Higher Inflation May Increase Your Taxes, Especially If Retired

Joe and I here, we’re going to be talking about inflation. And not just inflation and how it’s frustrating when you go to the store or stuff is higher. But inflation affecting your taxes. You know let’s think about that for a minute. But first, we want to make sure that everybody really has an understanding of what inflation is. We hear this word all of the time and especially over the last couple of years here. It seems like you flip on the News or some financial show and there’s talk of inflation almost continuously. And so Joe, what is inflation? When people hear that, what should they think about? Yeah, so inflation like Art said is something we’ve been inundated with over the News the last couple years. In it’s simplest form, inflation is just the rate goods and services are going up. We think about inflation, we can either take and optimistic or pessimistic point of view on it. Really inflation is healthy to have. Maybe not 90 %, but historically speaking, the Federal Reserve has always tried to target around the 2% inflation rate. Which means prices are going up, but it’s keeping in line with wage growth. And that means the economy is growing overall and everything should in essence going better. Inflation can be controlled through a few different mechanisms. One is through monetary policy and the other is fiscal policy which we’ll touch on when we start to get into tax rates. So when we think of inflation, obviously the pain at the pump, getting fuel or the pain in the grocery check-out line when your goods are more, stuff like that. That’s the immediate stuff that comes to mind. But what about your taxes? Now this is a very high level look at this. But we want to paint a picture for you. So let’s assume you’re retired. You’re collecting Social Security, you and your spouse are collecting Social Security and you’re fortunate and you’ve saved over the years for retirement planning for this. You have a 401K or Traditional IRA that’s pre-tax. Meaning you haven’t paid tax on it yet. And you’re using that to supplement your Social Security and to meet your needs. Well with inflation rising, you know the Social Security has the cost of living adjustment that went in. A pretty decent increase back in ’23. So you get a nice little bump there. Potentially let’s assume for this discussion that that didn’t meet your needs though. You needed to increase your distributions from that retirement account as well. So now you have a higher income. Your standard of living is the same, right, because stuff is more expensive, but you have a higher income. So how would that affect taxes? Well, you got it, right? Tax brackets. So depending upon the amount of income you have, not all of your Social Security could be taxed or maybe a lot of it is. But as you take more of those retirement accounts, potentially the more of your Social Security becomes taxable. And with that higher IRA draw to keep up with inflation, you could easily find yourself in a higher tax bracket. So not only here in this situation and we’ve seen this happen quite a bit with folks lately. Not only do you kind of have the pain of stuff costing more, but your Federal tax rate as an effective rate, could be a little bit higher. So be aware of that when you’re doing that and you’re taking those distributions and you know one of the things we talk a lot about is tax planning. You know and so when you take those dollars out of these pre-tax accounts, it’s going to come from somewhere, right? We have to pay taxes on that at some point. So Joe, you know when we talk about this and we talk about tax planning, if you’ve watched this show for any length of time, you’ve heard us talk about Roth conversions and all this sort of stuff. Joe, what could somebody do if they’re worried about this in the future or to best put themself in a position of success when you think of this. Yeah, one of the things I often think about and have concerns around is we’ve seen interest rates go up, inflation has started to come down. But still not to that target. So one of the concerns I have is around fiscal policy. These are going to be more government action to drive this inflation down. And that could potentially tax rates going up in the future. We think about taxes, but what we really want to try to do is be as proactive and take control of our own tax situation. One of the easiest things to do around that is if you have a lot of pre-tax dollars in our IRAs or our401Ks, starting to look at de-qualifying some of those assets and moving them into either an after-tax position or a tax-free position through Roth conversions or other strategies around. Just pointing those funds out. Still trying to be invested, but really hedging against tax rates potentially going up in the future. No, absolutely. And if you’ve heard one strong thing that Joe said there, if you took anything out of this conversation here today is take control. So be in control of your finances. One, know what you have. Know what your options are and know what those long-term projections look like and what the potential impacts are. That’s vital to success. So thank you so much for watching the show this week. Hopefully you got a lot of useful and valuable information out of it. And we’re here to help you plan to retire well.