.com/christophercarosa/)and Twitter (https://twitter.com/ChrisCarosa).
