I recently read an article in The Wall Street Journal titled U.S. National Debt Will Rise to 98% of GDP by 2030, CBO Projects. Obviously, this grabbed my attention.
I have known for a good while now that the country’s debt problems are significant, but just how significant are they?
The author of the article, Richard Rubin, wrote that the national debt, along with sustained federal budget deficits, would hit the highest levels since World War II over the next decade, according to the Congressional Budget Office. Deficits will reach or exceed $1 trillion each year for the foreseeable future.
The debt held by the public is projected to be 81 percent of gross domestic product this year and reach 98 percent by 2030. A lot of this comes from the recent tax cuts, along with the aging population utilizing Social Security and Medicare. Taking this a step further, the federal debt is projected to hit 174 percent of GDP by 2049, which is 30 percent higher than the CBO projected last year.
This data is something my associates and I talk about on a weekly basis, so we can brainstorm how to better help our clients manage future what-ifs. We have monitored this situation for the last several years to help plan for what we believe to be a heightened risk of a future increase in taxes. If this thinking is sound, what can one do?
There are three buckets where people could save and invest money: tax-today, tax-tomorrow and tax-free.
Let’s start with tax-today. This bucket includes savings accounts, certificates of deposit, individual brokerage accounts and most all other non-qualified money. This money is taxed each year on the realized gains/interest.
The second bucket is the tax-tomorrow bucket. These include the traditional IRA, pre-tax 401(k) and pre-tax 403(b). The final bucket is the tax-free one. This bucket includes Roths and properly structured life insurance.
I’m a believer in checking all the boxes and not just one. Unfortunately, most people I advise have most of their money tied up in tax today and tax tomorrow. Yes, they got a tax break for most of the tax-tomorrow bucket with the thinking that in retirement they would be in a lower-income tax bracket. Sometimes this is the case, but a lot of times it isn’t.
Higher-income earners might say they make too much money to contribute to a Roth and therefore can only accumulate assets in the first two buckets. To some extent this could be true; however, a lot of 401(k) plans now have a Roth component built in, allowing employees to contribute to the Roth 401(k) regardless of income level.
There also are strategies for high-income earners to contribute to a Roth IRA outside of 401(k)s, which would require the help of an adviser. For those who have capped out in funding 401(k) Roths and Roth IRAs and want to do more, properly structured life insurance has few limits in terms of what can be contributed. The biggest limits are income and insurability.
I find very few people get excited about having to pay taxes and take required minimum distributions from the tax-today and tax-tomorrow buckets. I see a lot of people excited to get tax-free withdrawals for retirement. Ultimately, who knows what taxes will do?
The data detailed above points to it being progressively likely each year that taxes will have to increase. Look back on the history of income tax brackets in this country. I believe that today we have a low tax rate, historically speaking. Knowing this, I am a firm believer that some tax insurance (tax-free bucket) in a financial plan makes all the sense in the world and something I find very under-utilized in traditional planning.
~ Lee Williams offers products and services through Nowlin and Associates. He also offers securities and investment advisory services through Ameritas Investment Corp. (member FINRA/SIPC), which is not affiliated with Nowlin and Associates. Contact him at 334-703-3454 or firstname.lastname@example.org.