2023 EP0708 | Financial Updates | Does A Traditional IRA Make Sense Anymore?

We want you to plan for success. Welcome to Planning Matters Radio. Peter, good to see you.

I have a good one today. Is there any reason to use a traditional IRA? America's IRA expert, Ed Slot, I know you know him well, recently told other industry experts that an IRA is just an IOU to the IRS. He says he doesn't see any benefit to using a traditional IRA right now because tax rates are so low. Do you agree?

Absolutely not. Now, Ed Slot is a very, very smart guy. He's one of the preeminent CPAs, certified public accountants.

He has been named by the Wall Street Journal as America's leading IRA expert. And his statement that the IRA is an IOU to the IRS is, in fact, 100% accurate. You do have a debt within your retirement account.

But to to say this with me, with an absolute is simply not the case because math. And so I've got many clients who make a pretty comfortable kind of income during their working career, but actually managed to live off of substantially less. Let's say we've got a married couple filing jointly and they're earning somewhere between 200 to $250,000. But their actual lifestyle expenses are more like $90,000. Well, they're in currently the 24% tax bracket and their lifestyle expenses indicate that they will be in the 12% bracket when they retire because retirement's not about replacing 100% of your work and career income. It's about replacing your ability to cover lifestyle expenses. So they'll go from that $200, $250,000 of income down to more like $90,000 of income.

And I know brackets are changing, but that's not the case. That's still a significant reduction in the amount of taxes that you would pay on those dollars. So why would you pay taxes today at those higher rates if you can foreseeably and reasonably expect to be in a lower tax bracket once you do retire and you are withdrawing those dollars? I would say paying your taxes now would be more attractive, but explain, Peter, though, how to pull in a tug with the tax deductions being more attractive when rates are high.

They are absolutely. A tax deduction is more attractive if rates are higher, but we can't look at the total tax environment alone. We have to look at our unique individual situation as well. Even though across the board, the environment right now is historically low, which, by the way, is going to change if nothing's done, laws on the book, taxes will be going up in a few short years. But we also have to look at our unique individual situation. Again, if we are in the midst of our working career earning a pretty substantial income, we may be personally in a higher marginal bracket than where we would expect to be.

In retirement. And if that's the case, even if taxes go up on those dollars, well, we may still be paying a lower effective rate when we harvest them versus when we are earning those dollars and putting them away in those tax deferred accounts. Now, you've got to crunch the numbers on this.

This is very specific and unique and individual to a person's situation. So, yes, the brackets, the environment is low historically, and I do feel likely to change even more than what is currently on the books. I think taxes will be going up into the future.

But when we crunch the numbers, do we have a reasonable expectation of being able to harvest them in future years at a lower rate than we are saving them today? And if so, then tax deferral does still make sense. So another argument Ed slot is making, let's say you converted all your tax deferred accounts now into a Roth.

A Roth, of course, has no required minimum distributions. Theoretically, you've lowered your tax bill for the rest of your life. Yeah, you've controlled your tax bill for the rest of your life. If everything was in a vacuum and tax rates stayed the same, then it's effectively a wash. Now, if you've got growth on your money over time, then you may be paying more dollars, but you actually get to net the same thing if growth rates are the same on both sides and if tax rates stay the same.

But the thing is, we've got a progressive system. So the more wealth you have, the more income you have, the more you pay in taxes on those subsequently higher dollars. And so it really does make sense to manage the taxes when you have the ability to do so at the lowest rate possible. Generally speaking, converting over your total balance would not keep you at the lowest rate possible, because if you convert over a larger sum of money, dollars are going to fall into those subsequently higher progressive tax brackets. So it is about managing the taxes and trying to stay at the lowest rate possible. I actually don't mind potentially spilling over from the 22 to the 24% bracket because the 22% bracket is slated to become the 25% bracket in 2026. So that still may be a savings, but you have to consider Social Security taxation, you have to consider Irma, the premiums that you will pay for Medicare, all of this has to go into that equation and be considered for is this a cost savings tax effort or am I just paying more than my fair share unnecessarily?

I'd like to stay on that thread. Okay, because again, slop believes Congress is purposely making tax deferred accounts less attractive, because of course, the government is in desperate need of tax revenue right now. And as we are talking through right now, you have encouraged people to pay their taxes now.

So again, where do I find the answer here and in this gray area? Well, if Congress was doing this, just to try to harvest more money now that would be very short sighted of them. So I don't put it past them. But it would be counter to the way that they have planned and prepared and really with pretty good foresight set the system up. I mean, they allowed us to defer and delay paying taxes on those retirement dollars because they understood what Albert Einstein said that compound interest was the eighth wonder of the world and the most powerful force on the planet. They knew that as the baby boomer generation deferred and delayed paying their taxes they saved and grew those dollars that they would be harvesting more tax revenue from those deferred dollars later and we are in the midst of the baby boomer retirement wave. So the time to benefit from that tax deferral from the government's standpoint is now right. They are harvesting those dollars that have compounded tax deferred. Now the taxes are due and they have pushed the required minimum distribution age back. So that would be counter to the fact that they are doing this just because they need those tax dollars now.

Look, there are no dummies there as much as we can second guess some of their decisions. They do understand that they are about to harvest the lion's share of that tax revenue on those yet to be taxed tax deferred $36 trillion in IRAs, 401ks and tax deferred retirement accounts. And whether or not people want to spend the money, need to spend the money, are required to distribute the money or pass the money generationally, Congress and the operating expenses for the U.S. are about to get a windfall because the baby boomers are turning from savers and accumulators taking advantage of those tax deferred accounts to net sellers of assets where they are taking distributions. They are taking withdrawals and they are going to be forced to pay the tax on those dollars. And even if they don't, when those accounts now pass generationally because of the secure act doing away with the stretch IRA, all 100 percent of the taxes on those tax deferred retirement dollars are going to come due. Those accounts must be liquidated within 10 years. So Congress has actually set themselves up in a pretty intelligent manner to harvest as much tax revenue from these accounts as they possibly can.

I think that it is wise to look at Roth, Roth contributions, Roth conversions and manage the tax liability on your account, which, yes, may add a little bit to the tax liability and the tax bill that we are paying today. But I don't think that this is what Congress is doing as a means to try to raise revenue with emergency or necessity here. I think that they are pretty wise in allowing Americans to defer and delay paying taxes. They know that they get to harvest more down the road.

Okay, last question. How about investing in a brokerage account instead of an IRA? At least with a brokerage account, there is no debt, no real deal with the government there. Yeah, well, I mean, they issue the dollars with each and every dollar.

There is a deal with the government there. They are the ones that back the promise of payment and every dollar does have a tax plan. So, yes, you can pay your taxes upfront and then invest it outside of those retirement account qualifications and advantages.

You don't get the advantages of the tax deferral or the tax-free growth. But when those accounts grow, there are taxes due. Like even in a bank account that's earning interest at the end of the year, you get a 1099-INT form, which says that you owe taxes again on the growth. So, you pay taxes once upfront and invest those dollars. And if you purchase investments that appreciate in value, and then you buy, sell, trade, transact, there is a taxable event that is realized there and you will owe taxes again on the growth. And, you know, you can offset that with some losses in the same account. There is tax loss harvesting.

There are opportunities there. There can be more tax advantaged. I mean, Warren Buffett famously said that he paid less in taxes than his secretary. Well, that's because his secretary was paying income tax. She was paying tax on money for the very first time, whereas Warren Buffett mostly is paying capital gains, meaning he's already paid tax once he invested the money. So, you're paying tax now on the growth that that money is generating. So, paying tax the second time as tax laws stand today, and this could change, but capital gains are less than being taxed as brand new income.

So, it's just a different bucket, right? And I think that some diversification of your tax status, tax deferred, tax free, after tax, non-qualified, is just as important as the diversification of your investment allocation. You shouldn't be all in one stock. You shouldn't be all in one tax bucket. Really interesting conversation, Peter.

I am grateful to, again, dive into these blanket statements, which kind of get a lot of people fired up, but this was really helpful to talk through. If somebody has questions about, again, where they should be putting their pre-tax, deferred, tax free, tax diversification, what's the best way to reach you? Yeah, or just manage the taxes on the nest egg that they've built.

That's a big one right now. It really is an opportunity. So, while we're sort of debunking the blanket statement as not being universally applicable, it is wise, now is the time, to look at managing the taxes on your nest egg. So, if you'd like to take a look at that, it's part of the optimized retirement plan that we put together, you're welcome to give us a call at Rishon Planning, 919-300-5886, 919-300-5886, or you can visit online and schedule an appointment right from the website.

Rich on Planning is what it looks like, because you don't get rich on accident, but it's my last name, richonplanning.com, richonplanning.com. Alright, Peter, thank you very much. Always a pleasure, Erin. Thank you. Thanks for joining us on this edition of Market to Market.