ECONOMIC MELTDOWN? NOW MAY BE THE PERFECT TIME TO GET TAXES OVER WITH
There’s hardly anyone around the world who isn’t feeling at least a little anxious right now. From social distancing measures to avoid COVID-19 spread, to watching the stock market plunge almost on the daily, these can be especially unsettling times.
FEELING A BIT LIKE THE GREAT RECESSION?
Whenever we experience dramatic change—especially during scary times, the tendency is for people to get paralyzed or “hunker down” and “wait out the storm” until things are back to normal.
Immediately after the September 11, 2001, terrorist attacks, the world almost stood still. People panicked, and over the next three years the financial markets plummeted more than 40%. Many people felt like they had lost their future. Many about-to-retire people had to put off retirement seven years.
For example, if people had saved $1 million in IRAs and 401(k)s by the year 2000, they saw that retirement nest egg dwindle in value to under $600,000 by the end of 2003. It took four years (until 2007) for people to recoup that loss and get back to break-even.
That’s because a 40% loss must be followed by a 67% gain, just to make the money back that was lost!
Then in 2008, most Americans lost another 40% in a single year. As Warren Buffet put it, “When the tide went out in 2008, it revealed who was swimming naked.” Again, it took another four years for most Americans to make back what they lost and break even again by 2012 (a break-even point that now wasn’t worth the same amount, due to inflation).
During that same 12-year period, many clients who owned what I call The LASER Fund followed the indexing strategies we teach, and they had tripled their money—tax free.
As an example, a million-dollar nest egg in a LASER Fund in 2000 would have been worth more than $3 million in 2012, and more than $4 million by end of 2015—an average return of 9.6% for 15 years.
More important, after each nose dive in the market, as a tax strategist I advised my clients who had money in IRAs or 401(k)s to act immediately, rather than wait until their account values regained the losses (which is what most people do).
I recommended they take advantage of the lower account values and lower tax rates to get the taxes over and done with sooner, rather than postpone paying the tax for some future, perceived, unknown advantage. Why? Because they could then reposition that after-tax money into LASER Funds (maximum-funded Universal Life Insurance policies) and ride the market back up, totally tax-free!
BECAUSE TAXES ARE LIKELY TO GO UP
You might be thinking right now … If I take the money out of my IRA, I’ll pay taxes and a possible 10% penalty (if under age 59 ½). Is that worth it? Yes. Let me explain why by first asking you a question: Do you think tax rates in the future will likely be lower, the same or higher?
Most Americans believe that tax rates will be higher in the future—substantially. Why? Because our government tends to spend irresponsibly and print money to cover debts. In addition, the government will need to find ways to pay for all it is spending to stave off the worst effects of the COVID-19 economic crisis. And new initiatives may take hold that are popular with nearly 50% of American voters, such as Medicare For All and the forgiveness of student loan debt.
Furthermore, most Americans are not in lower tax brackets when they retire (unless they didn’t save very much). Why? Because they were going down the highway trying to reach their destination of financial independence with one foot on the gas pedal, but the other foot on the brake. They put money into IRAs and 401(K)s, deferring taxes until retirement, because they were told they would be in a lower tax bracket then.
That has not be axiomatic for more than 25 years, because of what I call the Deduction Reduction. Many Americans have fewer tax deductions in retirement because they have paid off their mortgage (killing the interest deduction). Their adult children can no longer be claimed dependents (even if adult children are still living with them). Retirees don’t contribute any more to IRAs and 401(k)s, so that deduction is gone. And when retired, former business owners lose those deductions, as well. And never forget ol’ Uncle Sam likes to keep raising taxes and/or eliminating deductions.
Therefore, most retirees pay back every dime they saved in taxes over the 30 or more years on their contributions to IRAs and 401(k)s during the first three to five years of retirement. And they pay it back every three to five years thereafter—for the rest of their lives!
You see, the government has had a permanent tax lien on those accounts—only about one-third of the money in your current IRA or 401(K) is your money to use for gas, groceries, prescriptions, golf green fees, etc., during your retirement.
HOW CAN YOU PROTECT YOUR FUTURE?
So, here are three strategies that you should consider when the market is down:
- Take care of taxes now on some (or all) of your tax-deferred IRAs/401(k)s—while account values are less
- Take care of taxes now on some (or all) of your tax-deferred IRAs/401(k)s—at today’s tax rates—because your current tax bracket is likely the lowest tax bracket you will ever be in
- Reposition the after-tax monies using tax-free financial vehicles and strategies to recapture the gain on a tax-free basis.
A 33% loss must be followed by a 50% gain to get back to break-even—so why not rise with the market tax-free by performing what I call a “strategic rollout”? This is not a rollover, such as rolling over a 401(k) into an IRA and continuing to defer and delay the inevitable tax liability (which is like going from the frying pan into the fire).
Watch for my next article coming later this week, where I’ll dive into more details on what a strategic rollout can do for your future.
Want to learn more about some of the concepts in this article? Watch these explainer videos on our YouTube Channel!
What Is Better than a Roth, IRA, or 401k?
Is a Roth IRA or 401(k) the best way to save?
How much should I contribute to an IRA or 401(k)?
Are you ready to see the nuts and bolts of a LASER Fund? Get your FREE copy of Doug’s book, The LASER Fund. You’ll learn how to protect your “serious cash” and how to eliminate taxes on your retirement nest egg.