Howard Hook is a fee-only Certified Financial Planner and CPA with the wealth management firm of EKS Associates in Princeton, NJ. He has been named to Medical Economics’ list of top financial planners for physicians for nearly a decade and is a member of the Forbes Finance Council and contributor to that publication.
Let’s face it – when making decisions about the future we like to know exactly what the future will hold. It helps us feel like we are making the right decision, which is comforting. But the future is anything but predictable. That is something we all learned over the past 15 months. Daily activities we once took for granted, like going to the office or on a business trip, or for our children to go to school, have all been upended and may never go back completely to what they once were.
Predicting the future of tax laws is something people like to do when trying to make decisions about retirement. But tax laws, much like everything else, are hard to predict, despite the claims from politicians when a new tax law is passed that makes certain items “permanent.” Whenever I read or see that, it always makes me chuckle. Sure the only things in life are death and taxes, but exactly what those taxes are changes all the time.
According to the Tax Policy Center, there have been 11 major tax acts passed between 2010 and 2018. From 2019 until today there have been another five. Changing tax law so often makes it difficult to plan beyond a few years. For example, the Tax Cuts and Jobs Act reduced marginal tax rates for all taxpayers through 2025. This gave people a window of opportunity of eight years to recognize taxable income and pay lower taxes. This window may be closing much sooner as President Biden has proposed increasing marginal rates on high income taxpayers as early as this year. So how do you deal with the non-permanence of these “permanent” changes? The best way to do so is to be flexible with your planning even if by doing so you pay a little more in taxes.
For example, when deciding whether to make tax deductible IRA contributions or forego a current tax deduction and contribute to a Roth IRA, common thought is to make tax deductible contributions now if you expect to be in a lower tax bracket in retirement. Sounds good. But to make that decision you need to know what tax rates will be in the future, which of course no one knows for sure. So, what should you do?
Most people wind up making the tax-deductible contribution now figuring a bird in the hand is worth two in the bush. But maybe a better idea is to put half in a tax-deductible IRA and half in a Roth IRA. This way you create flexibility for yourself once retired, as you have several options to choose from when needing to take a withdrawal in retirement.
Another example of being flexible is when determining whether to collect social security early, at full retirement age, or delay collecting until age 70.
Once again, common wisdom is to collect as early as possible. That’s because it takes about 12 years to break even if you wait and of course you don’t know how long you are going to live. But if you don’t need the money, then maybe the best decision is to delay collecting until age 70. By doing so your benefits will be almost one third higher than if you began collecting at your full retirement age. Second, and maybe more importantly, is the concern that you live too long since social security benefits are increased annually by a lower amount than your living expenses are likely increasing.
The alternatives mentioned in the above two examples could turn out to be the wrong ones. But, so can the more conventional options. The difference is that the alternatives provide you with more flexibility if you are wrong, which gives you a better chance of leading a fulfilling retirement.
So, the best advice when facing such a decision may be this: rather than choosing the one that seems to be the best, consider the one that gives you the most flexibility.