The Upcoming Tax Increases....

OK, first the disclaimers.

First, I am not a politician. So this is not a politically partisan piece: I am not writing a commentary on the relative merits of the President's economic stimulus package.

Second, I'm not an economist. I just write from what to me is a common sense perspective.

Third, I'm writing for individuals, not the society at large. Which is to say that if everyone did what I am writing about, we'd probably be in a world of hurt, due to unintended consequences. But I am confident most people won't. Most people are more interested in consuming than saving. Most people operate for the short term, not the long term. Most people are only interested in what is right in front of them, not what is right down the block.

OK... enough. Now my premise: If you spend more money than you have, eventually you have to pay it back, and with interest. And there are only two ways to pay back extra spending (and interest): cut your spending somewhere else, or earn more money to make up the difference.

So it is with our federal government. The economic stimulus is calling for massive amounts of federal spending, most of it being borrowed. More is being spent than is being levied in taxes. Either the federal government will have to drastically cut spending in areas such as health care, social security, defense, and salaries, or taxes have to go up to pay for this mountain of debt we are accumulating.

Recently, Newsweek ran an article (http://www.newsweek.com/id/188154?from=rss) which stated that government spending is 47% of GDP with the current stimulus package. In other words, the federal government is spending 47% of everything that is being produced in the country right now.

To my layman's view, I would expect that eventually federal taxes will have to be raised to tax at least, on average, to 47% of your income. What would it be like to give half your income to the federal government? Is that economically responsibile Not if it's coming out of your own family's coffers.

Now, we don't know yet what kind of tax increases the federal government will impose. I expect higher income taxes, perhaps with lower bands. I expect higher unemployment taxes on businesses. In fact, some state governors want to refuse some stimulus money because their unemployment taxes will go up. We may see a rise in our social security taxes, maybe coupled with a reduction in benefits, or an extension of the age at which people become eligible for benefits. There some talk of re-instituting the "death tax." This means lowering the threshold of the value a person's estate so more estates can be taxed, perhaps coupled with higher estate tax rates. I've also heard that the capital gains tax might be increased.

Just be sure that the federal government will impose higher taxes. There is no free lunch. There is no free stimulus. The bottom line is that we know that money being spent today has to be paid back. And if the Federal government is spending 47% of GDP, then that would be a good approximation of how much of our own gross domestic production will be tapped for federal taxes. The economically responsible thing to do in my opinion is to anticipate the increase in taxes, and plan accordingly.

What are our options?

First, make sure you are enrolled in your employer's 401K if there is one. This is funded with pre-tax dollars, so it reduces your taxes today. Many employers also match part of your contributions. Your money grows tax deferred until you withdraw it at retirement.

Second, make sure you maximize your IRA contributions. Again, this reduces your taxes today, and grow tax deferred.

A Roth IRA is a good choice to grow investments tax free, although contributions are made on an after-tax basis.

If you are worried about the volitility in the stock market, an annuity may be a good choice for these investments. Ours guarantees a 3% rate, but currently pays a higher return.

Speaking annuities, non-qualified (meaning the contributions are not tax deductible) annuities still grow tax deferred. They're kind of like a Roth on steriods, in that you don't have a limit on what you can put into an annuity. So, if you are worried about how high taxes might go, you may want to look at an annuity, especially if you have more to invest than is allowed in a Roth. Look at it this way: if the income tax burden averages 47% of your GDP, a 4.6% yeilding annuity (our current rate) is like getting a taxable yeild of 6.72%.

Finally, people who want to avoid crippling taxes may want to consider a cash-value life policy. There are some very good--and legal--strategies so that life policy holders can accumulate and use their cash values in their life policies outside of the tax structure. And that is a good thing, especially if the tax structure gets more burdensome like we expect it will have to to pay off the massive federal deficit.