Whether a client's retirement dreams are five years away or 50, the single greatest threat standing in their way is taxes, warns Ed Slott of Ed Slott & Co.
The right tax management strategy can save clients hundreds of thousands of dollars, while the wrong strategy — or no strategy at all — can bring undue hardship during their golden years.
That's the central thesis of Slott's new book, "The Retirement Savings Time Bomb Ticks Louder." Reflecting the complexity of the topic, the book stretches to some 430 pages, but as Slott told ThinkAdvisor in a recent interview, he strove to make the material as approachable as possible.
"With untaxed retirement accounts likely to become your clients' largest asset, they face an explosive landscape of costly tax traps, penalties and a complex maze of rules when the time comes to tap into those savings," Slott said.
The book includes up-to-date tax information, Slott said, including new issues and opportunities presented by the Setting Every Community Up for Retirement Enhancement (Secure) 2.0 Act and other legislative changes with the potential to affect all Americans with a retirement savings account.
During the interview, Slott took particular interest in discussing the sections of the book that urge advisors and their clients to consider the particular virtues of Roth individual retirement accounts and Roth 401(k)s — especially in the current tax environment.
Simply put, tax rates are low from a historical perspective, and there are big budget pressures facing the federal government in the years ahead.
This means the traditional IRA is in a precarious position, as the funds in such accounts are not avoiding taxes — they are merely delaying them. And so, a future with a high likelihood of higher taxes makes the Roth account type look particular attractive today, Slott said.
By making Roth contributions and Roth conversions, investors can effectively "lock in" their tax rate and take future "tax risk" off the table.
Taxes in Their Historical Context
Early on in the new book, Slott offers readers an important history lesion about tax rates in the United States. While history doesn't repeat itself, he warned, it does rhyme.
"I give the history of tax rates from 1913 and the ratification of the 16th Amendment, which granted Congress the authority to issue an income tax without having to determine it based on population," Slott said.
"I take the story up through today, but I specifically highlight the years when the baby boomers were being born," he noted.
Many people don't realize how high taxes were back then and just how low tax rates are right now, Slott said.
"U.S. income tax began in 1913 at a starting rate of just 7%," Slott said. "Those were the days. At the time, opponents argued for a provision to cap the tax rate at 10%, but tax proponents pooh-poohed such a cap as unnecessary. They couldn't imagine rates would ever exceed 10%."
Just five years later, when the government sought funds to fight World War I, the top rate spiked to 70%. Flash forward another three decades and the rate topped 90% following World War II.
"Not until 1982 did the top tax rate finally drop from 70%-plus down to 50%," Slott observed. "The whole country did a happy dance. Finally, taxpayers were equal partners with the government on our own money, and we thought that was fantastic. Today, of course, the rates are much lower."
Today's top tax rate reaches just 37%, Slott said, although many people pay rates as low as 22%, 12%, or even 10%.
