03 June 2009

401(k) Accounts: Putting Off Paying Tax to a Higher Tax Rate Era

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.

7 comments:

Anonymous said...

Are you inferring that Obama has slowed the growth of government?

According the the Wall Street Journal ----- Mr. Obama's $3.6 trillion budget blueprint, by his own admission, redefines the role of government in our economy and society. The budget more than doubles the national debt held by the public, adding more to the debt than all previous presidents -- from George Washington to George W. Bush -- combined. It reduces defense spending to a level not sustained since the dangerous days before World War II, while increasing nondefense spending (relative to GDP) to the highest level in U.S. history. And it would raise taxes to historically high levels (again, relative to GDP). And all of this before addressing the impending explosion in Social Security and Medicare costs.

Yes, we all will soon be paying higher taxes even the working families that were promised a tax cut during the campaign....but it shouldn't make too much difference to a household as we will all be driving our two seat lawnmowers around town with propellers on our heads - thus conserving our gas expenditures so we can pay more taxes.

So I will now sit a wait for you liberals to attack the statements here or to somehow invalidateor interpret what they mean. The thing that energizes a liberal is to have a scapegoat or someone to attack.

Big Al said...

Anonymous,

First, I'm neither a liberal or conservative. I'm not registered in any party. In the past I voted for Reagan . . . both times. But I also voted for Clinton (twice), Gore, Kerry and Obama.

Second, you have some good info. about the budget but I'm not sure if the numbers agree with your statement the budget adds more to the national debt than all other President's combined. Of the $3.6 trillion blueprint budget, the deficit amount is $1.75 trillion (or $1.85 trillion according to the CBO), making it the highest deficit as a share of the economy since WWII. But here's something important: of that $1.75 trillion deficit, Obama inherited $1 trillion from the previous administration.

As far as "we will all soon be paying higher taxes", not necessarily all true. Obama's budget does project almost $1 trillion in new taxes over the next 10 years starting in 2011 as follows: for people making more than $250k, the Bush tax cuts will expire, thus bringing in $338 billion; again for the greater than $250k crowd another $179 billion will come in via elimination of itemized deduction; and finally for the greater than $250k folks the capital gains tax hike will bring in $118 billion.

If you're a business, here's how tax increases will supposedly bring in more money: $17 billion by reinstating Superfund taxes, $24 billion from tax carried-interest as income, $4 billion from codifying "economic substance doctrine" (whatever THAT means), $61 billion from the repeal of LIFO, a whopping $210 billion from international enforcement (good luck with that one) + reform deferral + other tax reform, $4 billion from information reporting for rental payments, $5.3 billion from an excise tax on Gulf of Mexico oil and gas, $3.4 billion from repealing expensing of tangile drilling costs, $62 million from repealing the deduction for tertiary injectants, $49 million from repealing passive loss exception for working interests in oil and natural gas properties, $13 billion from repealing manufacturing tax deduction for oil and natural gas companies (definitely a trend here in terms of taxing oil and gas companies), $1 billion to increase to 7 years geological and geophysical amortization period for independend producers, and finally, $882 million from eliminating advanced earned income tax credit. In some total, individual + business, looking at $353 billion in "new" tax revenues over 10 years.

Big Al said...

the rest of my previous posting . . .

One can argue that increases in biz taxes will correlate to increases in good and services from those businesses. So in that sense it's entirely possible we'll be spending more as a result of businesses passing on the higher taxes to consumers. But the folks making $250k or more/year will indeed see their taxes increase, just as Obama promised during his campaign.

One thing about Obama is he has promised to halve the federal deficit by the end of his first term. So even though it's pretty dang high right now he does have a plan to lower the defecit.

Obama's budget assumes a decline in government spending to 22 percent of the economy in 2013 from about 26 percent.

U.S. officials are saying the savings would come from winding down the war in Iraq and finding efficiencies in government programs.

Obama also proposes wringing some savings out of the defense budget by reforming government procurement.

In terms of the decrease in defense spending, Obama expects the costs of the Iraq and Afghanistan wars will total just over $140 billion this year.

The costs for the two wars will decline to $130 billion in the 2010 fiscal year.

I want to see if Obama's plan does make progress on halving the defecit in the next 3+ years. If progress can be validated with real numbers, great. But if the defecit doesn't start reducing . . . well . . .

One thing I have to say that's extremely ironic: it's amazing how the Republicans pride themselves on being the party of smaller government, most likely agreeing with Regan's observation that "Growth, prosperity and ultimately human fulfillment are created from the bottom up, not the government down" yet during GW Bush's 8 years in office he spent almost 2x as much as Clinton. In fact, adjusted for inflation, in 8 years President Clinton increased the federal budget by 11% while comparitively, in GW Bush's 8 years he increased the federal budget by 104%. Totally amazing how the Republicans have all-of-a-sudden become fiscally responsible.

Anonymous said...

Big Al,

I also pride myself as being independent. Frankly, I like your knowledge and post.....but in the end, I don't like government mandating anything in my life.

Big Al said...

Anonymous, thank you.

I, too, don't like government mandating anything in my life. But I like better the mandates I get here in the USA vs. countries like China or Libya or Chile or Vietnam or you-name-it country where the government is way more heavy-handed. And at least we get to openly blog and b__tch :-) w/o worrying if armed soldiers will be carting us away later today.

Big Al said...

One interesting tidbit I picked up today . . .

Many, many people are very angry and irritated at all the money we (read: Obama) are giving to GM. And to some extent, I agree. It's frustrating to bail out GM when, in 1980, they could've shown true leadership by investing in smaller, more fuel-efficient cars. Instead, GM kept saying, "SHOW ME THE MONEY!!", and kept right on building the big old gas guzzling V8 pickups and Cadillac sedans and the like instead of diversifying after the oil embargo era ended.

But get this: the amount our government gave GM is what we spend every 3 days in Iraq.

We're trying to keep GM afloat so as to not have massive layoffs in the auto and auto-related industries. In other words, there's a plan to make GM healthy again. Can anyone remind me what our plan is with Iraq?

sigh . . .

Life Hiker said...

"Anonymous" has never responded to my request for a biography. I suspect it consists solely of listening to a lot of Limbaugh and Beck. Come out of the closet, whoever you are! Surprise me...

Obama knows he's subject to the rules of economics, so the budget deficit will have to come down a lot. (We can't allow the U.S. dollar to become useful as toilet paper, can we?) It's going to be painful all around, so the special interests are all lining up to make sure they get hurt the least.

Who are all these people who just can't deal with the fact raised by Big Al? Clinton raised the federal budget by 11%, inflation adjusted, while Bush raised it by 104% and had a $1 Billion deficit in his final year. Blame the democrats? Get real.

My IRA is feeling even less healthy now, thanks to RWorld's very perceptive post on future tax rates.