Tax-Deferred Savings and Tax Rates

by Craig Moser on May 24, 2019

It can be very hard for people to grasp the fact that contributing to a tax-deferred IRA and/or 401k plan isn’t necessarily the best choice. There is a question of national debt, and a strong probability taxes will be higher in the future.  This means tax rates may cost you more to withdraw money in the future, outweighing tax savings gained by deferring taxes now.

Tax Rates

According to, historical tax rates for most Americans were a lot higher before 1987 than they are now.  The result is most of us have enjoyed lower tax rates for most of our working careers.  For example, between 1965 and 1985, tax rates ranged from 14% in the lowest bracket up to 70% for the highest tax bracket.  Those in the middle, earning $24,000 to $28,000, paid 32% to 36%.

Tax rates have been lower for a long time.  However, the baby boomer group is moving through time which gives the government a large demographic to tax.  The same baby boomers are also retiring at a rate of about 10,000 people per day.  (A rate projected to continue for the next 13-14 years).  Someone has to fund social security and Medicare benefits for this group of people.  Care to guess who pays that bill?

In addition to an increasing number of retirees, the United States also has a huge federal debt.  As of April 10th, 2019, that debt is over $22 trillion.  Think about that a moment.  Since one trillion is one thousand billions, then the debt is $22,000 billions.  The number 22 trillion has 14 digits.  Kind of boggles the mind to visualize 22,000,000,000,000 one-dollar bills.  Care to guess who ultimately pays that bill?

There is no way to know if, when, or how much taxes will increase in the future.  However, if they increase another 20%-30% by the time you retire, it costs you 20%-30% more to withdraw your money.  Given this fact, you need to consider whether it costs more to withdraw your money in the future than it does to pay  taxes now.  Paying taxes now means every dollar in the “bank” is yours.  This is different from traditional pre-tax IRAs and employer plans where government has some claim to that money.  They let you know, at some future date, how much and how quickly they want their money back.  Paying taxes not vs. later gives you greater control over your savings and investments.

Roth IRA and Roth 401k

If paying taxes now rather than later appeals to you, you should consider a Roth IRA or a Roth 401k (if your employer provides one).  Both options give you the ability to pay taxes now rather than in the future.  After paying taxes, you deposit money into the account and choose from several investment options.  No taxes are due when you withdraw funds.  Time and compound interest can make this a very powerful cash-flow source.  As with most investments, there are some rules.  However, the general idea is to pay taxes now so when you withdraw money later, you don’t have to worry about the tax bite.

Life Insurance

Another option for saving money in a tax-free type of account is a cash value life insurance policy.  Take a moment to think about it and you can see taxes are a type of wealth transfer.  Every dollar you make is either saved or consumed by a wealth transfer or lifestyle.  In a cash value life insurance policy, you pay a minimum amount for a specified amount of life insurance coverage.  The life insurance company determines your minimum cost.

Conversely, there is a maximum amount you can pay for a given amount of life insurance coverage.  In this scenario, the government determines the maximum cost.  Basically, they decide the upper limit of tax-advantaged growth allowed while still giving you tax-free access to your cash.  The limit is more liberal than Roth IRA limits and it allows access earlier than age 59 1/2.

Similar to a Roth IRA, you pay taxes before funding the policy.  When you get cash value in the policy, it grows either by dividends or interest.  It may also grow by participating in the upside of an index each year without risk to the downside if the index declines.  This is similar to how more successful annuities grow.

An advantage over the Roth IRA, is that you decide how much you want to “over fund” the policy and when you want to begin taking money out.  Another advantage is if you pass before withdrawing the cash value, your policy pays the death benefit amount (known as self-completing).  As you can see, the cash value life insurance policy provides competitive returns, the ability to save without a tax burden (provided you comply with guidelines), and the policy is self-completing.

If you’re a bit confused, that’s totally understandable.  It can be difficult to consider perspectives different from those you’ve probably heard most of your life.  Before making any changes, make sure you fully understand all of your options and take advantage of professional advice if needed.  Making choices that are right for you can result in thousands of dollars of after-tax wealth.  Your future self will love you for it.

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