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Why The 6.2% Increase In Inflation Means You May Pay Higher Taxes Thumbnail

Why The 6.2% Increase In Inflation Means You May Pay Higher Taxes

Americans just experienced the largest 12-month increase in inflation since 1990, with consumer goods prices rising 6.2% from October 2020 through October 2021. The highest 1-year increase in 31 years. Let that sink in for a moment. And wait a minute... are you going to wind up paying higher taxes as a result?

We've been hearing for months how the supply chain is affecting producer prices and consumer prices. The Federal Reserve has been saying since Spring that the inflation in the economy will be transitory, or short-lived. While this may be true (and it seems to be reflected in recent activity in the bond markets), the Fed has reason to be concerned that the significant increase in prices may stick around for longer than they expect. Most CEOs see no quick end to the supply chain issues that are driving up prices, and the Fed's ultra-low interest rate policy is forcing investors into real estate and the stock market to realize any meaningful returns. Are we inflating another stock market and housing market bubble? Time will tell.

So how will higher prices result in a higher tax bill? If you are in retirement, or planning for retirement, you know that IRAs and/or 401(k)s will be your largest sources of income. If the goods and services you consume are increasing at historic rates, that means you will need to withdraw more funds from retirement accounts to pay for them. The money you withdraw from retirement accounts will be taxed at today's current tax brackets. So, if inflation continues to rise, it will cause you to withdraw more money form your IRAs and 401(k)s to compensate, and you will pay more in tax, as a result.

If you are nearing retirement, or already in retirement, you should take inflation very seriously. Higher inflation over a prolonged period of time could completely change the longevity projections of your savings because the value of $1 becomes less over time. Paying higher taxes only compounds the problem because it does not matter how much you have in savings, it only matters how much you have after-tax. Our multi-year Guided Roth Conversions Program™ is designed to help reduce or eliminate income tax liability by converting IRAs to Roth IRAs. If inflation is here to stay, reducing or eliminating taxes in retirement should become an important objective for most.