What Should You Expect Taxes to Be in Retirement?

In this episode, James talks about key factors that might influence future tax policy. This is especially important for retirees and soon-to-be retirees because a change in your tax bracket could affect your income in retirement. We cannot see into the future, but we can make some predictions about how to best prepare for what taxes will look like in retirement.

            James talks a bit about the history of federal income taxes to show how even compared to their origins, we are currently close to those historic lows. The average income taxes people are paying today are substantially lower than before. New tax law was signed into place in 2017, but those brackets are going to expire in 2025. For most people, there will likely be an increase of 3-4% in their tax bracket at expiration in 2025.

            James lists three things that can inform what taxes will look like in the future: 1) the fact that taxes are near historic lows, 2) the national debt levels are rising, and 3) the population is getting older. The government must offset debt by either cutting spending or raising taxes. It looks like there will probably be tax hikes in the future.

James then lists some specific strategies you can use to hedge against potential tax hikes, including diversifying your investments and delaying drawing from retirement accounts.

Key Points:

Evidence we’re trending toward higher taxes:

1. Income tax brackets are near historic lows over the past century.
   1. We know for certain that taxes will increase in five years unless current tax law is extended.
   2. It’s probable that tax brackets will continue to rise over time.
2. The debt levels in the U.S. debt are rising.
   1. Important to note that we will always have debt.
   2. The problem is when payment on national debt exceeds GDP
   3. The government is trying to boost the economy during COVID-19; what does this mean for future taxpayers?
3. The population is getting older—which is good!
   1. This will place a strain on the economy because fewer people are paying into government programs while more are drawing from them.
   2. It’s feasible to expect taxes to go up as a result of this.
4. The current tax law is set to expire in 2025.
5. The political climate in this country could influence radical policy change—for better or worse.

What can we do about this?

1. Consider making Roth IRA or Roth 401(k) contributions.
   1. What is your tax bracket going to look like in the future?
   2. Consider IRA vs. 401(k) depending on if you think your income will increase over time.
2. Use the first few years of retirement to do Roth conversions.
   1. You’re likely to have portfolio income in addition to Social Security payments.
   2. Instead of delaying everything, it makes sense to drop your tax liability.
3. Invest outside of retirement accounts.
   1. You won’t be forced to take all of your money out of your IRA.
4. Determine where you’re going to live in retirement.
   1. Your retirement income could be affected by where you live in retirement.
5. Max out your Social Security benefits
   1. Make good money and pay more into Social Security during your career.
   2. Delay drawing from it to keep from being taxed on it.

Timestamps:

1:08 — Income tax brackets are near historic lows.

3:00 — We know for sure that tax brackets will increase.

4:45 — U.S. debt is rising.

6:40 — The U.S. population is getting older.

8:45 — Current tax law and current political climate could mean change.

9:20 — Consider making tax-free contributions.

10:50 — Make use of Roth conversions at the beginning of retirement.

12:20 — Invest outside of retirement accounts.

14:15 — Determine where you’re going to live in retirement.

16:30 — Max your Social Security benefits.