Is it really even possible to know? Most of us don’t even know what our taxes will look like for this year, let alone next year, or in 5, 10, or 20 years! We have a theory behind it all—the less we know, the more we need to plan.
Too many people focus on the here and the now. How can I lower my taxes today? This in theory can be a great strategy. After all, it has been a great strategy over the past. You did not have to think or plan much to figure out that maximizing your 401(k) or other retirement vehicle would lower your taxes - and help you save for retirement. The difference between then and now or in the future, though, is your tax rate may not be lower in retirement like your parents or grandparents experienced. It may be higher.
There is a very easy explanation for why we believe this to be true. It is simple economics and it works like this: R x P= RN (Rate x # of People= Revenue Neutral). In other words if Uncle Sam knew he needed $1,000 and had 100 people to tax, he would need to charge a rate of $10 per person. Today the majority of the baby boomers, which are the largest part of our population by far, are still working and being taxed. But what happens when the majority of our population is retired and the “# of people” goes down. Where will the tax revenue come from if we don’t have more people? The answer is simple—a higher tax rate for working individuals.
If this holds true, it could change everything about your retirement needs. Imagine that you might actually need 10-20 percent more income in retirement simply in order to pay your taxes. This would mean that you need to save at least this much more because you are playing catch up. Which is the point at which most people give up and say, whatever will be will be - only to ultimately discover that they may never be able to have the retirement they wanted. Or any retirement at all.
There is hope, though, and there may be a better way. What about developing a retirement plan that has tax flexibility? In other words, what if you built a plan where you are not just dependent your 401(k), pension, and Social Security, which are all taxable, to provide your income for retirement? What if you built in tax-free income, semi-taxable income, and taxable income into your plan? What if you could mix and match - not take income from taxable accounts in certain years and then turn it back on when tax rates favor a taxable income?
We call this tax diversification. It could be the one thing that makes or breaks your success in retirement. Don’t live by default—live Life on Purpose and remember that the young person you are today will be the only one to take care of the old person you will be some day. Every year you wait is another year you put yourself at risk. Start planning today!