Global conflicts and uncertainty can affect retirees in ways that are not immediately evident.
The impact of government spending and the ever increasing national debt is a critical concern that could have big effects on both retirees and pre-retirees. Increased national debt may lead to rising tax rates, affecting individuals and businesses across the country. One group that may end up suffering more than expected is middle-class retirees.
It has already been established that the tax rate cuts from the TCJA are expiring, which means tax rates are going up at the end of 2025. It is currently estimated that middle to upper middle class retirees may have up to 80% of their retirement savings in tax-deferred accounts. The most common include 401(k)s and IRAs. These accounts are funded by pre-tax dollars and as such are subject to taxation when money is pulled out.
This means that when money was put into these accounts, taxes were not paid. These accounts are built with the idea that when someone finally does pull money out their tax bracket will be lower because they are no longer working. However, once retired, keeping money in tax-deferred accounts is like betting that tax rates in the future will stay the same or go down. The growing national debt and entrance of the US into foreign conflicts may be signals to reconsider this bet.
When one is pulling money out of these accounts, that is when taxes become owed. Whether the withdrawal is part of a well-prepared income plan, or out of necessity due to required minimum distributions. When withdrawals from a tax-deferred account occur, tax is owed at the current tax rate.This could be cause for concern for retirees if tax rates increase. If tax rates increase significantly it would mean a significant amount of their hard earned retirement savings will no longer make it to them, instead it may go to the IRS. Rules around required minimum distributions as well as tax brackets have been changed with recent legislation and are subject to further change as the TCJA expires in 2025.
With global conflicts rising, it raises questions about the budget for US involvement. Military spending is already the number one discretionary expense, the question looms if more will need to be allocated due to increased conflicts in Ukraine and Israel. If the national debt continues to increase there are few things to pay attention to in regards to potential tax changes and retirement stability.
Interest Costs: When the government borrows money to finance war efforts, it incurs interest expenses on the debt. These interest costs compound over time, adding significantly to the national debt burden. To cover these expenses, the government often resorts to increasing tax rates.
Crowding Out Effect: As the national debt grows, it can crowd out other important government expenditures, such as infrastructure, healthcare, and education. When essential services suffer, the government may be compelled to raise taxes to compensate for the reduced availability of funds.
Inflationary Pressures: A growing national debt can put upward pressure on inflation. To combat inflation, the government may raise interest rates, which can have a cascading effect on borrowing costs for both the government and private sector. We have already been affected by the highest inflation rates in the last decade for the past 3 years, and as interest rates are raised to try and slow inflation, many retirees suffer losses as their bond portfolio takes a hit. While people often add bonds to their portfolio to balance their risk. Retirees are often advised that bonds reduce risk, these same bonds may have seen loss due to increased interest rates.
Downgraded Credit Rating: If a country’s credit rating is downgraded due to excessive debt levels, it may face higher interest rates on new borrowings. August 1st of 2023 the US’s long term credit rating was downgraded for the second time in 12 years. This may result in increased interest expenses and could prompt justifications for tax hikes to bridge the gap.
Diminished Economic Growth: A high national debt can impede economic growth, as resources are diverted from productive investments to service debt obligations. Weaker economic growth can translate into lower tax revenues, prompting the government to raise taxes to maintain fiscal solvency. Retirees with tax-deferred accounts such as 401(k) or IRA may be at a higher risk of seeing the rules for Required Minimum Distributions (RMDs) be altered yet again. The SECURE Act, and SECURE 2.0 both saw changes in the rules around RMDs, and with an estimated $40 trillion in those types of retirement accounts, it may not be too much of a stretch to think the government may want access to those funds through new taxation.
Uncertainty for Investors: A ballooning national debt can erode investor confidence and create economic uncertainty. This may contribute to increased market volatility. Investors may demand higher returns or be less inclined to invest in a country with an unstable fiscal situation. This can result in increased borrowing costs, pushing the government to raise taxes to cover these expenses.
The relationship between government spending and increasing tax rates is evident. With tax rates already scheduled to increase in 2025, retirees should be cognizant of how a growing national debt could lead to further justifications of tax hikes to meet obligations and maintain economic stability.
You can see your potential tax bill with free services such as RetirementTaxMap.com
Information above in reference to discussions with founders of Oxford Advisory Group of Florida. Christopher J. Dixon Jr and Samuel Dixon focus on tax planning for retirees in the greater Orlando and Tampa area, providing tax-focused financial planning. With proper planning, you may be able to reduce the risk of over-taxation. While no-one can with certainty say which way tax-rates will go, having a proactive tax plan could prove to be significantly beneficial for retirees.
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