5 Consequences of the National Debt & How to Protect Your MoneySubmitted by Reby Advisors | Certified Financial Planners | Danbury, CT on September 18th, 2020
By Doug Kuring, CFP®, September 18, 2020
We know that too much personal debt can undermine your financial security. What’s less clear is how the national debt can affect your finances.
The total national debt of the U.S. reached $26.5 trillion as of June 30, 2020 – and it’s even higher now. This equates to over $80,000 for every living person in the U.S.
Historically, the government has taken on new debt aiming to meet the challenges of the times or invest in the future. Few would argue, for example, that it was a mistake to run high deficits during World War II.
However, too much national debt can lead to negative consequences on a nationwide scale – and that may affect our future tax rates, retirement benefits, and investment performance.
In this article, I cover 5 consequences of the national debt and what you can do to protect your money.
1. Higher Income Taxes
Future tax increases may be inevitable. The government needs to collect more revenue if our spending commitments don’t decline. With tax rates on ordinary income and capital gains at historic lows, both are likely to increase at some point in the future.
So, what actions can we take now to prepare?
The first step is to understand which types of accounts have tax preferential status.
Action Steps: Roth IRAs, Roth 401(k)s, and Individual accounts
You’ve heard of the Roth IRA. It’s like gold in retirement because any money you withdraw from it comes out tax-free. You don’t owe the government taxes on that income.
It’s essentially the opposite of a Traditional IRA: Roth IRA accounts get funded with after tax money and you don’t get taxed a second time when you take withdrawals for retirement income.
If we believe the national debt is going to become an issue (which would lead to higher taxes in the future), then it makes the most sense to pay taxes now because we assume they will be at lower rates.
If you’re heading into retirement and decide to take a portion of an IRA account and convert it into a Roth IRA, you’ll pay taxes on the conversion. But again, you’ll have a nice pot of money that grows tax-deferred, and you can withdraw it later in retirement at no tax impact. Additionally, if leaving a legacy to heirs is important to you, your loved ones would an inherit a Roth IRA tax-free.
A Roth Conversion won’t be the right move for everyone, so please contact us if you’d like to explore whether it’s appropriate for your situation and goals.
Action Steps Recap
- Consider using Roth IRA or Roth 401(k) accounts
- Assess the potential long-term benefit of a Roth Conversion
- Reduce your heirs’ tax liabilities
- Speak with a tax professional and your financial planning team before making a decision
2. Reduced Social Security & Medicare
The Social Security Board of Trustees expects the Social Security Trust's funds to run out of money completely by 2035. This means there’s a high likelihood of reduced benefits going forward.
Plus, future medical expenses are a major concern for a lot of people heading into retirement.
Action Steps: HSA Funding, Plan for 2035
The answer is HSA funding, or a Health Savings Account. A lot of people have access to HSAs through their medical plan at work. If you don't, you can also contribute to an HSA if you’re eligible and enrolled in a high deductible health plan.
The reason HSAs work so well is that they’re known as a triple tax-exempt investment. You can plan ahead and avoid unnecessary taxes, saving you a lot of money.
As for Social Security, you should plan ahead now while you have the chance. If you’re not yet retired, you may need to contribute a higher percentage of your income to a retirement account so that your investment portfolio can generate more income for you in the future.
3. Increased Estate Taxes
The estate tax exemption limit was doubled by President Donald Trump through The Tax Cuts and Jobs Act in 2017. That’s set to sunset in 2026. The exemption limit will likely decline in the future, which means more people will be assessed estate taxes when they pass.
That’s another way the government can increase tax revenue. Only a few states right now have inheritance taxes. I would expect more states to adopt these taxes as a way to increase revenue.
Action Steps: Estate Planning with an Estate Attorney
Your best bet to combat potential increases in estate taxes is to focus on trust and estate planning with a competent attorney and your financial planning team.
Here at Reby Advisors, we advise clients on strategies designed to achieve their legacy goals – from financial planning and investments, to identifying gaps in estate documents and collaborating with an attorney to shore up those gaps.
If you would like advice on how to protect your legacy from taxes and other risks, please do not hesitate to reach out.
4. Slower U.S. Economic Growth
As we add more national debt, our interest expenses become higher and higher. This means the government has less money to spend on investments such as education, transportation, and infrastructure – or we pay higher taxes, resulting in less consumer spending.
Economic growth will probably slow down in the future.
Action Steps: Invest Internationally
I still believe very strongly that today, the United States remains the safest country in the world in terms of investment. However, a great hedge when maintaining a diversified portfolio for your retirement is to invest internationally.
You want to be strategic about where you invest and what funds you invest in. The bottom line is that taking advantage of emerging and developing countries within your asset allocation makes the most sense.
5. Higher Interest Rates
As the national debt grows higher, outside investors may perceive U.S. government debt as being more risky. Investors will demand a higher rate of return in exchange for taking on that risk when they purchase our debt. Interest rates on U.S. treasuries will increase, which will lead to higher costs of borrowing.
Action Steps: Manage Your Liabilities
It’s really important during periods like this (when interest rates are at record lows), to manage the liabilities on your balance sheet.
One of the biggest opportunities may be refinancing the mortgage on your home. If you have student loans, consider refinancing those as well.
The bottom line is that you can lock in a lower rate and decrease the liabilities on your balance sheet, increasing your cash flow.
Recap on Protecting Your Money
At the end of 2019, the U.S. national debt was 79% of GDP. This is expected to increase to 101% by the end of 2020 due to COVID-19 legislation. This affects both our national economy and our personal finances.
Here’s a quick recap of the impact and the action steps we can take now.
If you want personalized advice on how you can protect your wealth in pursuit of your retirement goals, contact Reby Advisors today. We offer a complimentary introductory consultation and would love the opportunity to advise you.