Just When You Thought You Were Out of Debt
American households are drowning in consumer debt, with the Federal Reserve Bank reporting a new record of over $1.13 Trillion in Credit Card debt in 2024.[1] Total consumer debt, including the largest category, mortgage debt, is also standing at an all-time high of $17.5 Trillion.[2]
In our new high interest rate environment, the interest payments alone on these loans are a heavier burden than ever before. Making the final payment on that mortgage or credit card can feel incredibly freeing; like the weight of the world is finally off your shoulders. Listeners to the highly popular Dave Ramsey show will be familiar with the primal “debt free scream”, as Ramsey disciples release the angst and stress they experienced over their years as a debtor. And it’s all too relatable. Except in those cases when debt is being leveraged for business purposes, getting completely out of debt is a highly desirable goal for just about anyone. In fact, I consider it a prerequisite to a successful retirement.
Naturally, there are situations in which it is unwise to prepay a debt with a low interest rate, but even in those scenarios, debtors look forward to the day they can be debt free once and for all.
While some investors with millions in their portfolio were born with a silver spoon in their mouth or had a large inheritance dropped in their lap, the vast majority got there through years of hard work and self-denial. Those who have experienced how difficult it is to accumulate wealth tend to be careful about preserving their assets and controlling their expenses. They certainly don’t want to be back in debt, or to be paying interest. Sound familiar? Once you’re out, you wouldn’t ever allow yourself to be in debt again, would you?
If that’s the case, I have a follow-up question: Do you have a traditional qualified account, such as a pre-tax 401(k) or traditional IRA account? If the answer is “yes” then you are not, in fact, debt free, you have a tax debt. You have earned income and investment income which has incurred a tax that you have yet to pay. Taxes will be paid on any withdrawals made from these accounts, and unfortunately, the U.S. government is a horrible creditor. While a traditional loan agreement includes disclosures such as the interest rate to be paid, the length of the loan, and the payment amount, this is not the case with the tax debt on your 401(k) or IRA. The amount you pay will be calculated at a future tax rate; a rate that is unknown, and potentially much higher than your current rate.
It is quite likely that your tax bill will rise over your lifetime. This is partly due to Required Minimum Distributions or RMDs. As you are likely aware, 401(k)s and traditional IRA accounts require withdrawals to begin at age 73, or age 75 for those born in 1960 or later. These RMDs are taxable, and that is the point: The US government wants their tax, and the RMDs are a device used to collect it. RMD amounts are derived by dividing the account balance by remaining life expectancy. An account balance that is assumed to grow, divided by a decreasing life expectancy, results in an ever- increasing RMD amount, and an increasing tax.
Further, the tax brackets in the future will very likely be higher than they are under our current tax scheme. Under current tax law, tax brackets will increase in 2026. More increases may be required to fund the Federal Government, which is spending like a drunken sailor (my apologies to drunken sailors). Consider that the Federal debt now stands at over $34 Trillion [3] and is increasing at the alarming rate of $1 Trillion every 100 days! [4] We can expect the Federal Government to become ever hungrier for revenue and a primary way to raise funds is through increased income taxes. Tax rates have been higher in the past than they are now, and they could easily rise again.
And it won’t end with you. The taxes on your 401(k) and IRA withdrawals will be paid by your beneficiaries after you are gone, and with recent IRS rules, children and other non-spouse beneficiaries are required to withdraw the entire balance over a maximum of ten years. This concentrates the taxable withdrawals, often spiking their tax bracket higher.
Bear in mind that as you are reading this, globalist, elite politicians and bureaucrats are developing new tax schemes and writing countless regulations every day. Our job here is not to attempt to forecast what they will cook up; no one knows what those new rules or rates will be, and I never put stock in fortune tellers (pun intended). No, the point is this: The amount of the future tax payments on our 401(k)s and traditional IRAs are unknown, and this represents a risk as well as a potential tax trap.
By converting to a Roth IRA, this risk can be virtually eliminated. To the extent that a traditional 401(k) or IRA account is converted to a Roth IRA, the tax debt is paid now. An investor who converts to a Roth IRA is effectively saying “I am willing to pay my tax debt now at a current, known tax rate, so as to avoid paying it later, in an unknown (and likely higher) tax rate. I want to truly be free of debt!”
One final opinion: You are a lone taxpayer, up against the most powerful and corrupt revenue collection system in history. The IRS and its allies work tirelessly around the clock to extract your wealth. If you choose to go it alone, you will lose. Get someone in your corner who knows how to use their rules to your advantage.
[1] Source: NewYorkFed.org
[2] Source: NewYorkFed.org
[3] Source: Treasury.gov
