For better or worse, government policies in any number of
areas can clearly affect the value of your nest egg, not to mention your retirement
prospects overall. Social
Security aside, tax rates are typically the main source of concern.
They can have a direct impact on how you save as well as how much of your
savings in 401(k)s, IRAs and other accounts will actually be available to
spend. The fact that rates can and do change frequently also makes it difficult
to plan. But tax rates are just one of
many government actions that can affect your finances and retirement
lifestyle.
In today's world, it's impossible to insulate yourself from
the effect of government policies, both here and abroad. But you can take steps
to help mitigate the effect of government actions -- or at least prevent them
from totally undermining your plan. Take taxes. You can't dictate tax policy, but you may at
least be able to hedge against future rate hikes by engaging in a bit of "tax
diversification" -- that is, spreading your retirement savings
around so that you have money in a variety of accounts that receive different
tax treatment. Traditional 401(k)s and IRAs hold mostly or exclusively
pretax dollars that are taxed at ordinary income rates when you withdraw them.
If you've got your entire nest egg in such accounts, a hike in ordinary income
tax rates could leave you with significantly less after-tax spending cash in
retirement.
But qualified withdrawals
from Roth accounts are tax-free. So if you also have some savings in a Roth
401(k) or Roth IRA, that money wouldn't be hit by the higher tax on ordinary
income. Similarly, tax-free withdrawals from Roth accounts don't count in
determining whether any of your Social Security benefits are taxable. So a Roth
may be able to give you some wiggle room on that score as well.
Being smart about how you withdraw money
from retirement accounts may also be able to help you trim your tax tab.
Generally, you're better off taking funds from taxable accounts first, then
tax-deferred 401(k)s and IRAs and finally Roths.
But flexibility is
key.
Carefully choosing which investments go into your retirement
portfolio can also provide a measure of protection against the downside of
government policies. For example, if you're concerned that long-dormant
inflation might spike in the future due to the Federal Reserve's easy monetary
policy or generous government spending, you can add natural resources funds,
REITs or Treasury
Inflation-Protected Securities (TIPS) to your asset mix.
And to assure your portfolio's performance doesn't depend
solely on the U.S.'s policy and economy, you should consider investing a
portion of your portfolio in foreign stock funds. With a single fund -- a total
international index fund -- you can virtually invest in all publicly traded
investments outside the U.S.
Finally, if you've still got some time before you retire,
finding ways to save more
in 401(k)s, IRAs and other retirement accounts is always a good way to hedge
against any type of uncertainty. After all, the larger the nest egg
you go into retirement with, the greater the margin you'll have to withstand
the effects of higher taxes or anything else that adversely affects your
retirement finances. You don't want to go overboard with any of these moves. If
your chances of moving into a higher tax bracket in retirement are slim, it
wouldn't make sense to plow lots of money, if any, into Roth accounts.
Similarly, you wouldn't want to give up the tax advantages of a 401(k) or IRA
just to get money into a taxable account that will generate long-term capital
gains.
Politicians will always change the rules. As an individual
there's little, if anything, you can do about that. But if you follow the steps
I've outlined here and stay flexible about how you save, invest and manage your
income in retirement, you can at least try to make the best of whatever rules
happen to be in effect.
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