In his recent book, THE RETIREMENT SAVINGS TIME BOMB TICKS LOUDER, Ed Slott argues that IRAs are a ticking time bomb. Slott says that “taxes will be the single biggest factor that separates people from their retirement dreams.”
Slott argues that taxes will be much higher in the future, so retirees should do everything possible to minimize their taxes. Slott’s main actionable advice is to use Roth conversions and permanent life insurance to avoid future taxes.
While I agree with some of Slott’s premises, particularly about future tax rates, his conclusions and recommendations miss the mark in several critical ways.
Where Slott Gets It Right: Future Tax Rates Will Likely Increase
The data supports Slott’s concern about future tax rates:
Current U.S. debt levels are at historic highs, matching only World War II levels. However, unlike the post-WWII era when America was the world’s factory with favorable demographics, today’s economic landscape offers fewer advantages for growing out of this debt.
Our federal deficit as a percentage of GDP is unprecedented outside of wars or recessions.
Current federal tax rates for high-income individuals are relatively low compared to historical levels.
As Ed Slott correctly notes, “If history is any lesson, tax rates on retirement savings will likely increase substantially just when you need the money the most – upon withdrawal in retirement. …given the financial mess our country is currently in…taxes will have to increase.“
Where Slott’s Analysis Falls Short
Overemphasis on tax planning:
Slott focuses so intensely on tax minimization that he loses sight of the bigger retirement planning picture. In my experience working with retirees, taxes rarely emerge as the primary obstacle to retirement success. Far more important factors include:
- Savings rate
- Spending habits
- Investment strategy
- Overall financial planning
Misunderstanding the Math
Slott makes some puzzling claims about investment returns versus taxes:
What good is making even a 50 percent return on an investment if, at the time of withdrawal, taxes will step in to claim 70, 80, or maybe even 90 percent of your nest egg?
When it comes to retirement accounts, it’s not enough to earn great investment returns. Yes, that’s important for building the account, but even if you earn 30 percent a year, every year, for 30 years, what good is it if, at the end of the line, 50 percent or more of the account’s value is lost when your savings pass to your heirs? That’s exactly what can happen without sufficient funds to pay what could soon be the combined estate and income taxes on an inherited IRA.
Let’s run the numbers. Starting with $10,000:
The numbers clearly show that investment returns here matter much more than the final tax rate. Even if the final tax rate were 90% you would end up with over $2.6 Million by going with the higher return option.
Overlooking Legislative Risk
While Slott correctly points out that “the tax code is written in pencil,” he ironically promotes solutions that face similar legislative risks. For example:
- His favored Roth IRAs were targeted in the Build Back Better proposal, which considered Required Minimum Distributions as high as 50% for wealthy individuals.
- The tax advantages of permanent life insurance could be modified by future legislation.
The Life Insurance Misconception
Perhaps most problematic is Slott’s broad endorsement of permanent life insurance as an estate planning tool. He states:
The single best, most cost-effective yet amazingly underutilized strategy for protecting retirement account balances, especially large ones, from being decimated by the highest levels of combined taxation is to buy life insurance to offset the tax burden that beneficiaries may face.
In most cases, more funds will go to the eventual beneficiaries, and with fewer taxes, than if the IRA was left directly to the beneficiaries or to an IRA trust subject to taxation…
Consider permanent, cash-value life insurance as the new vehicle that will help you reach your estate-planning promised land: larger inheritances, more post-death control, and less tax. That’s what I recommend across the board.
This ignores a lot of the actual math on life insurance. In fact, I find permanent life insurance an appropriate planning tool in a very small number of actual plans.
Consider this example: A 70-year-old male non-smoker would pay $3,161 annually for $35,000 in coverage (per quotes on Progressives website). If they instead invested that premium and earned 10% annually, they’d accumulate nearly $85,000 by their actuarial life expectancy (13.69 years per Social Security) – far exceeding the insurance payout.
The Bottom Line
While future tax rates deserve consideration in retirement planning, they shouldn’t drive your entire strategy. Permanent life insurance makes sense in very specific scenarios (primarily for ultra-high-net-worth individuals passing along illiquid business assets) but isn’t appropriate for most retirees.
Focus instead on fundamental financial planning principles: proper asset allocation, diversification, spending discipline, and comprehensive estate planning. Don’t let fear of future taxes lead you into expensive, complicated solutions that may not serve your best interests.
Scott Caufield, CFA, CPA