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Higher taxes and retirement

By Barbara Whelehan · Bankrate.com
Friday, December 10, 2010
Posted: 11 am ET

Over the past couple of years, individuals and businesses have focused on deleveraging by cutting spending and paying off debt. The recession scared us all into trying to restore balance to our balance sheets. It's the responsible thing to do.

Extending the Bush-era tax cuts for another two years -- cuts which were never paid for in the first place -- does not seem like the responsible thing to do when it's clear our country is sinking ever deeper into the red.

Just last week, the president's Debt Commission came up with solutions to address the out-of-control deficit, but that news was drowned out by the partisan politicking going on over the Bush-era tax cuts.

In an NPR interview aired this morning, President Barack Obama indicated that over the next two years, the national conversation to address midterm and long-term deficits and debt will continue. But right now the focus has to be on the economy and on the folks who depend on unemployment compensation to pay their bills.

"When we look at the deficit and the debt, I think it's important to understand this doesn't need to be Armageddon," Obama told NPR's Steve Inskeep. "This is not a situation where we've got to slash and burn everything. It does mean we've got to make choices. And it means that discussions have to be serious and they've got to be based on fact."

Taxes and retirement

How would increased taxes affect Americans' retirement? According to a study released this week by the Center for Retirement Research, or CRR, at Boston College, increased tax rates wouldn't affect our retirement preparedness all that much.

The study examines how higher tax rates would affect the National Retirement Risk Index, or NRRI, which measures the percentage of American households at risk of not being able to maintain their standard of living after retirement. Based on figures from the Federal Reserve's Survey of Consumer Finances, the NRRI shows that, at current tax rates, roughly half of households (51 percent) were at risk in 2009.

No big surprise there. We're all used to surveys that reveal how woefully bad we are at retirement planning.

The study points out that government spending is projected to increase rapidly in the next few decades. Left unchecked, "government debt will increase from the 2010 level of 61 percent of GDP to 79 percent by 2020, 118 percent by 2030 and 180 percent by 2040," the study cites, using numbers from the National Research Council and National Academy of Public Administration.

Clearly this is an unsustainable situation.

So CRR looked at what would happen if current tax cuts would be allowed to expire and the top personal income tax rate would increase to 50 percent by 2020. (Historically, that's not out of line.) Plus a value-added tax would be introduced in 10 years, with the rate gradually increasing from 0.9 percent to 8.1 percent by 2050. Plus payroll taxes levied for Social Security would increase from 12.4 percent today to 14.7 percent by 2080, with caps raised.

The study doesn't resemble the Debt Commission's final report, though it acknowledges there are many ways to address the looming debt problem. This is just one hypothetical scenario.

It concludes that most of us can deal with these tax increases, even in retirement. Gen Xers would have to cut back on spending -- before and after retirement. The hardest hit demographic segment would be high-earning early boomers, those at the cusp of retirement who are in the top third income group. They would be hard-pressed to maintain their sumptuous lifestyle after retiring. (OK, so that last sentence does not appear anywhere in the study.)

Hey, I can live with that, if it will prevent our country from sliding into an abyss.

What do you think?

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12 Comments
Barbara Whelehan
January 12, 2011 at 4:29 pm

In an earlier comment within this blogspace (dated Dec. 13), I provide a time-value of money calculation that assumes a 6 percent annualized return on investment in a scenario where the 6.2 percent of FICA taxes currently diverted to the government were instead contributed to Individual Retirement Accounts. That calculation shows we'd end up with bigger piles of money that could buy higher incomes from an immediate annuity. But I do think the Social Security program has value and is important as a safety net against poverty. I'd rather live in a society that cares for its elderly than one where it's everyone out for him or herself.

Ryan
January 12, 2011 at 3:59 pm

You didn't even mention the lost time-value of money for people saving for retirement. This amounts to hundreds of thousands of dollars for individuals contributing to 401k's and IRAs. The government needs to get out of the way and stop confiscating property (income).