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I got a lot of great comments last week about the impact Trump might have on the real estate market. It will definitely be interesting to see how that all shapes up. On a different note, something I’ve been pondering over recently is what I should do about my 401k.
Currently, I have the ability to contribute to a Roth 401k and Traditional 401k at work. For the past five years, I have been able to max out my Traditional 401k and then max out my wife’s and my Roth IRAs through brokerage firms like Betterment and Motif Investing. My initial thought was that I was diversifying my tax risk for the future.
Honestly, if you told me a year ago that Donald Trump would be President and that he would lower tax rates across the board with a Republican Congress, I would have probably laughed. But based on the chart below, it appears that could be happening.
|Single||Married Filing Jointly||Tax Rate|
|$0-$37,500||$0 – $75,000||12%|
|over $112,500||over $225,000||33%|
A Little Tax History Lesson
I decided to do a little bit of research to figure out how tax rates have fluctuated. To say that they have varied over time is an understatement. The earliest data that I could find shows that in 1643, tax collectors would go door to door asking people how much income they made. They would then calculate the tax right there on the spot and would receive payment. What that tax rate was, nobody knows. I haven’t been able to figure it out, and I think there is a chance that they didn’t follow a specific rate either. As I’m sure you can guess, that did not do very well as people sometimes alter the truth when it’s advantageous to them. So that form of tax collection yielded very little revenue.
Income Tax During the Civil War
The first income tax law was implemented in 1861 during the Civil War. Earned income over $600 (present-day $15,478) to $10,000 (present-day $257,968) was taxed at a rate of 3%. Over $10,000 (present-day $257,968) was taxed at a rate of 5%. Can you imagine that? A flat 5% over $10,000– I’d be jumping up for joy if I saw that type of tax rate.
No Need for Taxes
In 1873, the tax actually expired when the need for federal revenues dried up. Yep, you read that right. The government decided they didn’t need anymore money. For some reason, I don’t anticipate witnessing that in my lifetime…
The Wilson-Gorman Tariff
A Democratic-led Congress reintroduced the tax when they passed the Wilson-Gorman Tariff, which taxed income of $4,000 (present-day $107,578) at 2%. That was the first time income taxes were collected during a non-war time. This bill was passed to deal with the reduced income received from tariff reductions during the Presidency of Grover Cleveland, which interestingly enough, got overruled by the Supreme Court due to some wonky legal jargon around personal property and apportionment around the states. I’ll spare you the details. Trust me, it’s boring, but google “Wilson-Gorman Tariff” if you really want to learn more.
Revenue Act of 1913
The next great event in income tax history occurred in 1913, when the Revenue Act of 1913 was passed. You can see in the chart below, the massive tax rates that individuals were paying. I kid, I kid.
Income Tax in 1913 (In Constant 2013 Dollars)
Can you imagine paying 1% of your income up to $463,000? I am salivating at the thought of all the things that I could do with that tax savings. Not to mention that it would be a no-brainer if a Roth IRA had been implemented to lock in those low rates because 4 short years later (1917), the top bracket went from 7% to 67%.
Whoever had invested in their Roth IRA at this point was sitting pretty. I’m just kidding. I don’t want to confuse you. The Roth IRA was not implemented until 1998, so it wasn’t actually possible to do this. I don’t want you calling up your grandparents and asking them why they weren’t using Roth IRAs back in their day.
In 1917, I’m not sure who was making $35,874,063 (present-day $669,213,829), but I have a feeling that they were clearly targeting some of the entrepreneurs who had near monopolies in certain industries. The next year (1918), that top bracket rose another 10% to 77%.
The Great Depression
Over the years leading up to 1925, tax rates started to decrease such that the top bracket was 25% again. That remained until the Great Depression (1929) when rates jumped back up to a top bracket rate of 63% and even higher to 79% in 1936. The rate continued to rise to 81% in 1941 on income over $78,093,197 (present-day $1.2B). Until 1944, the top tax bracket rate hit 94% on income over $2,609,023 (present-day $35,396,437.15), which was the US top tax rate apex.
The top tax bracket stayed above 90% until 1964, when it fell all the way down to 77%. It remained at 70% until 1982, when it dropped down to 50%. I have to admit that I had no idea that when I was born that the top tax bracket rate was 70%. I can’t imagine a rate that high again, but then again, I had no idea that at one point individuals were paying a top tax bracket rate of 94%.
Lock In or Take a Chance?
I think most of you are probably familiar with the tax rates that have been going back and forth since Reagan’s time through Obama’s presidency. Each President and Congress differs in determining the proper amount of taxes to maximize the revenue needed to fund the federal government.
I’m sure some of you are glazing over and mad at me for making you read all that tax history. But my dilemma is, should I lock in the low tax rates that I currently experience, or if I should take a chance that the government might potentially lower tax rates even more in the future?
Quick side note: I’m going to make the assumption that Congress doesn’t change the rules on me and at some point decide that Roth IRAs are illegal and that my tax-free growth all of a sudden becomes taxable income.
Under the Trump tax cuts, my wife and I would have an effective tax rate that would be lower than the 15% tax rate. My guess is that it will be somewhere in the high single digits. I’m trying to decide if it makes sense to just pay taxes now and not have to deal with taxes in the future. I know that I may only have 4-8 years if this works out to really maximize this strategy.
But, for all I know, in the future, Congress could adopt a national consumption tax or figure out ways to eliminate tax in its entirety. For those reading this early in the morning, that was suppose to elicit a laugh. I don’t actually believe the latter would happen 🙂
So readers, what do you think? Are you doing anything to make your portfolio more tax-efficient? Are you currently maxing out your Roth 401k? Share your thoughts below.