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Are Tax-Deferred Savings a Ticking Time Bomb?

"If Thomas Jefferson thought taxation without representation was bad, he should see how it is with representation." – Anonymous

Deferring taxes has always been a bedrock principle of retirement planning. The logic is simple: why would anyone pay the government now when tax-deferred accounts allow you to delay your obligation for 15, 25, and maybe even 40 years? If a reduced household income after retirement put you in a lower tax bracket, the savings could be considerable.

But, what would happen if your tax rate after retirement was actually higher then what you would pay today? Could we see a scenario where deferring 25 cents in taxes today ends up costing you 33 cents (or more) when you withdraw your money in retirement?

It’s a frightening thought if you worry, as I do, about the sustainability of current tax rates. Given the poor financial health of the federal government and our unfunded liabilities associated with health care and social security, many experts believe that tax rates will surely rise over the coming years.

The Wall Street Journal’s Jonathan Clements examined this concern in a fascinating article, "Protecting Your Retirement No Matter Who’s President". Under most reasonable tax rate scenarios, he concluded that tax-deferred accounts still generally make sense if you have a long enough time frame.  He ultimately recommended a sensible sounding 3-pronged strategy that should hedge your exposure to most tax code reform efforts. There are a lot of caveats in his analysis so I suggest you read the article carefully and run your own analysis.

In today’s show, I also share my thoughts about a favorite fund of mine, Dodge & Cox Stock, that’s recently reopened its doors to individual investors. I generally don’t recommend actively managed large cap mutual funds, but this fund’s approach to investing and its long-term track record might make them worth a look for your portfolio. Since your situation will be unique, please reach your own conclusion by examining their prospectus and track record.

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