It’s not enough that baby boomers have just lived through one of the worst years in stock market history. It also seems that they’ve been duped on the tax-deferment scheme of 401(k) accounts.
The idea behind a 401(k) is not that you avoid taxes. It is that you defer them. Many people lose track of this, but if you put money into a 401(k) account today, you pay no taxes on what you invest.
For example, assume that your household income last year was $100,000. You put $10,000 in a 401(k), thereby avoiding $2,500 in taxes (25% marginal tax rate).
But you have to pay taxes on the capital and return of this invested amount when you retire. The general assumption is that your income in retirement will be lower so you will pay taxes at a lower marginal rate. You save by getting in on a lower tax.
Today Bernanke announced that the projected debt to GDP rate is unsustainable. Deficits will have to come down. Given that our last four “conservative” administrations (Nixon, Ford, Bush and Bush) failed so spectacularly to slow the growth of government, it seems inevitable that reducing deficits will ultimately mean raising taxes.
What does this mean for baby boomers? They might just have avoided lower taxes for higher ones.
I find it perfectly plausible that the people who avoided $2,500 of taxes when working will pay $3,500 in taxes when retired.