By Tom Sedoric and Casey Snyder

Since 1913, the federal tax code has undergone dramatic changes. The Tax Reform Act of 1969, which was phased into action from 1970 to 1976, raised the maximum tax rate on capital gains to a staggering 49%, the highest level since 1921. In contrast, as of February 2021, federal capital gains taxes sat at 0%, 15%, or 20%, depending on the asset in question. All of that is to say, rates have shifted dramatically and will continue to evolve throughout the future, but one thing will remain the same—taxes have always been and will always be life’s biggest expense.

It has always been of the utmost importance for us at The Sedoric Group to help our clients set tax-efficient savings strategies in place. We know with absolute certainty that tax policy will continue to change, and the low rates that many of us are enjoying today may not persist for much longer. The federal deficit has reached a mind-boggling $3.1 trillion and we see no way for federal taxes to remain as low as they are currently, given the state of this debt. However, with a comprehensive, tax-efficient plan in place, savvy savers can increase their net rate of return despite the inevitable changes to tax policy.
 

Prepare for the Inevitable, Hope for the Best

The first thing we tell our clients is, “Don’t put all your eggs in one tax-basket.” New clients often come to us with the vast majority of their savings in pre-tax 401(k) accounts—we’re here to advise against that. Tax-deferred savings are enticing during our peak earnings years but too much becomes a problem as soon as we enter retirement age.

Someone who wants to live off $150,000 a year in retirement would need to withdraw around $200,000 from their 401(k) to account for taxes in today’s world. This additional tax cost is often not factored into retirement savings plans and comes as a shock as soon as retirement rolls around. To add to the dilemma, tax policies are likely to change and an increased tax rate could mean that retirees are forced to draw even more annually from their tax deferred (i.e. 401(k) or traditional IRA) nest egg.

Balance is the key to long-term success.

With a tax-efficient approach to saving for retirement—a balance of pre, post, and tax-free (Roth) investments—every one of us can prepare adequately for future changes to tax policy. It’s very attainable, especially with proper guidance. As tax policies change, investors need to adjust their saving strategies, distributions, and investments to accommodate for those shifts, later resulting in an increased net rate of return. A fiduciary can help distribute the proverbial eggs across all of your investment baskets for the best long-term outcomes, no matter what changes to tax policy arise.
 

Tax Efficiency’s Worst Enemy: Optimism Bias

One habit we all experience is the tendency to extrapolate from our current tax policy situation. It’s tempting to look at our low tax rates and assume that they will continue to stay low—or even decline—forever. Tempting, but deeply problematic. Tax policy will always change, sometimes for our benefit and other times to our chagrin, but it will change. We cannot let optimism bias obstruct our decision-making and prevent tax efficiency for the future.

Optimism bias, at its core, is our inherent belief that nothing bad will happen to us. Optimism is central to the human experience—it drives progress, it creates innovation, it’s responsible for happy marriages and loving families. Our ability to be optimistic is in many ways what makes us human.

That said, we’ll argue that optimism bias has no place in our financial lives (or, at least an extremely minimal role). It masks potential hindrances to our progress towards financial goals, particularly in regards to future tax exposure. You may enjoy the benefits of tax-deferral today, but as you enter retirement you’ll face an unknown tax paradigm. Avoiding optimism bias by taking the proper steps to prepare for our financial future is the best path to success despite whatever changes to tax policy we might see in the coming years.

We believe that tax planning should be discussed early and often. Whether you’ve been working on your tax-efficient saving strategy for years now, or haven’t yet started, there’s always time to make improvements for future success. One thing is certain—taxes will always be your life’s single greatest expense. But with proper planning and preparation, you can confidently enter retirement knowing that you’ve maximized your net rate of return at every opportunity. 

 



Opinions expressed are those of the author and not necessarily those of Raymond James. Raymond James does not provide tax or legal services. Please discuss these matters with the appropriate professional.