Investors Must Be Proactive About Managing Retirement Taxes

Among the many informative charts and graphs included in the 2017 J.P. Morgan Asset Management Guide to Retirement are Social Security timing break-even analyses and projected spending for individuals and couples on Medicaid premiums—along with a look at when Roth might work best.  

Each year the firm invites a scrum of financial industry reporters in to discuss the updated findings, and for the third year in a row the informative presentation was led by Anne Lester, head of retirement solutions, and Katherine Roy, chief retirement strategist. The pair shared an extensive analysis of the firm’s economic outlook, which pegs long-term equity market return potential around 5.5% per year, a drop of a full percentage point from last year’s projection.  

“In this environment we know that the key to meeting the challenge of lower return expectations is getting people to save more. It is even too optimistic to suppose that high-single digit returns will be a reality over the next decade,” Lester observed. “This implies that managing taxes will be one of the big levers for people to take control of their retirement prospects, as will the decision about when and how to claim Social Security and to enroll in Medicare.”

Individual investors cannot do anything at all to improve the overall equity market outlook, but they can take control of these factors, Roy agreed. While they both believe the bull market still has some real legs, they also believe that “saving early and consistently in a diversified portfolio of stocks and bonds is the only way to meet the retirement challenge of today without a real struggle in the future.”

One set of stats from the Guide paints the picture quite well. According to J.P. Morgan’s data, a 25-year old making $50,000 per year needs to start saving 7% of that salary today in order to meet a basic definition of retirement readiness by age 65. The firm defines such readiness as having roughly 72% income replacement. For the same age group but accounting for a $300,000 salary, this individual would have to save 17% of their annual income from this point until age 65 to reach the same level of income replacement. On the other end of the spectrum, a 50-year-old making $50,000 would have to start saving a whopping 31% of their annual salary to achieve this. A 50-year-old just starting saving today with a salary of $300,000 would need to save 76% of that per year through age 65 to achieve the same income replacement adequacy—clearly an impossible task.

“It is hard to make it any clearer than this, why folks need to start saving early and consistently. It is actually very encouraging for Millennials to see this picture and that an early commitment to saving aggressively will pay off hugely in the future,” Roy explained.

NEXT: All eyes on Washington tax reform 

Lester and Roy suggested that, “like pretty much everyone in the U.S.,” the investment management teams at J.P. Morgan are closely watching the policy debates unfolding in Washington, D.C. In the retirement-focused business segments there is naturally a focus on what might occur related to taxes imposed on all the various types of retirement accounts, particularly Roth and traditional individual retirement accounts (IRAs) but also 401(k)s.

Lester went so far as to suggest Roth IRAs are perhaps the least likely to be a target for near-term tax reform, given that they only hold a fraction of the assets of traditional IRAs and 401(k) plans. Both Lester and Roy agreed that the political cost of significantly increasing taxes on retirement accounts “primarily used by individuals who need as much help as possible pursuing a basic level of financial wellness” will be steep—although perhaps not insurmountable if attempts at compromise are made.

“We believe we are more likely to see ‘traditional’ pre-tax money being forced out of tax-exempt accounts,” Roy noted, with some hesitation. “But even this is perhaps not all that likely. We know for example that lawmakers in the U.K. considered this idea of pushing people away from tax-exempt contributions more in favor of a Roth-like approach, but it really never picked up enough steam. The same thing could happen here.”

And so the pair encourage investors to start thinking deeply about how to best optimize the division of investment and savings between tax-deferred and taxable accounts. Related to this, they also encourage defined contribution (DC) plan sponsors and advisers to strongly consider offering participant support on such challenging topics as tax optimization, when/how to claim Social Security, etc.

More information about obtaining the 2017 Guide to Retirement is available here.