The Retirement Math Problem

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By on August 8, 2019 in Retirement with 0 Comments

Young woman with her back to the camera scratching her head and appearing puzzled as she stares at a plethora of math problems drawn on a chalkboard

If your annual household budget looked like this:

Income $68,000
Spending $80,000
-$12,000

Is there a problem?

How about the household budget of the United States:

United States 2018

Federal Revenue $3.33 trillion
Federal Spending $4.20 trillion
-$873 billion

Is there a problem?

As leaders of our country move forward on a budget deal that will add $1.7 trillion to the debt over the next 10 years, this math problem is going to get larger.

According to the Congressional Budget Office, “The United States is on an unsustainable and dangerous fiscal path. Our nation’s debt is at historically high levels and projected to rise dramatically, posing a significant risk to our economy and to every American’s future. Our debt challenge isn’t based on politics or partisanship – it’s the simple math of spending more than we take in.”

Perhaps a bigger problem is our country’s unfunded liabilities of $122 trillion, which includes Medicare, Social Security, Federal Debt, plus Federal Employee and Veterans Benefits.

According to the Peter G. Peterson Foundation, the Baby Boom generation – 73 million strong – has already begun to leave the workforce and access federal healthcare and retirement programs.

Today, and every day for the next 11 years, roughly 10,000 baby boomers will celebrate their 65th birthday. Over the next 35 years, the number of people 65 and older will climb by 35 million, an increase of 67%.

Not only will the number of older Americans increase, but they are also expected to live longer in retirement due to significant improvements in life expectancy.

This is telling us that the government will need to spend more for programs that will serve older Americans, such as Social Security, Medicare and Medicaid. The Medicare Trust fund is on schedule to be depleted in 2026 and the Social Security Trust Fund is scheduled to remain solvent until 2034.

While I could devote pages of the fiscal issues challenging our country, I don’t choose to do so. I would rather focus on what we can do to protect ourselves.

Most people believe that taxes will rise. We know that the Tax Cuts and Jobs Act of 2017 is scheduled to sunset in 2025 and that tax brackets will go back to higher levels. It also means that taxes could go even higher than they were pre-tax act of 2017.

What is uncertain?

The News:

Many Presidential candidates are seeking to:

  • Reduce federal and gift exemption to lower levels
  • Impose a new wealth tax on the ultra-wealthy
  • Increase top marginal tax rate from 37%
  • Eliminate or reduce the preferential rates on dividend and capital gains 

What is certain?

Major Things That Impact Taxes:

  • Next Presidential election
  • Change in leadership in the Senate?
  • Provisions of the tax cut that will be sunsetting -Tax Cuts and Jobs Act
  • Major provisions – which are permanent and which are sunsetting?
  • Debt is at an all-time high
  • When is financial doomsday?

One of my favorite quotes, spells it out preciously: “We can throw stones, complain about them, stumble on them, climb over them, or build with them.” William Arthur Ward 

We know as individuals we can’t fix the problem, but there are things that we can do to proactively make changes now to protect ourselves in the future.

As Americans, we can throw stones and complain, or as William Arthur Ward says, build on the opportunities that we have available now. We have 7 years to save or convert taxable funds to tax-free funds.

Tax Planning Strategies to Consider Now

Here are some strategies to consider now:

Strategy 1: Contributing to Roth TSP vs. Traditional TSP

Do you want to pay tax on the seed or the harvest?

Autumn is the season when farmers all over harvest their crops. How rewarding it must be for them to start from a small seed, to water and feed it and watch it grow, and then to reap the bounties that their hard work has produced.

The same can be said for us as we plan for retirement… we start with a seed, watch it grow over time and then as we enter retirement with the intent to reap the bounties of our growth – only to find out that the IRS has a right to a part of it.

One of the great advantages you have is the Roth TSP or Roth IRA. A Roth investment allows you to pay tax on the seed (the smaller, starting investment) and reap the bounties (the investment plus growth/interest) tax-free.

Strategy 2: Roth Conversions

A Roth conversion strategy (TSP to Roth IRA or IRA to Roth IRA) is another tax planning strategy. You can spread these out over time (7 years) to take advantage of the current low tax rate environment. Note: you will have to pay the tax on any pre-tax funds in the year you do the conversion.

At Franklin Planning, our team is very busy this year analyzing Roth conversion solutions for our clients, given that they still have 7 years to make the tax bite less momentous. It doesn’t always make sense when looking at the total financial picture, so I strongly suggest doing an analysis before processing Roth conversions. This strategy can make a significant positive outcome to your retirement.

Strategy 3: Contributing to a Health Savings Account (HSA)

A Health Savings Account (HSA) can be a significant benefit for many reasons, but the most unique of all is that it is the only vehicle I know of where you to get a tax deduction on what you contribute to the HSA and the funds come out tax-free if used for a health expense.

Think about the money we spend on healthcare. The average cost of healthcare in the United States is $250,000 just in retirement.

Unfortunately, there are limits on who can qualify. There is no doubt that the younger you are the more significant the benefit will be because you will be able to make these contributions for a larger period of time.

First, the features of an HSA:

  • It can carryover funds and interest each year
  • Earns tax-free interest on unused balance
  • Portability – you can take it with you if you leave the plan or retire
  • Funds are held with a custodian who provides a debit card
  • There are usually investment choices available from no risk to taking risk in a mutual fund
  • It can be used in retirement, however, you can’t contribute after age 65
  • It is inheritable, just like an IRA
  • HSA distributions are not included in MAGI, so they don’t affect Medicare premiums

Second, to be eligible to enroll in an HSA:

  • You must enroll in High Deductible Plan first
  • You cannot participate if you are:
    • Enrolled in Medicare
    • Covered by non-OPM health plan
    • Enrolled in Flexible Savings Account (FSA), except for dental and vision
    • Covered by Tri-Care or Tri-Care for Life

If you make donations to a charity and are 70 ½ or over, why not contribute to the charity from your IRA and get a dollar for dollar reduction from your taxable income? This is much better than a deduction, if you will even be able to do it with the current tax system.

To use this strategy, you must be age 70 ½ or older by the end of the year and the distribution needs to be part of your Required Minimum Distribution (RMD) not to exceed $100,000 in any year. In addition, it has to be paid out directly from your IRA to the charity. (This cannot be done with your TSP RMD).

Securities offered through J.W. Cole Financial, Inc. (JWC) Member FINRA/SIPC. Advisory Services offered through J.W. Cole Advisors (JWCA). Franklin Planning and JWC/JWCA are unaffiliated entities. Securities are not FDIC insured or guaranteed and may lose value. Investments are not guaranteed and you can lose money. This presentation is for educational purposes only and is not an offer to buy or sell an investment. Neither Franklin Planning and JWC/JWCA are tax or legal advisors and this information should not be considered tax or legal advice. Consult with a tax and/or legal advisor for such issues.

© 2019 Carol Schmidlin. All rights reserved. This article may not be reproduced without express written consent from Carol Schmidlin.

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About the Author

Carol Schmidlin, Certified Financial Fiduciary®, MRFC® is the President of Franklin Planning and has been advising clients on how to grow and preserve their wealth for 25 years. In addition to her financial planning practice, she is the founder of FedSavvy® Educational Solutions, which provides Financial and Retirement Literacy Programs for Federal Employees. She is passionate about helping families with all phases of Wealth Management and is a member of Ed Slott’s Master Elite IRA Advisor Group. Her practice maintains a home office in Sewell, NJ along with a satellite office in Washington, DC. Carol can be reached at (856) 401-1101.

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