Briefcase Study

October 2014: Briefcase Study

In Briefcase Study, Income Planning, Investment Management, October 2014 by Adam Cufr

Each issue of The Steward will include a brief case study. In it, strategies will be highlighted that we utilize in solving problems and creating opportunities for our clients. We hope you’ll enjoy this case study and find some wisdom in it that may help you in your own planning.

A Primer on the Myth of Rising Taxes

I just had a recent meeting that inspired an interesting question. It had been suspected by the IRA owner that converting a Traditional IRA to a Roth IRA would be a profitable action because of the certainty of rising taxes in the future. The move would have caused a sizable tax bill today on the conversion, but consistent with popular sentiment, would be a wise decision because tax rates would be higher in the future, or so we thought.

I’ll admit it. I have said it myself and many of you say it to me without any hesitation:

“Because of our government’s actions, failing Social Security and Medicare systems, taxes are sure to go up in the future.”

While there may be some truth to this statement, we must dig a bit deeper and ask ourselves whether it truly is all taxes or just some taxes and if so, what impact should this have on our decision-making? As I often do, I did some research. Although this article is not a comprehensive analysis of tax law, please allow me to point out two notable findings.

There are several tax reform proposals on the table for dealing with our national debt, as well as Social Security and Medicare’s lack of funding. The most popular and most likely approach is to increase payroll taxes on those who are working and earning wages, in order to generate increased tax revenue.

The US does not have a Value Added Tax (VAT) while most major economies do. What does this mean? It means that the most popular solutions that will raise taxes, will not necessarily raise your taxes, as a retiree.

Without going into a detailed discussion of marginal tax rates, we can determine with relative certainty that doing a large Roth IRA Conversion may not be in the best interest of most retirees. This is big time news!

But, as surprising as this may seem, if you think about it, it becomes apparent that if the retiree’s marginal tax rates do not significantly rise in the future, the main reasoning for self-inflicting tax pain in the short run may be dramatically oversold.

So what do you do? Well, a better approach may be to make decisions now that allow you to maximize the lowest tax bracket threshold to take advantage of any room you have before moving your next dollar of income into the next marginal tax bracket.

While the discussion of taxes, current and future, is very nuanced, there are some strong takeaways I’d like for you to consider. When someone offers an absolute like “Taxes are going up in the future” or “Social Security won’t be there for me” please pause, take a deep breath and ask yourself whether that’s entirely true. Very often, absolute statements are balanced precipitously on a myth or misconception. The consequences of making decisions based on misconceptions are generally costly.

Admittedly, it takes time to gather all of the necessary data and flesh out the myths that may be present in current thinking. The benefits to having an open mind can be worth many thousands of dollars as well as some sleep-filled nights. If you feel you may have some blind-spots in your thinking, please let us help. We’d love to chat. Even if we don’t have the answers right away, we will happily do some research, just for you.