Get out of debt? Absolutely. Start by reducing your Retirement Tax Bill.
If you’re in the financial services business, it’s impossible to avoid people asking about Dave Ramsey.
Dave Ramsey is perhaps the best-known financial commentator in the country. And his advice is heeded by millions of Americans.
One area of passion for Mr. Ramsey is his laser focus on reducing debt.
On TV, on radio, and in print, Dave Ramsey loves telling people how to get out of debt.
And generally speaking, I agree with this focus.
But I also take issue with the way Mr. Ramsey talks about debt.
I’ve noticed on his radio show, in his books, and on his blog, Dave Ramsey advises savers to reduce their debt. He talks about paying off student loans, buying new cars with cash, paying down your mortgage, and paying off your credit card in full every month.
Those are all good things. So why do I take issue with his remarks?
Dave Ramsey’s advice on debt isn’t wrong. It’s just incomplete.
It’s incomplete because Mr. Ramsey never discusses one of the largest debts the average American holds, and that’s the debt to the IRS that has built up inside their IRA or 401(k).
Debt to the IRS
Americans currently hold trillions of dollars in tax-deferred retirement accounts, which are immensely popular vehicles like IRAs, 401(k)s, and 403(b)s.
In tax-deferred accounts, savers have put off paying their taxes in the future.
And whether or not savers realize it, that creates a kind of debt.
The Oxford Dictionary defines debt as: Something, especially money, that is owed to someone else.
And that term applies to the build-up of taxes in an IRA.
Consider this:
A 65-year-old client comes to you with an IRA statement showing he has $500,000 saved in his account.
Can that client cash out his IRA and go buy a $500,000 vacation home?
No, of course not.
After all, not all of that $500,000 in the IRA is his to spend.
If he has a 20% tax liability, only $400,000 of those funds really belong to him.
The other $100,000 he owes to the IRS in the form of taxes.
Remember the definition of debt: Something - especially money - owed to someone else.
Does that sound like taxes in an IRA?
Absolutely.
If your clients have saved in a 401(k), IRA, or any tax-deferred vehicle, they owe a debt of taxes to the IRS.
In fact, it’s a debt that grows with interest. After all, your clients owe taxes not only on their contributions but also on all the growth in the funds in their accounts.
And it can add up to a lot of debt!
Reducing IRS debt
Of course, there are ways to reduce your debt to the IRS. And now may be the perfect time to help your clients do it.
Many experts have noted the U.S. is likely entering into a period of higher taxes for American savers. That means your client’s debt to the IRS is growing. If taxes are higher in the future than they are today, your client will be paying the IRS a higher share of their retirement assets.
Tax mitigation strategies are becoming a crucial component of retirement income planning.
“Buying out” the IRS now at a known rate is appealing to many savers. That’s why we’ve seen a rise in Roth conversions over the past two decades.
But before we can help our clients address this risk, we have to help our clients understand it.
Understanding the risk
Many savers look at their retirement account balances and forget to net out the federal government’s share. And that means many Americans may be overestimating the amount of spendable retirement income they can generate.
If you’re looking for ways to communicate this risk to your clients and prospects, I have an easy solution.
Check out these two message frames I’ve created: Debt to the IRS and Your IRA’s Silent Partner. Put these to use in your seminars and workshops, client meetings, social media posts, and email campaigns.
And next time a Dave Ramsey fan asks for your opinion, let them know there’s a way to address debt that’s far more complete than Mr. Ramsey’s approach.
