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Hedging Against Tax Hikes

MoneyWise

Christian talk radio with Rob West

October 7, 2022

Supreme Court Justice John Marshall once said, The power to tax is the power to destroy. In the early 1800s, Marshall was actually defending the federal government against taxation by the states. But what defense do you have against taxation by the federal government? We’ll talk about it today. History has shown us that given the opportunity, government will almost always raise taxes. As the national debt continues to rise, there’s ever more reason for lawmakers to want more of your money. Even with the recent downturn of the stock market, Americans still hold trillions in 401k accounts, and you can be sure that many federal and even state lawmakers would like to get a bigger piece of the 401k pie. Now, we’re not talking about the federal government confiscating your retirement savings. That would be political suicide. It’s much easier for politicians to simply raise income taxes. So when the day comes that you withdraw funds from your 401k, you pay more in income tax. SOMETHING YOU SHOULD KNOW ABOUT 401Ks You have to understand something about the 401k, and for that matter, the traditional IRA, as well. One of the huge tax benefits of those plans is also a weakness. Money goes in tax-deferred, meaning grow now, pay later. Contributing to these plans has always made sense because most of us assume that our income will be lower in retirement when withdrawals are taxed as regular income. The weakness is that the government can always increase taxes on 401ks and traditional IRAss in the future. And there’s plenty of reason to do it. It’s one more thing you can blame on the coronavirus pandemic. Business shutdowns and high unemployment caused a huge drop in government revenue. Add in the cost of relief programs, and you have federal and state governments looking for ways to overcome budget shortfalls, even more than usual. So no doubt, some lawmakers are looking at the trillions held in these accounts as the solution, and that’s why we might expect tax hikes down the road. So what’s your defense against that possible outcome? Well, first of all, you don’t want to stop contributing. Qualified retirement plans have a range of benefits that you should take advantage of. But you should heed the warning in Ecclesiastes 11: 2, Divide your portion to seven, or even to eight, for you do not' know what misfortune may occur on the earth. That biblical principle tells you to diversify your retirement holdings. The same way you spread out your holdings in stocks versus bonds or by holding equities in different sectors of the economy you can also diversify between taxable and non-taxable income streams in retirement. If you have a 401k, the easiest way to do that is by putting some of your money in a designated Roth account if your plan has that feature. This is a Roth account within your 401k where you would contribute after tax money. Later in retirement, withdrawals of those contributions and earnings will be tax-free. So you’re setting up a tax-free income stream in retirement. Of course, there are limits to what you can contribute to a Roth 401k, those deposits count against the total allowed for 401k contributions. In 2022, the limit is $20, 500, or $27, 000 if you're age 50 or older. If your 401k plan doesn’t offer a Roth option, you would still want to contribute enough to get the maximum employer contribution if there is one. After that, if you still have discretionary income to invest, you could open a Roth account outside of your 401k, which, of course, you should do if your employer doesn’t offer a 401k at all. Okay, by now you might be thinking, If government can raise taxes on withdrawals from 401ks and traditional IRAs, it can also start taxing Roth withdrawals. It could, but politically, it wouldn’t be nearly as easy to start taxing Roth accounts as it would be to simply raise taxes on the other plans. Roth accounts were specifically created to have tax-free withdrawals. It’s the whole reason for their existence, and remember, Roth contributions are already taxed going in. It would be far more difficult for lawmakers to suddenly do a 180 and effectively double tax Roth accounts. Now, there’s one more possible hedge against future tax hikes, and it’s actually using a taxable brokerage account. It would allow you to get around the contribution limits of qualified retirement plans, although you would incur taxes year to year. So it’s not a great option, but if you’re able to max out your contributions to a 401k and Roth and still have money to invest, a regular brokerage account is probably the way to go. On today’s program, Rob also answers listener questions: ● Is it unbiblical for a married couple to have separate checking accounts? ● Can you allocate VA money to a spouse with the veteran in question is in long-term care? ● Is there a good way to build a budget on a smartphone app? RESOURCES MENTIONED: ● MoneyWise App

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