Protecting Your Nest Egg From Taxes


Protecting Your Nest Egg From Taxes



Do Higher Tax Rates Mean More Taxes? Maybe Not.

Anyone who’s ever studied the U.S. Constitution, or seen the musical Hamilton, knows Americans have been talking about taxes since our country’s very inception. The Founding Fathers knew we needed a way to bankroll our new government, so they gave Congress the power to levy taxes to pay for the country’s defense, debts and the general welfare of the people. As our country has grown, so have our taxes.

Over the years, we’ve argued about who should pay more and how our money should be used, but we all agree on a single, universal truth – no one likes paying taxes! Since there’s just no getting out of it, let’s take a look at how you can protect your retirement nest egg – arguably one of your most important assets – from the shifting tides of tax reform.

Promises, Promises – Political Parties and Tax Reform  

“Read my lips – no new taxes.”
George H.W. Bush 

Tax ideology tends to fall along party lines. Democrats historically support a more progressive tax structure that imposes the highest taxes on the wealthy, whereas Republicans tend to be associated with tax cuts and reduced government spending. We see these difference clearly in the contrast between the Trump and Biden administrations.

On December 22, 2017, former President Trump signed the Tax Cuts and Jobs Act (TCJA) into law, which resulted in tax cuts on individual and corporate taxes, including:

  • Lowering the corporate tax rate from 35% to 21%
  • Limiting the State and Local Tax (SALT) deduction to $10,000
  • Limiting the mortgage interest deduction for married couples to $750,000 of debt (from $1,000,000)
  • Increasing the standard deduction to $24,000 for married couples filing jointly (from $12,700), $12,000 for single filers (from $6,350) and $18,000 for heads of household (from $9,350)
  • Lowering individual tax rates on five of the seven income tax brackets:
    • 39.6% to 37%
    • 35% (unchanged)
    • 33% to 32%
    • 28% to 24%
    • 25% to 22%
    • 15% to 12%
    • 10% (unchanged)

Under TCJA these changes are set to expire in 2025 and revert back to the higher rates.

Now that President Biden is in office, the growing consensus is that tax hikes are coming, and they will be focused on the wealthy. Biden’s proposed American Families Plan would be funded by levying capital gains tax and ordinary income tax, as well as increased tax audits for those earning more than $400,000 a year. The current $1.2 trillion bipartisan infrastructure plan going to a procedural vote this Wednesday excludes raising corporate taxes for now. However, increasing corporate taxes will likely go into the budget resolution $3.5 trillion reconciliation package which might include additional tax increases such as:

  • Increasing the tax rate to 39.6% on taxable income above $509,300 for married couples and $452,700 for unmarried individuals (from 37%).
  • Increasing the maximum capital gains rate to 28% (from 20%) for people earning more than $1 million per year.
    • Remember that the Net Investment Income Tax (NIIT) of 3.8% is added to the capital gains tax above for married couples with a modified adjusted gross income greater than $250,000 ($200,000 for single filers).

If you’re retired, keep in mind these changes are based on your taxable income. That’s box 15 on your U.S. Individual Income Tax Return Form 1040. In retirement, you’ve shifted from that steady paycheck to diverse sources of income such as pensions, social security and IRAs – which may or may not be considered taxable income. Even if you have over $1 million in retirement savings, that doesn’t mean your taxes will increase. The lesson here is, while you can’t eliminate the possibility of no new taxes in retirement, you can look at how your income sources add up to try to mitigate your taxable income.

Let’s take a look at a couple of examples:

  • Anxious Annie retired three years ago and is now 71 years old. She has $1.1 million in an IRA. She receives $28,000 per year in pension income, $41,000 in social security benefits and takes $36,000 annually from her IRA. Annie just completed her 2020 return with her CPA which reflects approximately $85,000 in taxable income. This means Annie is in the 22% income tax bracket and would not be affected by the individual income tax changes above.
  • Responsible Ray and his wife Rhonda just turned 62 and retired last year with over $5.3 million in taxable and qualified retirement accounts. They’re holding off on social security but taking a combined $300,000 annually from their portfolio to cover their current living expenses. Their 2020 return, after itemized deductions, shows a taxable income of $175,000. Rhonda and Ray are in the 24% tax bracket and like Annie, would not be impacted by the proposed tax changes.

Bottom Line

“In this world nothing can be said to be certain, except death and taxes.”
Benjamin Franklin 

Amen, Ben! Truth is, our country reforms its tax policies as often as it changes Presidents. Consider all of the tax bills proposed over the last 40 years among Carter, Reagan, George H.W. Bush, Clinton, George W. Bush, Obama, Trump and now Biden.

No matter who’s in office, don’t lose sleep over how changes in taxation will affect you. For the majority of Americans – especially retirees who typically have less earned income compared to when they were working – the more things change, the more they stay the same. And in 2021, most retirees won’t see their taxes increase if these proposed tax increases are passed into law under the current administration.

Of course, to ensure you’re holding on to as much of your hard-earned money as possible, consider working with a trusted qualified financial planner and/or Certified Public Accountant (CPA) to discuss how these proposed tax increases might (or might not) impact you.

Disclosure: This information is provided to you as a resource for informational purposes only. It is being presented without consideration of the investment objectives, risk tolerance or financial circumstances of any specific investor and might not be suitable for all investors. Past performance is not indicative of future results. Investing involves risk including the possible loss of principal. This information is not intended to, and should not, form a primary basis for any investment decision that you may make. The information contained in this piece is not considered investment advice or recommendation or an endorsement of any particular security. Further, the mention of any specific security is solely provided as an example for informational purposes only and should not be construed as a recommendation to buy or sell. Always consult your own legal, tax or investment advisor before making any investment/tax/estate/financial planning considerations or decisions.


Read other Articles

Tools & Calculators

Ready to talk with an advisor?