The Importance of Tax Diversification When Saving for Retirement

As of July 26th 2019, the United States national debt is over 22.5 TRILLION DOLLARS and GROWING! Social Security and Medicare has over 100 TRILLION DOLLARS of unfunded obligations, meaning the money is not currently sitting in an account to pay the benefits… This leads to the question we think about on a daily basis – “How can we help our clients save money for retirement and hedge against higher tax rates in the future?” The simple answer is by contributing to post tax saving accounts such as Roth and Maximum Funded Life Insurance policies. If someone thinks tax rates will be higher in the future due to our National Debt, Social Security, and Medicare obligations, “Post Tax” savings accounts become a great option. Just to be clear, people contributing to “Post Tax” accounts have to pay the tax in the year they are filing their taxes, which is where a lot of people get push back from CPAs because they LOVE tax deductions today and are generally not trained to think about realistic tax rates down the road. If you don’t believe us, ask your CPA next time you see them: “Where do you think tax rates will be in 10 years, 20 years, 30 years, and how do you think the United States will pay back the national debt and continue to pay Social Security and Medicare Benefits?” If they do not say “HIGHER TAXES”, then please write down their answer and file it away so you can re-reference the conversation at a later time, and consider start shopping for a new CPA.

At Pacific Insurance Group out of Bellevue Washington, we believe ANY type of savings for retirement is better than not saving at all. But when speaking with multiple clients over the last 19 years we have found most people have never processed what paying the tax on their savings accounts in retirement actually looks like. For example, if someone today were to save $6,000 per year for the next 30 years ($180,000 of contribution) with an 7% compound interest rate they would have $612,438 in their account. Now, here is the important part of the equation, if that was a Roth IRA the individual would have realistically paid around $1,500 of tax the year they made the contribution, so a total of around $45,000 in taxes total. Now, lets look at the other side of the equation, instead of saving money in a Roth IRA they decided to do a Traditional IRA and receive a $6,000 tax deduction (which rarely makes an impact on someone’s tax return) and delay paying the tax until they take distributions down the road. If tax rates happen to be 50% in 30 years when that person starts taking distributions they will get hammered with paying taxes on the back end. For example, they took a $100,000 distribution from their account with $612,438 they now have $512,438, received $50,000 to spend, and got to pay $50,000 to Uncle Sam. Now do the math on how much taxes will continue to be paid to the US Department of Treasury from the Pre-Taxed Individual Retirement Account this person diligently saved over the last 30 years. Furthermore, people have to start taking distributions from their “Pre-Tax” IRA, SEP IRA, SIMPLE IRA, or retirement plan account when they reach age 70½. Roth IRAs do not require distributions until after the death of the owner, and generally speaking the accounts pass on tax free to the beneficiaries. 

A common saying or question over the years around this concept: “If you were a farmer, would you rather pay tax on the seed or the harvest?” Most people answer this by saying “the seed of course!” But, why are the majority of people saving in “Pre-Tax” account then? Honestly, we don’t know… we believe it is because people have not taken the time to ponder the reality we are currently living in, they are either oblivious or listening to the wrong advice. There is a huge problem brewing when the United States is spending way more than it is currently collecting from federal tax returns. What if right now the rest of the world were to stop lending the United States money?  What would our current tax rates have to increase by in order to just service our national debt interest and pay for Social Security and Medicare benefits? As a country we are basically taking out another credit card to pay the interest and payment on our previous credit cards. It doesn’t matter where someone stands politically, that is not the issue… the issue is balancing the federal budget and servicing OUR DEBT (if you are a U.S. citizen). Time to explore creating tax diversification strategies in order to hedge against higher tax rates in the future. We are extremely confident that people who take action now, pay a little tax, start saving in “Post Tax” accounts will never regret doing it.

First let’s take a look at Roth options, if someone is looking to save $6,000 or less per year and make less than $122,000 per year, someone could open up Roth IRA account and contribute up to the 6K per year and start hedging against higher tax rates in the future. Phase-outs start at $122,000 of income for individuals and they make over $137,000 per year Roth IRA is no longer an option. We do not understand the reason for this rule, but regardless, it is the rule. It is very easy and straightforward to open a Roth IRA with E-Trade or similar platforms and start building wealth through Roth IRA’s. If people are married filing a joint tax return the phase outs start at $193,000 of combined income and people are ineligible when their combined joint tax return shows over $203,000. So, if people are married and combined you make less than 193K per year, they are able to contribute 6K a piece, $12,000 total. If combined they make more than $203,000, Roth IRA’s are off the table, not an option. However, if someone works at a job and have a Roth Option on the 401k plan, there is no income restriction. This becomes an incredible way for people who make a lot of money to still be able to contribute $19,000 per year after tax and build up a very sizable “Post Tax” savings account. For someone making 200K or more per year Roth 401k provisions are a phenomenal option when it comes to hedging against higher tax rates in the future.

The second “Post-Tax” savings account is an overfunded permanent life insurance contract because of the current tax code when it comes to building up cash value in a Whole Life or Universal Life insurance contract. Generally, life insurance premiums are not tax deductible which makes the cash value tax deferred and loans through the policy are not taxed as long as the policy does not lapse and a death benefit is paid out.  It is wise to work with an experienced independent life insurance agent who has access to working with the most competitive products in order to design the best policy for your situation. If you would like to get additional information please call 425-246-4222 to set up a free phone consultation or visit to schedule an appointment with Carter Gray.