Why now may be the right time to lock in current tax rates.

Income taxes have been a cornerstone of U.S. fiscal policy for over a century, evolving significantly since their inception. Understanding this history is crucial, especially for retirees and those approaching retirement, as tax changes can profoundly impact financial planning.

A BRIEF HISTORY OF INCOME TAXES

The U.S. government first introduced a federal income tax in 1862 to fund Civil War expenses, imposing a 3% tax on incomes between $600 and $10,000 and 5% on incomes over $10,000. This tax was repealed in 1872. In 1913, the 16th Amendment established the federal income tax system we know today. Initially, the tax rates were modest, but they escalated during World War I, with the top rate reaching 77% in 1918. Over the years, tax rates have fluctuated, peaking during World War II at 94% and gradually decreasing thereafter. Significant reforms, such as the Tax Reform Act of 1986, further adjusted rates and brackets.

WHY TAXES MIGHT BE “ON SALE”

Currently, federal income tax rates are relatively low compared to historical highs. The Tax Cuts and Jobs Act (TCJA) of 2017 reduced tax rates across various income brackets, with many provisions set to expire in 2025. Given the nation's increasing government spending and national debt, there's potential for future tax increases. This environment presents a unique opportunity for retirees and pre-retirees to capitalize on the current lower rates.

HOW THIS COULD IMPACT YOUR RETIREMENT

Tax changes directly influence retirement savings vehicles like 401(k)s, IRAs, and Social Security benefits. For instance, traditional 401(k) and IRA withdrawals are taxed as ordinary income, meaning higher future tax rates could reduce your retirement income. Conversely, Roth IRAs offer tax-free withdrawals, making them an attractive option in a rising tax environment. Keep in mind, however, that you may be hit with a sizeable tax bill and immediate drop in account value when converting to a Roth IRA. Additionally, up to 85% of Social Security benefits can be taxable, depending on your combined income, further emphasizing the need for strategic tax planning.

STRATEGIES TO CONSIDER

● Roth conversions: Converting traditional IRA or 401(k) assets to a Roth IRA allows you to pay taxes now at potentially lower rates, securing tax-free withdrawals in the future.

● Tax diversification: Maintaining a mix of taxable, tax-deferred, and tax-free accounts can provide greater flexibility to manage your taxable income in retirement.

● Alternative strategies: Similar to a Roth conversion, these methods can generate tax-free growth and income, but you could pay $0 out of pocket and maintain interest earning power on dollars that would have gone to taxes

NEXT STEPS

Given the potential for future tax increases, it's essential to:

● Review your retirement strategy with taxes in mind: Assess how current tax laws affect your retirement savings and identify opportunities to optimize your tax situation.

● Consult a financial advisor: A professional can provide personalized advice, helping you implement strategies like Roth conversions or alternative strategies to achieve greater tax diversification.

● Be proactive: With possible tax law changes on the horizon, taking proactive steps now can help you lock in today's lower rates and enhance your financial security

Want to see if a Roth IRA conversion or another strategy could help you keep more of what’s yours? ensure you're taking advantage of today’s tax rates before they go up? Contact us today for a free retirement tax planning consultation!