Hedging Your Tax Rates
When sharing information on social media, I think everyone gets the know-it-all responses that have something negative or an opposite opinion to what your advice may be. When it comes to building your assets in the most tax efficient manner, there is no one perfect answer. Everyone has an opinion! The question I ask my clients is “where do you think tax rates will be in 10, 20, or 30 years?” Most will say “higher than today”. Some will say, “Not sure”. If we look at historical tax rates, we are still in a relatively low tax environment. The next 10-20 years will be crucial when determining where we save our nest eggs.
I always tell clients, set yourself up for any tax environment. You should be saving in three different tax “buckets” equally, if possible. Typically I come across new client or individuals who have everything saved in their pretax retirement bucket, on the top right, where almost all of their assets are taxable in retirement. In this type of situation, you back yourself into a corner and you’re subject to any and all tax changes. Trying to save in all three of these buckets will give you the most control if taxes move higher or lower in the future. The top right bucket will be best when tax rates are lower, because you pay less tax on assets withdrawn for retirement. The bottom bucket is best when tax rate are higher in the future because all assets are tax-free upon withdrawal. And the top left can be managed to be tax-efficient in most tax environments and gives you the liquidity you need for emergencies and major life purchases, such as a second home.
Proper planning will help position yourself to have more control of the money that stays in your pocket in the future. Start thinking how you can hedge your future tax rates!
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