Brace yourself for political drama, because we are nearing the final stretch of the presidential election. As all elections go, promises will be made and broken, character attacks will consume every free minute of TV advertising, and each side will accuse each other of threatening the financial future of everyday Americans.
The problem is it may not matter which side is elected. Many of the major political policies being proposed by either party have severe consequences for future retirements. While there is no way to fully avoid potential losses to your retirement via changes in legislation, there are some actions you can take to mitigate risks.
Over the last 25 years, taxes on the middle class have mostly fallen. Some would argue that we are overdue for higher income taxes.
The last thing any retiree wants to see is Uncle Sam take a bite out of his retirement thanks to tax increases. Luckily, a Roth IRA account is designed to shield you from future income tax increases. Contributions to Roth accounts are made after tax. When you withdraw your money in retirement the proceeds are tax-free. It ensures that the highest tax rate that you’ll pay is your rate at the time you make contributions.
Income Tax Decrease and Adoption of a National Sales Tax
I wish I could say “open a Roth IRA and your retirement is safe from tax policy.” Unfortunately, there is a particular scenario that could put Roth savers at a serious disadvantage. What if income taxes decrease and the nation adopts a new tax, like a VAT or sales tax, to replace lost revenue?
If taxes are to decrease in the future, then Roth savers made the wrong bet since they’d be saving when taxes are high and receiving a tax advantage when taxes are low. A new VAT or national sales tax would make the problem worse since Roth tax advantages are limited to income taxes. Roth savers would be paying more tax money to contribute funds and paying more tax money to withdraw funds. They lose at both ends of retirement saving.
This isn’t a made-up scenario. In fact, politicians on both sides of the aisle have supported this exact policy. Former Republican frontrunner Herman Cain ran on a plan for a 10 percent income tax and 10 percent national sales tax. Romney’s vice presidential pick, Paul Ryan, has also supported similar policies in the past. Obama’s debt commission supported the same strategy.
While there is no good way to shield your retirement savings from new taxes like a VAT or national sales tax, a 401k or traditional IRA is a better choice for savings if you think taxes will decrease in the future.
Cuts to Medicare
Medicare is a pot of water that has slowly come to a boil—and you’re the frog swimming in it. With an aging population and a health system that has costs growing faster than the economy, Medicare is going to grow exponentially in the years to come. That’s why politicians are planning to do something.
What? We don’t really know, and we may not know for many years. Some politicians like the idea of creating something they like to call “future savings.” Others like the idea of retirees footing more of the bill and switching from full coverage to payment support. What’s important to recognize is that Medicare could be very different by the time you retire, and it’s more likely to be worse than better.
The best way to ensure that you can afford healthcare decades from now is to have the money to pay your healthcare bills, so that regardless of the political winds, you are able to get the care you want. Health Savings Accounts would be a good place to consider investing. Contributions to an HSA can be made pre-tax, roll-over each year, and can appreciate with the investments you make. Not everyone will have access to an HAS, as they have to be offered by an employer in conjunction with a high deductible health plan. If you don’t have access to one, talk to your employer about establishing one.
No one knows when or even if these proposals will become law. However any legislative change could have a negative impact on your retirement. Unfortunately, simply voting may not be enough to avoid these proposals. A little planning now could save you financial pain from policies that could be enacted decades into the future.
JP is the author of the money blog My Family Finances, a site dedicated to helping families make wise financial decisions. He is also an MBA and works in corporate finance.