Most people are led to believe that saving for retirement does in fact reduce taxes, but let’s evaluate all the facts. Most available retirement options operate as a tax deduction for those who are willing and able to contribute. However, whether it be an IRA (traditional not Roth), a 401k or some other plan, the amount you fund does not directly reduce your taxes but provides a tax deduction.
For example, if you make $200,000 per year and you contribute $10,000 to a 401k, you will ultimately be taxed on the difference, or $190,000. For tax year 2016, that puts you in the 28% federal bracket, so let’s just say you save $2,800 in taxes by putting $10,000 into your 401k.
Here’s the problem: the country has a huge amount of debt – literally over $19.1 trillion – and counting by the second. (If you want to be depressed – check out www.usdebtclock.org.) Part of the problem are the entitlement programs, specifically Social Security and Medicare, that people pay into and rely upon when they retire at age 65 or later. How are we going to pay for folks in the future? Some would argue we won’t be able to and others aren’t so skeptical – but everyone agrees the debt is an issue and the current trajectory will not solve the problem.
So who relies on Social Security? Well, a lot of people do, but it’s irreplaceable for those who have not saved for retirement or have a pension when they are done working. So why didn’t they save for retirement along the way? Because they couldn’t afford to!! Think about this for a second:
If you are a working class family and have an effective tax rate of 10% – if you fund the same $10,000 into retirement you save $1,000 in taxes – so you have to come up with $9,000 in cash. However, if you are upper class and are paying 50% in taxes – if you fund $10,000 you save $5,000 in taxes and have to come up with far less cash ($5,000) and can actually afford this. It seems backwards, right?
The obvious solution to this is a complete overhaul of the tax code and moving to a simpler and more logical tax code where everyone is affected the same, but as we know, that will likely never happen. There are too many special interests and government programs that people are dependent on to really fix the problem that quickly. It needs to be a tiered approach.
Let’s consider this – what if retirement contributions were treated as a credit? Within the current funding limits, what if every person got to choose whether their money went to the government or went to their own retirement account? That same $10,000 contribution would save both the lower income and the higher income person the same amount of money – $10,000. This would significantly reduce the dependency on the government to provide benefits and would also eliminate forcing people to contribute to a government run plan which they do not receive proportional benefit.
Before you start poking holes in the theory – there are things that would need to be refined and defined; i.e. it would need to be nonrefundable so you could not put more in than the tax you owed etc. In an era where we need problems solved, not just discussed, these are the kinds of simple tax moves that allow people to truly control their destiny and plan for their future.