Everybody's Missing the Biggest Story in Washington — Our Debt Nightmare

All signs are pointing to higher taxes in the future. The middle class, especially those diligently saving for retirement in their 401(k)s and IRAs, need to be ready for that.

By Michael Andersen, Investment Adviser

published 5 August 2019

in Features

(Image credit: martinwimmer)

There’s so much political news these days. I can’t turn on any news channel and not hear a constant drumbeat of Trump, Trump, Trump.

But he’s not the only story.

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A lot of the noise coming out of Washington and the media really doesn’t matter. What does matter is the size of the mounting federal debt — over $22 trillion. And on top of that are the obligations to baby boomers for Social Security, Medicare and Medicaid – $60 trillion.

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Nobody seems to care about it, but it’s a mathematical nightmare for our country over the next generation. We are borrowing at an ever-increasing rate, and at some point, the lenders will say, “No more.” And when you look at the developed economies — the countries that have money — you’ll see that they’re all in bad shape, too.

So, what it comes down to is this: This problem isn’t something we can cost-cut our way out of. That’s because federal programs like Social Security and Medicare are unlikely to be meaningfully cut or reformed. There are just too many reliable voters in that group. Take Florida, for example. Donald Trump would not carry Florida in the next presidential election if he goes before the American people in 2020 and says, “I’ve got to cut Social Security.” Unfortunately, this potentially debilitating problem with our federal debt was created by politicians and never addressed.

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There are only a couple of options to start bringing relief to the debt, and neither is appealing.

No. 1, the Fed can print more money, but you can’t print that much money without massive economic dislocation. Look at what’s happened in Venezuela, for example.
No. 2, we can raise taxes, and ultimately, that’s what’s likely to happen. Once the cuts put in place by the Tax Cuts and Jobs act expire at the end of 2025, you can almost bank on higher taxes happening.

It’s not unheard of for taxes to get extremely high when the situation is what our country is in right now. Keep in mind that the highest marginal income tax rates in U.S. history topped out at over 90% in the 1950s and ’60s, compared with 37% today. Some who were voted into the House of Representatives during last fall’s midterm elections have already talked about legislating astronomically high tax rates to deal with debt and social programs, and unfortunately, the math may demand that.

According to an analysis of IRS data by Pew Research, upper-income and middle-income people pay the lion’s share of federal taxes. In fact, those with adjusted gross incomes of $250,000 paid almost 52% of all income taxes, even though they represented fewer than 3% of the returns filed. Meanwhile, those in the bottom 20% got more money back from the government than they paid in taxes. So, it would seem clear that the way the government can raise money is by taxing the middle and upper-middle class.

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The result likely will be that the middle and upper-middle class who saved in their IRAs and 401(k)s — and with taxable mandatory distributions coming at age 70½ — are likely to face taxes at a higher rate. From a retirement-planning standpoint, you might see a nice, round million-dollar figure in your 401(k) today, but how much of it 20 years from now will actually be yours, and how much will belong to Uncle Sam?

That’s the big story. I wish ABC, CNN, NBC and Fox News would stop talking about things that don’t matter and look at what will really matter to so many retiring Americans. What we really need to look at is the hard fact that we’re $22 trillion in the hole, and we’re adding to it at a rate of over $1 trillion a year.

Protecting Your Retirement from Taxes

Part of the solution, if you want to call it that, to our national debt problem might mean taking a bigger chunk of your retirement dollars — unless you take extra precautions. What investors should be doing is looking to position their money to protect it from potential tax implications.

The bottom line is that people need to stay on top of ever-changing laws. They need to realize that tax-favored accounts like Roth IRAs are not set in stone to be forever tax-free; laws can change.

In the Meantime, Let’s Watch What Happens

The solution the president tried to make happen with his tax bill was to try to grow the economy quickly. The U.S. spends a lot of money on those social programs, but if we’re pumping out 5% to 6% a year in economic growth, we can actually pay for it. We’ll see; the Federal Reserve is certainly heavily involved in the economy, and it plays a larger role in terms of monetary policies than, say, modest reductions in corporate taxes.

Meanwhile, we continue to just kick the can down the road — again. There has to be some type of limitation on government spending. You can’t have spending grow faster than the economy grows, or by nature you’re going to end up in a bad place.

Nobody seems to care. All they want to talk about in Washington is how they can spend more money. The financial consequences to future generations are unbelievable — higher taxes and a lower quality of life. But in some ways, these dire consequences aren’t surprising. The politician’s job, after all, isn’t to grow the economy. It’s to get elected.

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Dan Dunkin contributed to this article.

Disclaimer

This article was written by and presents the views of our contributing adviser, not the Kiplinger editorial staff. You can check adviser records with the SEC or with FINRA.

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Michael R. Andersen is the founder and president of Andersen Wealth Management, a Registered Investment Adviser. He is an Investment Adviser Representative and a licensed fiduciary. A firm believer in financial education, Andersen holds regular informational seminars for clients and the community, and he is the host of the "Wise Money" radio show.