After weeks of social distancing, Americans are slowly emerging from their homes. There’s no telling when the country will be fully back to normal, or what the new normal will look like. But everyone looks forward to an economy that is fully up and running again. Many Americans have been negatively impacted by the COVID-19 pandemic. There’s no reason why you can’t make a plan to help get your finances on track and ready for the future.
Some might be confused by how the stock market can see signs of recovery amidst such a poor economic climate and high unemployment rate. We’ll look at how the economy and stock market are different, and why the market might be showing some signs of recovery.
With a volatile market and a delayed tax filing and payment deadline, your tax burden might not seem as important right now. But when it comes to your retirement income having a long-term tax minimization strategy in place is crucial. We’ll discuss how record unemployment will affect Social Security reserves. And, how it could lead to higher taxes in the future. So, if you believe there is potential for tax rates to go higher in the future, you may want to have a strategy in place to minimize your taxes in retirement. Below are a few considerations.
Before you make plans for what you’ll do when you can eat out and travel again, consider making a plan for your financial future. There are so many components to a comprehensive retirement plan. From Social Security maximization, to an investment strategy, to tax minimization – and they all have to work together. That’s why going to one professional for all your financial planning needs can be the best approach.
Recent Events
The stock market rallied amidst data showing a poor jobs report.
The Dow Jones jumped more than 400 points on Friday May 8th.
At the same time, recent data had shown that the U.S. economy lost more than 20 million jobs in April.
The COVID-19 lock down pushed the unemployment rate up to 14.7% officially, but it might be higher than that.
How can this be?
The economy and the stock market are not the same thing.
The market is forward looking and has already anticipated a sharp but short recession. A lot depends on consumer spending in the next few months. Not all sectors have suffered recently. Tech-oriented and non-cyclical sectors will likely see growth in earnings. Tech and healthcare sectors may have relative new highs versus the S&P 500. Preliminary reopening could have an impact on the market before the economy.
How much would taxes need to go up to avoid a cut to benefits?
According to The Motley Fool, the tax hike needed to stabilize Social Security’s retirement benefits program depends how quickly an increase occurs.
If payroll taxes were increased immediately and permanently, the trustees report says, a 3.14 percentage point increase would be necessary. Social Security payroll taxes, which are currently at 12.4%, would have to jump to 15.54%. Employers and employees split the amount of these taxes, with each currently paying 6.2%. If this increase occurred, employees and the companies that employ them would each pay 7.77% instead. Self-employed workers would bear the brunt of the full 15.54% tax burden.
If payroll taxes don’t go up until the combined trust funds run short in 2035, the trustees say, the tax increase would need to be much bigger: 4.13 percentage points, putting the new Social Security payroll tax at 16.53% total, with employers and employees jumping from paying 6.2% currently to 8.265% each.
These payroll tax increases would ensure Social Security remains solvent over 75 years without any benefit cut, either now or in the future.
Will payroll taxes be increased?
While tax increases are needed to preserve benefits, they’re not likely to happen anytime soon. In fact, the Trump Administration has been floating the idea of a payroll tax cut in response to the COVID-19 pandemic.
Even without a payroll tax cut, the great lockdown necessitated by the coronavirus could very well worsen Social Security’s finances, since high unemployment leads to both reduced revenue collection and more people claiming benefits early.
The Social Security Administration has warned that the projections in the report do not reflect the possible impact of the pandemic, so it is possible next year’s report will recommend even larger tax increases to shore up the program.
How to convert a traditional IRA to a Roth IRA:
You can do a rollover, in which you take a distribution from a traditional IRA and deposit it into a Roth within 60 days. This involves paying tax on the funds rolled over. Then, the funds can be taken tax-free from the Roth account later on. Weigh the trade-off. Converting to a Roth may mean a larger tax bill in the present, in exchange for a smaller one in the future. Your tax burden might increase later, because of your income or future tax policy. You can continue to make Roth contributions for the rest of your life.
Other advantages of a Roth IRA:
You don’t have to take RMDs from a Roth IRA, which is important if you plan to leave it to heirs. RMDs from a traditional retirement account can also increase your tax burden in retirement. For those who suffered job or investment losses recently, a Roth conversion this year could be a good idea if their income is low.
Above are a few considerations when deciding how to proceed during this time of uncertainty. Whether you plan on having retirement income come from social security, retirement accounts like Roth or Traditional IRA’s, there is a lot to look at and consider. If you have questions about your accounts, please feel free to send us a message at [email protected].
