Not too many people do, however, ignoring this topic could be problematic to your fiscal well-being. Here is the scoop!

The Trump Tax Plan was voted on in 2017 and implemented for the 2018 tax year. The only exception to the tax reduction was the lowest bracket of ten percent which was not lowered, all other brackets were reduced.

Here is the other side of that story, on December 31, 2025, the Trump tax plan will “sunset” back to where the taxes were in 2017. So, every bracket, except the lowest one, will see a tax increase. The second bracket (12%) will see a 25% increase up to 15%! The next bracket (22%) will see a 13.6% increase up to 25%, the next bracket (24%) will see a 16.6% increase up to 28% and the increases continue up to the highest bracket, all getting a tax increase. The top tax bracket now is 37% and that is going up to 39.6% in 2026.

President Biden has indicated that he will not raise taxes on anyone below $400,000 of income. In time will we find out about the changes that he wants to make to the tax code. The important thing to keep in mind is that the Trump tax plan would keep the current, lower, rates in place through 2025. President Biden could “cherry pick” only the higher income earners for now, but, will he let the tax provisions/law sunset in 2025 as the current law states or will he lobby to keep the current lower taxes for those earners that are under $400,000 of income? Your guess is as good as mine! So, keep an eye on this topic!

Strategies to Protect Against Rising Taxes

Due to the likelihood of a future with higher income taxes, one strategy is to put your money away after you have paid taxes on it. This is an especially good idea for younger investors, and one of the most popular vehicles to use for this purpose is the Roth IRA. A Roth IRA is funded by money you’ve already been taxed on (after-tax contributions), and it grows in a tax-deferred manner, meaning there are no taxes on investment gains as the account is growing. Additionally, assuming you play by the rules, your money and investment gains are not taxed when they are paid out to you, resulting in an income that will be free of income taxes for the rest of your life, based on current tax rules. The two rules that you must comply with to gain this great tax-free benefit are simple: the Roth IRA must be established for at least five years, and you must have reached age fifty-nine and one half.

If you’re currently retired, a Roth IRA can still be strategically valuable in legacy planning as a vehicle to efficiently transfer wealth to your heirs. For example, if you have a big chunk of money in a 401(k) and you know you will not need that money during your lifetime, you may be able to shift those dollars into a Roth IRA and pay the income tax due at today’s lower tax rates.

Currently, you can pass on a Roth IRA to your spouse, and then again to your children and/or grandchildren. The investments continue to grow in a tax-deferred manner and the income can be tax-free as it is paid out to the heirs. It is a cool strategy many people ignore, but probably shouldn’t. It’s a fabulous way to pass money to your heirs on a tax-deferred and tax-free basis.

If you’re fortunate enough to have a retirement plan at work that offers a Roth structure—a 401(k) Roth, for instance—then by all means, take advantage of that. Under current law, you can contribute higher amounts at older ages. You can $19,500 into those plans regardless of your age, but if you’re age fifty or above, you can contribute an $6,500 for a total of $26,000 annually (in 2021).

In Traditional and Roth IRAs, you can currently contribute an additional one thousand dollars per year, if you’re age 50 or older (contributing a maximum of $7,000 annually, as opposed to $6,000 for everyone else). There are income qualifications and limitations for IRA contributions, and tax laws may change after the time of this writing, so you’ll want to utilize a qualified accountant or financial advisor for up-to-date information if these strategies are of interest to you.

Additional Tax-Advantaged Options

As I’ve mentioned, there are contribution limits to both Roth IRAs and 401(k) Roth plans. However, the insurance industry has another option for you, where there are no limits to the amount of money you contribute each year. If you’re a business owner, this can be a huge way to use after-tax money to build assets on a tax-deferred basis. The insurance product used for this is generally referred to as a cash value life insurance contract, and there are many different types of this plan. The type we tend to prefer for many of our clients is called an indexed universal life insurance contract. There are many different types of life insurance plans out there, so it’s important to have your advisor do the shopping for you and compare the various products to determine the one that is the best fit for your circumstances.

These life insurance policies are structured very differently than traditional life insurance. Most people view life insurance as a bill and want to spend the least amount of money each month and receive the highest possible benefit from it upon death. That is why temporary (“term”) life insurance is so popular. You pay a small amount for a high amount of coverage, but the downside is that term insurance becomes more expensive in your later years, and you don’t build any cash value with the premiums that you pay.

There are IRS regulations requiring a corridor between the cash value and the death benefit. If the cash value gets too close to the death benefit, the IRS could declare that it should be considered an investment instead of an insurance product. If it’s an investment, it could become fully taxable and lose its tax advantages. These policies are typically structured to account for those rules. As the cash value builds up within the policy, if it gets too close to the amount of the death benefit, the company increases the death benefit to comply with IRS rules. If the cash value is too close to the death benefit, the IRS could disqualify the death benefit as income tax free and tax all the growth within the policy. Obviously, that would not be a good outcome! By pushing up the death benefit, the cash value can continue to grow higher.

Tax-deferred growth is the primary reason I like the structure of indexed universal life insurance contracts. In many cases, you have the potential for double-digit rates of growth (assuming the market goes up by double digits), with favorable tax treatment. Additionally, these types of contracts can be designed to offer protection against losses. It’s possible to have an indexed universal life insurance contract with a ten percent cap on annual earnings. In that case, if the S&P 500 Index goes up twelve percent, you hit the cap and ten percent growth is credited into your insurance contract. If the S&P 500 Index gains seven percent the next year, you get all of the seven percent, because it’s within the ten percent cap.

Here is the critically important benefit available within these contracts: your gains are locked in annually. If the market goes down by twenty percent, you earn zero for that year, but you keep all the dollars you’ve gained in previous years.

Think about that. If you never experience a loss, and you share in the gains of the market, do you think you would be doing well over the course of many years? The math proves that answer to be yes. During the decade spanning from 2000 to 2009—the worst decade in the history of the stock market—the S&P 500 Index lost an average of one percent per year. Many people lost a significant amount of their retirement savings. During that worst decade, you would have averaged about a five percent gain per year, by locking in the gains in the up years and avoiding the losses in the down years. That is the power of not losing money while still having the opportunity to participate and share in the upside of market gains.

Utilizing life insurance products can fulfill two needs. First, we often call it a “self-completing plan” because it accomplishes its goal regardless of how long you live. If you need life insurance to protect your family or business, and you want to have access to the assets you’ve built toward retirement, it works well. If you live to be one hundred years old, you’ll be able to enjoy the income benefits of the insurance product. If you pass away early, however, the death benefit feature of life insurance will complete your financial plan for your family. In that scenario it is a self-completing plan that operates much differently than an IRA or 401(k), where you just get the actual cash balance upon your death. In this type of life insurance contract, the death benefit is much greater than the cash value built up within the policy.

While I’ve given a general overview of how insurance products can be used as part of your financial plan, there is a tremendous amount of detail with these types of contracts, and it is very important for you to receive an illustration from your advisor. Your advisor can show you the historical performance of each insurance product, as well as explain how they might perform in the future.

The National Association of Insurance Commissioners (NAIC) limits the percentage rate that can be used in illustrating potential future gains, to assure that advisors’ projections are realistic and sustainable. I completely agree with that approach.

Disinherit Your Uncle

With many people agreeing that income taxes will likely be much higher in the future, it makes sense to pay taxes at today’s lower rates. This disinherits your Uncle Sam for the future, and he won’t be able to dig into your pocket when you receive tax-free income from Roth IRAs, 401(k) Roth plans, or life insurance products via the loan provision.

As our country gets deeper into debt, we increase the likelihood of higher income taxes in the future. If taxes do indeed rise significantly, you’d be better off paying today’s lower tax rate on your investments and avoiding the higher taxes of the future.

Tax mitigation is always a key part of a well thought out retirement plan. That is why we advocate that you work with professionals regarding your retirement planning; it’s just way too important to ignore.

For more information contact Massey And Associates, Inc., Retirement Wealth Advisors at (401) 333-8000 and www.MasseyAndAssociates.com. The office is located at 250F Centerville Road in Warwick, RI.

Massey And Associates, Inc. is an independent financial services firm that utilizes a variety of investment and insurance products. Investing involves risk, including the potential loss of principal. Any references to protection benefits, safety, security, lifetime income, etc generally refer to fixed insurance products, never securities or investment products. Insurance and annuity product guarantees are backed by the financial strength and claims-paying ability of the issuing insurance company. Our firm is not affiliated with or endorsed by the U.S. Government or any governmental agency. Neither the firm nor its agents or representatives may give tax or legal advice. Individuals should consult with a qualified professional for guidance before making any purchasing decisions. Investment advisory services offered only by duly registered individuals through AE Wealth Management, LLC (AEWM). AEWM and Massey & Associates, Inc. are not affiliated companies. 830679-02/21