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Smart Personal Finance 101: Bank for Retirement (Part III)

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By Dr. Gary L. Deel
Faculty Director, Wallace E. Boston School of Business

and Dr. Karin Ford-Torres
Faculty Member, Wallace E. Boston School of Business

This is the third retirement article in a series on sound tips for financial security and prosperity. These articles are intended to share a general overview of conventional, commonly practiced financial methods from business school faculty members and are in no way intended to influence or impart financial/legal advice or actions to or on behalf of readers. Readers should always consult with an attorney or licensed financial advisor before making any financial decisions.

In the previous part of the Smart Finance 101 series, we discussed the important differences between pre-tax and post-tax retirement investment strategies, and how income brackets at the time of contribution versus the time of withdrawal can make major differences in net returns. In this part, we’re going to look at another major factor in attempting to strategize for retirement: changing tax laws.

Tax Brackets Are Fluid and Hard to Predict

Trying to predict what tax bracket you might fall into at the time of retirement — which for many people is years or decades away — is hard enough. But another critical element is the fact that tax brackets are fluid. They change often with shifts in political winds and new political leadership at the federal level.

Republicans generally favor lower taxes for high-income earners, while Democrats traditionally support greater levels of taxation on the rich. So depending on which party happens to be in power at the time of your retirement, the tax liability brackets could look very different from their current forms.

Another factor to consider is inflation. Even if political headwinds on taxation were to remain fairly consistent between now and your retirement, we do know that they will need to be revised to adjust for the changing value of the U.S. dollar.

For example, in the previous article we discussed that a tax rate of 35% is currently imposed on single individuals making more than ~$200,000 — and this of course is predicated on the idea that $200,000 in annual income is generally considered a very good living today. In fact, persons who earn more than $200,000 a year are currently in the top 5% of all American earners. Doctors, lawyers and other highly paid professionals are among those in this group. Incidentally, the current Biden administration tax plan calls for even higher tax rates for the ultra-wealthy.

But in 20 or 30 years, $200,000 obviously won’t have the same buying power as it does today. And as such, tax codes will need to be revised to account for upward inflation and the continually decreasing value of the dollar (relative to costs of living).

For all of these reasons, trying to estimate with any accuracy the tax liability you might face at the time of retirement when that is any considerable length of time away — say, more than just a couple of years — is nearly impossible.

If retirement is near enough that income can be projected with confidence and political power is not likely to change drastically in the meantime, that’s one thing. But for people who are five, or 10, or, in my case, 30 years from retirement, this is little more than a guessing game. There are simply too many variables and unknowns to skew possible eventualities, and too much time for slight deviations to cause massive changes in predictions.

The Role of Diversifying Investments

But as we discussed in the previous article, estimating tax liability at retirement is essential to understanding whether you should focus on pre-tax or Roth (post-tax) retirement investments earlier in life. So what can we do?

One thing we can do is diversify our IRAs. Diversifying investments means taking simultaneously adverse investment positions so as to minimize the potential risks of loss involved.

For example, suppose there you’re headed out for the day and you aren’t sure whether it will be sunny or rainy. A good idea would be to bring both your sunglasses and your umbrella – this way, you are prepared either way.

How do we do this with retirement investment? We do it by playing both hands. Dr. Deel says, “In my case, I have about half of my retirement investments in traditional pre-tax accounts and the other half in Roth post-tax accounts. This way, if my tax liability is high when I reach retirement, I may get slammed on the taxation of my pre-tax investments at the time of withdrawal. But I will still make a fair return on the Roth investments since I will have already previously paid the tax on them.

But if my tax liability at retirement is low, then I will conversely do well with my pre-tax investments by paying a low tax rate at the time of withdrawal. I may have paid a higher tax rate on the Roth investments earlier on, but hopefully any lost opportunity there will be offset by the tax savings with the pre-tax accounts. We won’t know the exact way things will play out until we get there. But by putting our ‘eggs’ in multiple ‘baskets,’ we limit the possibility of a truly disastrous loss.”

But if you don’t have an employer-sponsored retirement program, are there still ways you can invest for retirement on your own? The answer is yes, but there are a lot of important details to understand about contribution limits and terms and conditions with different scenarios. In the next part, we’ll look at individual retirement accounts (IRAs) and Roth IRAs as they compare with 401(k)s and other types of employer-sponsored retirement accounts.

American Public University and American Military University offer academic programs in accounting and finance, which cover important financial discussions in depth. Readers who are considering expanding their knowledge and credentials in this field are encouraged to visit our program pages for more information.

About the Authors

Dr. Gary Deel is a Faculty Director with the Wallace E. Boston School of Business at American Public University. He holds a J.D. in Law and a Ph.D. in Hospitality/Business Management. Gary teaches human resources and employment law classes for American Public University, the University of Central Florida, Colorado State University and others.

Dr. Karin Ford-Torres is an Associate Professor with the Wallace E. Boston School of Business at American Public University. She holds a Ph.D. in Business Administration with a concentration in Advanced Accounting and Financial Management. Karin teaches accounting and finance courses for American Public University, Purdue University Global and Colorado State University-Global. She has 24 years of prior banking experience with Bank of America.

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