Welcome to Pension Attention, the best show for first responders who want to take control of their finances.
After advising Los Angeles city firefighters for over 12 years, financial advisor, Brad Barrett now shares how you can grow your wealth, build your legacy and enjoy a life of freedom. And now here's your host, Brad Barrett. [00:19.9]
Brad: Welcome to Pension Attention, the show for you, first responders who want more out of their deferred compensation and pension plan. My goal with this podcast is to reach you where you are. At whatever stage in your career, you are in, in order to provide my nearly 15 years of experience working exclusively with both active and retired service members on their investment and retirement planning. My team of fiduciary advisors here at One Capital Management are dedicated to ensuring you not only take control of your finances and build the life you deserve. And to find out more about myself or Toby Rodriguez or any one of our advisors here at One Capital Management, you can go to our website at PensionAttention.com or give us a call, you can call us at (805) 409-8150. If you haven't already done so you can go to our website again at PensionAttention.com. You can click on the media tab and there you can download and subscribe the Pension Attention podcast and leave us a review. Leave us a comment, let us know how we're doing, it's always good to get feedback. And if you like this show, as I say every week, share with someone you like, we'd appreciate that. I guess if you don't like the show, share it with someone you don't like. But today I want to talk about something that we hear often in our practice, and it ties into a lot of things going on lately in our we'll call our environment, everything from domestic politics, all the way out to geopolitical events around the world. And believe it or not, it boils down to Roth and the 16th amendment. So let me explain. [01:55.6]
Look, first and foremost, using tax advantage, retirement savings vehicles, such as a Roth or your 457 plan, which has a Roth feature inside of there. Not paying income tax on gains, essentially allowing a bigger pool of savings to compound will result in more retirement income, whether it's traditional, deferred comp or Roth deferred comp for you both have tax deferred growth. So, let's spend a few minutes talking specifically today about Roth and tax rates here in the U S. Now, as you probably know that bridge, I'm making their tax rates has been a large conversation lately. In fact, in a couple of weeks, I want to be doing a special on the Pension Attention podcasts around Biden's tax proposal and law. I spoke about it a few weeks ago on the Pension Attention podcast, I titled it - Don't Fear the Biden Tax Hikes, cause for many of you listening right now, it's understandably noted that anytime we have increase in taxes, we think it's going to affect us all. And the reality is it's not. But let's go back a minute for a second and talk about something I think is really profound to understand. [03:07.4]
Do you remember what year the United States permanently adopted an income tax? Probably not. No one ever really talks about it because it was more than a hundred years ago. In fact, it was 108 years ago to be exact in 1913. So, for the entire time that virtually all of us had been breathing, the income tax has just been a fact of life. I think anyone listening right now to me on the Pension Attention podcast has always known the income tax to be around, it's just a fact of life. Anyone over 113 years old listening to me right now may differ, but I don't think that's the case. But when you really think about it in a nation that is only 240+ years old, the income tax has been in existence for less than half the time. Interesting to think about it that way, not too bad if you really think about it. But that brings us a little comfort, but it's practically speaking none of us were alive as I mentioned prior to our nation's income tax being instituted. So, we simply don't know in the other world paying income taxes is our norm. [04:14.3]
The federal income tax was made possible by the 16th amendment to our constitution, which was passed by Congress in 1909 and again, ratified by the states in 1913. The amendment, by the way and forgive me, I think get a little nerded out on these kinds of things, but I liked the history of all this, and I think it's really good for all of us to know it. The amendment authorized Congress to impose a federal income tax on U.S citizens and corporations. It may strike you by the way, as somewhat strange that an income tax would ever be adopted. I mean, after all, who would vote at that time to give a portion of their income? Well, believe it or not in 1913, there was literally widespread support for state ratification of the 16th amendment. You see, prior to the income tax being put into place, government revenues were derived primarily from taxes on goods, import tariffs on products made abroad and excise taxes on things like alcohol. I mean talk about hitting below the belt on that one. And that type of revenue, by the way, the revenue generation model really hurt working class people and really only benefited the rich. People don't think about it that way, but that's how it works. So, it was very much a regressive tax design and people were mad. They were off and rightfully so. So, in the early 1900’s, America's common man, guys like you and me believed that there were shouldering the majority share of paying taxes. And by establishing an income tax, it would force the quote unquote, rich to pay their fair share. Sound familiar in today's conversation? [05:52.7]
Now, as a result in 1913, the 16th amendment became the law of the land, with 42 states voting for the amendment and only six states voting against it. Initially the 16th amendment enjoyed essentially, like I mentioned, overwhelmingly popular support. But now let's fast forward 108 years to 2021 today to a person practically everyone hates paying income taxes, myself included. And April 15th has become the most dreaded day of the year. By the way, according to a study published in the American medical Association's journal, which was in 2012, so about nine years ago on April 15th Tax Day, there is a 6% increase in the odds of you dying in a car accident. Interesting. The article goes on to explain contributing factors such as stress, distraction, and sleep loss. At the very least, I think that taxis in does cause many people to have a high degree of we'll call it irritability, helping to bring honestly road rage, maybe to a climax. So, look, be careful out there. You guys see it. You're the first responders reacting to it. So, we know what's around just kind of interesting fact, I guess, but using that stat, I mean, what's all the frustration about? Why does April 15th bring so much pent-up anger to the surface? [07:15.2]
Well, the U S tax code is composed of an estimated currently 4 million words. That's 4 million words in our U.S tax code. That's about six times as many words as the Bible think about that. And there’s a lot less good in the tax code in the Bible, I must admit. And even the new simplified tax cut legislation can at times be confusing and ambiguous. And I can only presume the new tax law that's coming into place is going to have more words and have more confusion. Now, according to the U.S house ways and means committee it's estimated that Americans people like you and me each year collectively spend about $170 billion and 6 billion hours trying to comply with the tax code. That's simply an incredible amount of time and money wasted. Wouldn't you agree? And even other than time, just the concept, in my opinion, reminds me of a Winston Churchill quote, which he said, “I contend that for a nation to try to tax itself into prosperity is like a man standing in a bucket and trying to lift himself up by the handle.” [08:25.9]
It's just not in my opinion, the way that we get back to prosperity, but with a country's national debt sitting in the high twenties of trillions of dollars, raising tax revenue, sadly is somewhat of paramount importance. Now I'm not saying across the board, there needs to be some level to this. And we're going to talk more about this in the coming weeks and really listening right now that are concerned about taxes. And you can reach out to an advisor, talk with them, make sure your situation falls into some of these new planning, arenas coming up with regards to Biden's tax hikes. And if you don't have that person, you can call us. You can call us at (805) 409-8150 that's (805) 409-8150 or go to our at PensionAttention.com and you can schedule some time with myself or one of our advisors to go through your situation. [09:15.4]
And we know that all Democrats think that the rates are too low, and Republicans think that they're too high. We've seen this. And in all honesty to some degree tax rates, believe it or not have hardly ever mattered because the system is still riddled with so many loopholes and deductions, all of which forced people to spend money to shelter, income in an attempt to avoid taxes. This is how we end up with essentially billionaires paying a lower tax rate than their personal assistants. I always love it because every tax year I'm going through with my accountant, and my wife and I kind of talked about it. And she's pretty funny, if you get to know her, she always goes, well, Hey, can we claim the voices in my head as dependence? I'm always a little scared by that statement, but I always thought it was kind of funny because there really are just so many loopholes. The pendants you can take on, I mean, all this kind of stuff out there, you know, as I was driving around the other day, I was actually listening to a radio ad, believe it or not, which was promoting a book that claims to show you how you can take advantage of loopholes in the new tax reform bill coming up. [10:15.6]
Basically, resulting in what he says, paying $0 in tax. Now maybe you can read the follow up version of the book from your jail cell, but I'd be really careful about those kinds of things, but it's out there. You know, another real problem to be fair about all this. And I know I'm on a soap box, when I say this is government spending. Remember the government gets its money by taxing us and by borrowing from us. So, any way you look at it, when the public sector spends more the private sector, you and I have less to spend, it's just math. And who do you think makes better decisions with your hard-earned money, the government or you? I bet you do, especially working with a good advisor. So given all this, where are tax rates today? And then I'm going to get into how we utilize that heading into what we perceive to be a pretty interesting law change coming up, which we'll talk about more about, but I don't think, as I said before, a couple of weeks ago will affect many of you listening right now. That's not necessarily tax advice across the board. You want to seek out that counsel, but you'll see the income limits in certain areas may not affect you based on what Biden is proposing here. [11:23.3]
Do you know how much you should be contributing to your deferred compensation plan? Are you getting the most out of your current investment options? Looking at entering or about to exit the DROP program? Go to www.pensionattention.com to find out how we can help. [11:39.5]
So, looking back all the way to 1913, relatively speaking, today's income tax rates look, believe it or not comparatively low. Today's top tax rate currently is around 37%, which is somewhat modest in comparison to yesteryear. Now, with that said, it's called gross pay because it's disgusting to see how much money you would have made before taxes. So even at 37%, again, this is for top tier taxpayers, okay. It's still disgusting for all of us look at our paychecks and be like, man, that's what I would have made before taxes no wonder they call it gross pay. Believe it or not now for the most of the 1940s and essentially all of the 1950s, the top income tax rate was more than 90% But in reality, almost no one paid that rate. There were a lot of the directions again and loopholes in a temper just like today. [12:37.7]
So, at today's rates, once you take all of your legal deductions, not necessarily listening to that ad, I heard in the car, but legal deductions, do you know, you actually pay in federal income taxes. I heard someone say it right, more than I should be paying. And that's probably very true and I tend to agree. Now, according to MarketWatch, more than 44% of Americans pay no federal income tax whatsoever, That's more than four out of 10 wage-earners. Now in an article written by Quentin Fottrell, which is dated actually a couple of years ago, February 26th of 19 MarketWatch also reports approximately 76.4 million or 44.4% of Americans won't pay any federal income tax in that year, which was 2018 up from 72.6 million people or 43.2% in 2016, the year before President Trump's Tax Cuts and Jobs Act according to estimates from the tax policy center, which is a nonprofit joint venture. [13:36.9]
So, the country's federal tax burden is shoulder by roughly 55% of workers. In other words, in a country of 320 million people, 93 million pay federal taxes, which is roughly 30%. So, let's connect a few dots. We have a huge national debt, we have massive government spending, we have one third of the nation, citizens paying federal income taxes, and we have historically low in comparison purposes, federal income tax rate. Given all that, what conclusion do you draw now? I framed it that way because it's a question and a comment we've been seeing a lot. In the conclusion going through your mind right now, as you see that and hearing that probably a lot, like what I've been seeing and something we have to plan for, but again, we don't want to plan for them that hasn't happened yet. But the notion of federal income tax rates essentially will be more in the future than less. You can see with all those things. I mentioned again, national debt government spending given this last year with COVID and essentially one third of the nation's citizens, essentially paying federal income taxes, something, the Democrats are essentially hell bent on trying to fix that's a later conversation. But the idea is that tax rates may go up. [14:47.6]
So why am I bringing Roth into this? Right away the first thing I want to go through is when we talked to clients, especially younger clients when we talk about the options you guys have in your deferred comp plan to defer to Roth, there isn't an end all be all answer, okay. Because the difference between a traditional deferred comp plan and a Roth, and this is largely for those listening right now that are active service members right now, it's a tug a rope. And here's how I describe it. In a traditional defer competent. As you know, you take a deduction for it now, and when you retire, it will become out taxable, meaning no tax now tax later, okay. Roth is the inverted, right? You're putting it in post-tax meaning not any deduction for that contribution going in, but later it comes out Tax-free. Now the idea where Roth became so heavily prevalent was around this exact notion of taxes being higher in the future, or essentially when you retire. [15:45.4]
So, Roth was instituted by a Senator named William Roth. So, from 1971 to 2001, Bill Roth served as a Republican Senator from the state of Delaware. He was actually quite a guy if you look at it. He was an attorney, a graduate of Harvard university, he was a veteran of World War II, as many of you know, and my nerdiness and my history buff, I love that. And he was a fiscal conservative, a man after my own heart. And it's not a stress to say that Bill Roth might have given you and me might have given all of us the biggest legal Tax sanctuary that exists - the Roth IRA or the Roth 401k or the Roth deferred comp plan. Again, I want to clearly state here that it's not that it's the end all be all, but it's a great opportunity, especially now more than ever for us to shift some of our discussions around, do we want to split some of the money's going into tax deferred or tax later? Now I've shared this before and I don't mind sharing it again in my own personal finances, right? I currently contribute to tax deferred, not Roth. And I do that from my own personal planning solely on the notion that I'd rather work with the devil I know now than what I think might happen in the future. [16:59.2]
Now that's not to say that's right for you, but I share that about my story. I know that I'm paying taxes now. I do not know necessarily it will go up later. I can presume that because I'm with you. I see all the things going on. And as an advisor, I make sure to build our plans and have our planning discussions around your unique situation. And for me, for my wife, Veronica and I, it makes sense for us to get the deduction now. And it's honestly more of a theory, I have that. I'd rather just know what I'm not paying now than think about something in the future. Not saying that's right for everybody again, but it's an interesting note when we talk about the Roth and what Bill Roth gave to us is actually a pretty cool event. So, this is going to go into a little bit about Roth, which you may already know. So just bear with me though, and it's good to know the history behind it. [17:45.8]
So again, Roth IRAs, which not really talking about so much as Roth deferred comp plan right now for our first responders, they're essentially vehicles that help investors save money for retirement just like your deferred comp plan, your traditional deferred comp plan. Roth’s are different though in that contributions cannot be deducted, as I mentioned. So, however, the Roth distributions later, as I mentioned before, are federally income tax-free. So, think about it this way. When you put money into a Roth, your current year's contribution is not tax deductible it's made with after tax dollars dollars, you've already been taxed on. And as you invest those contributions, the Roth provides tax-free growth for gains. No different in that regard to your traditional deferred comp plan. But best of all, there on the Roth when you're ready to begin a retirement income, when you're ready to take money out of the Roth it's income is federally tax-free. This works for first responders, because one of the things I've said before is that the good thing is you have a pension. The bad thing is you have a pension. There was here's what I mean by that is no matter what we do, you're going to be in a decent federal tax bracket because of your pensions, your earned pension. [18:50.3]
So, for those listening right now, anywhere between 80,000 currently, and let's say $120,000 a year of pension puts you right in that 12 to 15% automatically federal income tax bracket. Now that's not including any other income related, whether it's rental properties, maybe have some social security, not totally affected by the windfall provision or a spouse who has income. So, you can see that we're always in a tax bracket. So having a bucket of Roth doesn't hurt, it's something to consider. And for those clients listening right now, you'll be hearing this more from me and I'm not saying we need to make big shifts. This is not something you to be dramatic and shift over. Trust me if it's something for your planning, we would already reached out to you and gone through it. Or in our planning discussions, we would have talked about it, but it's a good way to prompt as a future discussion point for us. And I'm bringing this up on the heels of a Pension Attention episode, I'm going to write, as I mentioned for you around the Tax Law changes that we are seeing with Biden and some of the mis information and miscommunication that's out there that's really going to affect or be more around my first responding client. So, I'm going to go through that more. And I really wanted to kind of talk about today, some history on the tax rates, just to get some perspective and context before we get wrapped up in these Democrats, just kind of all they were increasing and increasing it. [20:04.4]
Look comparatively so we're in the same tax rates that we were as we were a long time ago. So, let's put it into context for you number one, and I want to talk about Roth because it's something I've been getting questions on and we go through the planning and for those clients listening, know if you have questions on that, let's talk about it. For those listening, that aren't working with a current advisor, it's really important to go through that with them to know what is right for you, because a 100% traditional or a 100% Roth may not be your right route. It may be a 50-50 approach. It might be looking at the overall picture, taking a look at your age time on other assets you might have in the family. Spousal income is a lot to consider when it goes through that. But as we touch on taxes, again, I want to put a bow in this week's episode in saying this. Roth is an asset class, therefore you, in a way, a bucket, if you will to look at, to know that you're going to be paying taxes on it now, but it might be something. If you're really scared about taxes going up and you really believe taxes are going to go up and you just know it, right, Roth might be a feature. And we can talk about that for your planning. [21:06.6]
That's said I also want to get some context, as I mentioned, as history for the tax code and all the rhetoric that's going on out there about this new tax law being enacted potentially here. And so we're going to talk more about that as well, but I want to thank you for listening to the Pension Attention podcast this week. And as always, as I mentioned before, you can go to our website at PensionAttention.com. There you can set some time with myself or Toby Rodriguez or any one of our advisors here working solely for first responding clients or you can give us a call and call us at (805) 409-8150. And as always before acting on anything discussed today, remember to speak with a financial advisor near you about your specific situation, or again, if you'd like our help, you can go to our website at PensionAttention.com or give us a call at (805) 409-8150. And until next week stay safe. [22:00.4]
The information in this podcast is educational and general in nature and does not take into consideration the listeners personal circumstances. Therefore, it is not intended to be a substitute for specific individualized, financial, legal, or tax advice.
To determine which strategies or investments may be suitable for you consult the appropriate qualified professional prior to making a final decision. [22:24.3]
