My Opinion

The inequality advantage

There is much that can be done with our tax code to better support the middle class if we look in the right places. 

Proponents of the inequality theory say that most of the growing wealth of the 1% is in the form of investment earnings (capital gains and dividends) which are taxed lower than ordinary income. To solve that they see raising the taxes and using the federal bureaucracy to somehow redistribute those higher taxes.
If we seek to help the middle class (those that actually pay income taxes), how can it be efficient to merely raise taxes and lose those taxes in the federal bureaucracy?

Other possibilities. 

Retirement investment earnings from any qualified retirement plan are taxed as ordinary income. Why not tax these distributions at the lower of income tax or investment rates? This will enhance the income for middle income Americans age 59-1/2 and older, lower the dependence on Social Security and cut out the federal bureaucracy in the process.

Delay any taxation of Social Security benefits until the full amount paid in payroll taxes by the beneficiary has been received in benefits. This too will give many Americans a helping hand in their early years of retirement and lower pressure on them to withdraw from savings thus giving them more time to grow in value. In addition, the required minimum distribution (RMD) from retirement plans should be eliminated for anyone with a gross income less than $100,000 (indexed).

Who do these benefits go to? Well they mostly go to middle and upper middle income Americans who have worked and saved for a lifetime … what a concept 😳

How do we pay for this?  First, most of it is a delay in paying taxes, not avoiding them and second, does anyone doubt there is enough waste in government spending to pay for a lot of things?

I find it amazing that despite the trillions spent on various government support and transfer programs, the poverty rate is little changed while fifty years later so many people see doing more of the same as the answer to inequality. Why is that?
None of this is the real answer given nearly half of Americans pay no federal income taxes, the focus should be on creating an economy, opportunity and the skills so that all Americans earn enough to pay income taxes. Solve inequality from the bottom up, not the top down. 

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11 replies »

  1. You want a lower tax rate on retirement plan investment earnings? How about zero? Try Roth.

    Or, you can hold employer securities in your plan and take advantage of IRC 402(e)(4) provisions regarding deferral of taxation, and potential capital gains taxation for in kind distribution of employer securities.

    If you want to pitch for regular capital gains treatment as others have on investments outside a 401k, have Congress expand 402(e)(4) to include any other individual stock. Or, have Congress expand 402(e) to include in kind distribution of mutual fund shares. Then, of course, good luck convincing plan sponsors to add individual stocks as investment options or in paying for in kind distribution functionality.

    I have been a participant in only one plan where we had access to other individual stock.

    I have no problem with your SS order of payout change where individual contributions come out first, and tax free … but, a better solution would be to adjust the dollar thresholds for inflation. I don’t believe they have changed since introduction in 1984 – 30 years ago.

    In fact, the dollar thresholds have been $25,000 single and $32,000 joint since introduction in 1984. Even indexed at 3% / year, in 2015, we would be talking about $62,500 and $82,000.

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    • Let’s make all 401k and IRA plans Roth and be done with it, no RMD to worry about either. There is too much complexity in the whole process to begin with. The average person has no clue what they are doing or about the long term consequences … and we haven’t even mentioned picking investments.

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      • Actually, no, RMD still applies to Roth monies in a 401k or 403b. I call that a Fidelity Rule, as in Fidelity Rules – it will prompt the rollovers to IRAs that they want.

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      • There you go more complexity to deal with. On the other hand, if someone puts after tax money in the 401k plan that money counts toward the RMD even though it’s tax free. I learned that from experience. By the way I have a question. Let’s say a plan takes all expenses of administration from the trust. In other words participants pay all plan expenses. Now a consultant comes along and tells the employer to charge all inactive accounts a quarterly fee on the basis they can do a rollover. This includes all retirees. Would you agree the plan is charging these people twice for the same services? Why wouldn’t they want to do a rollover? Well, there is a good mix of funds plus all those funds are getting institutional fee rates and the overall fees in total are only about 0.88% of assets.

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      • I agree that the average person has no clue. I did not have a clue 35 years ago. The Roth was not even offered to me back then. In the beginning the only way I was able to contribute was with pre-tax dollars. It took me about 10 years to get to a 15% contribution rate by upping my contribution with each annual pay raise that I got.

        I also could not even begin to guess that I was going to make over $35k in 1985, so in reality pre-tax, post-tax did not mean anything to a twenty something with a new baby at home. I still had a pension back then and it was not clear that I was going to need any extra savings. I was watching the pre-baby boomers retire with full pensions.

        My crystal ball has not worked so well over the years. The stock market has not made the “historical returns of 8%” for over a decade. Financial planners have changed the draw down rate from 5% to 4% from your retirement accounts. Most importantly I had no idea that I was going to make six figures and have a six figure retirement income.

        Try to convince a twenty something that all these things will happen and they will laugh at you. Those who went to college and are having a hard time these days believing due to the poor job market and with their debt load to save, good luck. For 30 years the government tells you that you will get X dollars at age 65 and so you count that into your retirement planning. Then the age gets raised to 67 and all the other proposals to reduce the payouts just makes the fear of the shifting rules pointless to save.

        The average person who even thinks about retirement at a early age cannot even guess what to do and I am not sure that financial planners can help so far in advance other to get people to save. Which vehicle to use does not seem to be come clear until it is too late. It is very complex if you ask me.

        Most of us here know how important it is to save. Young workers today will retire with no medical, no pensions and most know this but do not understand what it will really mean. To me it means they will be working longer, totally depended on Medicare and what little they will get from social security. I fear that we will be going back to the days before social security and will be working until death permits them to stop. The only way out of this is to change the attitude of Americans from a nation of consumption to a nation of savers. If America does not consume then the economy will fail. These are very complex issues that who’s solutions will not be clear until 40 years later.

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      • Seems to me you are right on two counts. They will retire later if at all and there will be growing pressure on Medicare and Social Security to provide more benefits. There is no doubt in my mind we are headed to a socialist state for one reason. More and more Americans do not think beyond their immediate wants and thus need someone to do it for them … enter the government and taxes to do so.

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      • I don’t have an issue with charging more for inactive a so long as there is a real difference in expense to administer – rember fiduciary rules still apply. Less savings in nominal dollares, maybe but need not be. If they save the after tax equivalent, the difference if any will depend on tax rates. So, a young ee at the start of her career may be in her lowest tax bracket … Or they could be working in nyc and later relocate to Texas – where there never will be income taxes. It depends.

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      • Except that inactive accounts are less expensive given no payroll deductions to update each pay period, no loans to process, no hardship withdrawals, just update account balances like every other account and process a withdrawal, probably once a year.

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      • Nope. My plan has monthly installment payouts and ad hoc payouts, rollovers in and rollovers out, loan repayments and loan initiations, everything but payroll deductions. And, those are electronic and really cheap. So, admin for a former employee is marginally more expensive because of access to monies.

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