I feel uncomfortable with the word “can’t” in relation to political risks and my retirement plans. Political risks being the possibility the legislative action will negatively impact your retirement.
Last week, commenter Lucas made some excellent points on my article about income tax changes and Roth IRAs. Particularly, explaining the public finance rationale behind traditional and Roth IRAs (please check them out). However, he did make a point that I felt uncomfortable with accepting:
“Politicians would tamper with that (meaning tax benefits to Roth IRA) arrangement at their peril.”
I’m certain that compared to the reality of the future, I’m overly pessimistic about how government will evolve and affect Americans’ retirements. While I can only speculate, and though some proposals seem like political suicide, the sheer amount of proposed negative retirement legislation only reinforces the possibility that something major will occur before I reach retirement.
Remember when there was a time where people thought that the US would never default on debt? In fact, the risk-free return rate in banking is based on that assumption. Now that idea of default is bandied about regularly. Dramatic political events do unfold given enough time and I’m certain that in the 30 years before I retire, some political decision will adversely affect my retirement.
My experience with politics is that time forgives all political miscalculations and the scary thing is that politicians know this. You might hate them today, but tomorrow you’ll either forget you were angry or realize that the alternative is worse. You simply cannot rely on the general public to stay angry enough to correct bad politics.
Here are the most likely legislative changes that could affect your retirement (arranged in order that I believe most likely to occur). Remember, I may be paranoid, but I also might be correct.
Talk to a millennial about social security and you’ll likely hear something about how they are planning a retirement without the expectation of a social safety net. It’s a good saving strategy that I encourage, but it’s still important to understand that it is a major retirement benefit.
Even if it won’t cover all your retirement expenses, a few hundred each month is far better than nothing. Traditionally, social security benefits have increased with the cost of living. It’s a huge advantage to have an income that increases with inflation.
Any increase in age or decrease in benefits will create a hole that needs to be filled in with savings. There is a big difference between retiring at 58 and needing to bridge 5 years to social security and needing to bridge 7 years.
I think the millennial approach is the right way to go; don’t count on it and you won’t be disappointed. However, there are plenty of people near retirement that are counting on the entitlement program and don’t have that luxury.
How to avoid getting hurt: Don’t plan your retirement around receiving social security funds.
I won’t spend a lot of time on how this topic given that I already wrote a more detailed article on it. Let’s just say that it is more politically expedient to always lower and never raise middle class income taxes, but that doesn’t mean that they don’t have revenue generation plans. Having low income taxes or no income taxes in the future hurts Roth IRA investors, especially since this scenario would lead to my next topic…
How to avoid getting hurt: At least diversify in other retirement options like a 401k, if not avoid Roth IRA altogether.
Get ready for double taxation. What happens if you save money with after-income tax dollars today, then the tax code shifts so that there is a national sales tax or a VAT tax by the time you retire? The answer is: your retirement funds will get double taxed; once by income tax when investing and again by consumption tax when you spend in retirement.
It sounds like this would be political folly to pass, but I’m not certain that Americans understand the potential for double taxation in retirement.
How to avoid getting hurt: Invest in a 401k and traditional IRA before mutual funds and Roth IRA. Move out of the country when you retire.
It is a reality that some politicians do not like the tax-deductibility of 401k plans. Why wouldn’t they? It delays revenue collections for 30-40 years. Thus, at least once in the last four years, someone has proposed to do something about it by restricting possible contributions and create a “forced” savings. The forced savings, let’s say 5% of income, would then be managed by the great retirement fund managers of Social Security. Obviously, money taken from you for a government entitlement is money that you can’t control. More recently, it has also translated into money that you cannot count on.
The point of all this is not to persuade you into paranoia over what politicians will do. It’s to point out that we base our retirement plans on assumptions of how government is today, forgetting that 30 years is a longtime and a lot can change.
What are your thoughts? Do you think any of the legislation I listed will be enacted? Are there other laws that could be passed that aren’t in the list above?