Donald Trump and Congressional Republicans recently passed their long-anticipated tax bill, which offers tax cuts for the majority of Americans.
I’m sure you are reading news summaries of the bill, wondering if it will lower your taxes. However, instead of hoping for a tax cut, maybe you should strongly consider a tax “increase” instead.
Saving For Retirement Shouldn’t Be Optional
Savings in America is abysmal. Nationwide, our savings rate is currently 3.1%. As a result, many Americans are relying on Social Security and possibly a pension to fund their golden years.
However, many Americans want to have a better lifestyle than what Social Security can provide. Therefore, unless they want to work for the rest of their lives, they will need to save far more than the average American in order to achieve a comfortable retirement.
I’ve recommended saving 25% of your pre-tax income for retirement. If you’re falling short of that, consider imposing a tax “increase” on yourself this year.
You’re Already Being Taxed To Pay For Your Future Retirement
Remember that the government already forces Americans to save for retirement through taxes.
It’s called Social Security.
The Social Security system taxes you now, so that it can pay you later. The government takes 12.4% of your income (6.2% from you and 6.2% from your employer, or 12.4% if you are self-employed), which they squirrel away in Social Security. When you retire, you get payouts from Social Security that are correlated with the amount you contributed during your working years. If you make more money, you pay more Social Security taxes, and you will receive more Social Security benefits when you retire.
You can’t spend what you can’t see
The government takes away 6.2% of most people’s paychecks before they even see it. Most people don’t even realize that it’s getting taken away from them. If the government abolished the Social Security tax, would people take that money and save it for retirement?
No! They’d spend it in a heartbeat. According to a survey by Bankrate.com, only 34% of respondents said they would save or invest their tax refund.
Consumers’ spending habits adapt to the amount of money that is available to them, so when their take-home income goes up (whether by increased salary or decreased taxes), they tend to adapt their lifestyle to that new income.
Benefits Of Your Own Personal “Social Security” System
By imposing a retirement tax on yourself, you are essentially creating your own Social Security system with one contributor and one beneficiary: you. Here are some of the benefits of this system over the government Social Security system:
- You don’t have to share the money with anyone else.
- There is no risk that your personal “Social Security” system will become insolvent.
- There are no bureaucrats or administrators to pay.
- The money is invested how you want, not how the government wants it to be invested.
- You can withdraw the money when you want. You don’t need to wait until you’re 62 to start receiving payments.
- Withdrawals are not tied to a formula like with Social Security. You can withdraw the money how you want, based on your needs.
- When you die, the money goes to the people you care about, not back into the system.
How To Impose a Tax “Increase” On Yourself
The best way to impose the tax “increase” on yourself is through automatic withdrawals and spending.
Contributions to a 401(k) or 403(b) are generally automatically deducted from your paycheck and put into your retirement account. You could increase your savings rate by increasing the amount you contribute to your 401(k) each year. For example, to max-out your 401(k), you could split your annual contribution into 24 bimonthly contributions of $770 per paycheck.
Sure, it might be more efficient to front-load your investments at the beginning in the year, but psychologically its easier to forget that you’re contributing to the account if you use automatic withdrawals.
Roth IRA contributions for residents can also be split up over the course of the year through automated contributions.
After you max out your available retirement accounts, you may want to put additional “taxes” into a taxable account. You can also do that through automatic withdrawals.
A great way to avoid the temptation of cutting your savings rate is to create a taxable account that you don’t see. You could keep it at a different brokerage, or have it under your spouse’s login. You really shouldn’t be checking your investments that often anyway, but when you don’t look at your accounts, you not only reduce trading frequency, but it helps you forget that you contributed the money in the first place.
Now that less of your paycheck goes into your bank account, you’ll naturally adapt your spending to your new “take-home income”. Looking to take that extra vacation? Maybe not. Noticing that you are spending more than what is hitting your bank account each month? Maybe you’ll eat out less often. By forcing a “pay cut” on yourself, you adapt to your new take-home income and save more for retirement.
You don’t have to impose a huge tax increase on yourself — even a 5% increase in retirement savings can make a huge difference in the long run. It also makes adjusting your spending to your new take-home pay a little easier.
So this year, pay a little extra in taxes — but send that check to your investment account, not Uncle Sam. Unlike Social Security, you know that “tax” money will be waiting for you, with interest, when you decide to retire.
What do you think? What do you think of the Republican tax bill? Do you plan to increase your savings rate in 2018?