A Flat Tax on Traditional IRA Withdrawals?

On this episode of The Long View, David Bach, financial advisor and author of 12 national bestselling books, including The Latte Factor, Smart Women Finish Rich, Start Late, Finish Rich, and The Automatic Millionaire, discusses the importance of taking breaks throughout your career, rethinking spending in and before retirement, and the impact of a potential new tax on IRA withdrawals.

Here are a few excerpts from Bach’s conversation with Morningstar’s Christine Benz and Amy Arnott.

How Planning and Reliable Income Can Help You Spend With Confidence

Christine Benz: With retirement, there does seem to be this persistent issue when you talk to financial advisors, where their clients are overly frugal. They can’t turn off that savings mechanism, like the thing that helped them accumulate this wealth. It’s very difficult to turn off. Do you have any thoughts on that? Any tips for people who are in retirement, getting close to retirement, on how they can give themselves comfort with spending what they’ve managed to save?

David Bach: Absolutely. First of all, the biggest thing that can give you comfort is a financial plan. If you’re working with a financial advisor, they have run a financial plan for you. Hopefully. I can’t imagine today anyone that you would be working with hasn’t run a financial plan. If you’re working with a registered investment advisor, which I would think anyone who’s listening probably is, they’ve run your financial plan, and it’s sitting on a dashboard. I can tell you that my financial advisor, what do we do? Every six months, we sit down, and we go back into the plan, and we look at it on the dashboard, and I know exactly what we spent, and I can see how much the account has grown, and I can see where the dividends have all gone, and I sit there, and I review it with my wife, and we do planning. That’s a simple thing that you can do.

A second simple thing you can do is make sure, if you’re worried about spending money, that you create yourself an income stream of money that’s guaranteed, whether that’s coming from bonds or CDs or annuities, but giving yourself a guaranteed income stream can be very helpful in retirement. I think what’s happened, and I say this now having been in financial-services industry for 33 years, I look at the fact that there’s $45 trillion in retirement accounts, and I ask myself, “You know, what’s happened here? There’s so much money in retirement accounts, and people aren’t using their retirement money. How did that happen?” Well, one thing that’s happened is we just spent 40 years, myself included, teaching people to save and invest for retirement. Ninety percent of all efforts that have been done around financial education is about making sure you put aside enough money for retirement. It’s all been about accumulation. Save and invest, save and invest, save and invest, save and invest. Very little time has been spent on spend and enjoy.

And I think the financial-services industry now actually really needs to be looking at this, and you’d be looking at how do you start to—decumulate even a bad word, right? Nobody likes to decumulate, but if the financial-services industry started spending time on “how do you spend and enjoy your money because now’s the time to do it?” that would be really powerful. Now, the problem that you run into, I think, is that there’s a conflict of interest in the financial-services industry. I’m saying this, having been in the industry. The financial-services industry gets paid based on assets under management. So, they’re not always jumping up and down to get you to take more money. And that’s a problem, actually.

And then the other issue is that all financial planning, every single financial-planning software that exists today in America, defaults to take retirement dollars last. So, if I open up my account with my advisor sitting on top of Orion, and I look at my dashboard plan, my dashboard plan looks just like everybody else in America. And it shows me taking IRA money at the age of 75. That’s when I’m going to have an RMD. That’s my required minimum distribution. And so, it shows how much I’m going to probably have to take at 75. Now, here’s the thing. I’m going to have an extremely large IRA account at 75. And if I only take RMDs, which is the minimum, because I don’t need the money, because I’m like a lot of people who saved and invested, I don’t need the retirement money, so I’m going to take the minimum, it’s going to continue to grow. That’s why so many people today have these multimillion-dollar IRA accounts. In some cases, they’re having eight-figure retirement accounts now. And so that’s a problem because we’re not encouraging people to take this money earlier. And so part of this is education.

And then part of this is you, as a client, you’ve got to start thinking through, like, are you sure you don’t want to use some of this money? Because I don’t know what you’re waiting for. I would sit here and do these events with my advisors, and I would look out in the room, and I would say to the clients, “Take some more money, and go enjoy it.” And often the wife would, like, sit there, and she’d kind of elbow the husband, like, “Did you hear what he had to say?” And people would come up to me, and go, “Thank you for telling me that.” I’m like, “Guys, stop traveling coach. OK? If you’ve already hired these advisors here, you have plenty of money. If you don’t want to travel coach anymore, don’t travel coach. Or if your car is broken down, get yourself a new car, whatever it is you want to go do …” Because everybody who’s listening who’s a financial advisor knows that if you’re a typical financial advisor, your clients have plenty of money, and the problem is they are not spending it.

I had a client who came into my office one day. I told the story in Smart Couples Finish Rich. She was so upset because her CDs were coming due, and she had like a 7—back in the day, she had like a 7.0% CD—and it was coming due, and the rates were like 4.5%, and she was distraught. And she sat down with me, and I opened up her file, and I said, “You know, we’ve been talking about you wanting to take your family on a cruise for the last three years. You haven’t done it yet. You don’t spend any of this money. All this interest just keeps piling up in the brokerage account, and then we just sweep it back into another CD. Why don’t you go downstairs, and talk to the travel agent, and go price the cruise you want to take, and let me worry about the CD, and come back upstairs in an hour, and tell me what the cruise cost?” She did that. She comes back upstairs, and she says, she tells me the cruise cost, and I go, “Listen, Lynn, you can take this cruise three times this year.” She’s like, “Seriously?” I’m like, “Seriously.” And she’s like, “Well, if I only want to take the cruise once, could I get a bigger suite?” I’m like, “You can get a bigger suite.” And she took her family, she took her kids, she took her grandkids, and they did that trip. And about two years later, she was in her early 70s, and she passed away unexpectedly because she hadn’t been sick. And her kids would come in and show me pictures of that cruise, and they would say that was the greatest thing our family ever did.

And to me, that’s what financial planning is all about. That’s the purpose of financial planning. The purpose of financial planning is not just dying with the largest account. It’s using your money to live your best life. And those who are listening who have saved and invested over decades, you’ve earned the right to enjoy your life.

Will a Flat Tax Incentivize IRA Withdrawals?

Amy Arnott: You’ve also proposed a change in the tax code where there would be a flat 12% tax on retirement account withdrawals after age 60 for eight years from 2026 through 2033. Can you talk about some of the benefits of that, and how it might make people feel more comfortable spending?

Bach: The idea is called an IRA flat tax. You can actually go to IRAflattax.com, and I’ve done a white paper, and I built a website that has all the analysis that we’ve done on this idea—because that’s what it is. It’s an idea that I’m trying to get in front of Trump and other politicians. I started having calls with senators on this. The idea is we’ve got $45 trillion in retirement accounts. Eight out of 10, specifically 83%, according to JPMorgan, 83% of retirees who have money in an IRA account will not take their money out until they’re forced to at the RMD age, the required minimum distribution age. For all the reasons I just talked about, they’re not taking money out. They’re literally waiting until their RMD age. Why? The number-one reason is they don’t want to pay taxes. They don’t want to pay ordinary income on their deductible retirement accounts. I asked a question, and I’ve been thinking about this for like five years: Well, what would happen if we incentivize that money to come out of these accounts sooner, if we made it easier? I think it would change everything.

My idea is that I ran the analysis, what happens if we had a flat tax of 10% on IRA distributions, or 12%, or 15%? And either one of these numbers would, for someone who’s got a lot of money in an IRA account, they’d like either one of them. We ran the analysis, and what we think would happen based on the analysis is that trillions of dollars would come out of these retirement accounts. It’s like doing a Roth IRA conversion, only the money would come out, and retirees would use this money, and they’d either move it into a taxable account, leave the investments that they’re already in and pay the flat tax, or some of that money would get loosened up. They might go buy, they might pay their home mortgage off, they might help their kids buy their first house, they might go to help their kids pay off their student loans; it goes back into the local economy. It actually creates trillions of dollars worth of economic movement. And the analysis that we’ve done shows that GDP could actually go up by a 0.25% to 1.0% annually, and it pulls forward trillions of dollars in tax revenue.

And my idea is this is basically an eight-year tax window. It’s not a permanent thing because what you want to do is you want to incentivize baby boomers to start utilizing some of this retirement money. And people go, “Well, isn’t there a risk that people will take this money out and just go to Vegas and go crazy?” And the answer is, “I don’t think so.” I don’t think so because the people who are taking money out of their retirement accounts already—they’re taking money out of the retirement accounts because they need the money. A baby boomer who’s leaving money in their IRA account until the RMD age, for the most part, is simply waiting because they don’t want to pay taxes, and they want the tax deferral. For somebody who’s in a low tax bracket, it wouldn’t affect them, because the way I recommended that the government consider this idea, if you’re paying 0% tax on your IRA distributions because you’re in a low tax bracket, fine, great. It doesn’t affect you. But if you’re somebody who’s paying 37% taxes right now and you can take money out of your IRA account at, let’s say, 12%, you’ll take the money out. And you’ll still pay taxes, but you’ll pay less tax. I think a lot of people would take advantage of that. I also think what it would do is it would super-motivate people in their 50s to save more for retirement.

And the reason is we have catch-up provisions to save more in your 50s, and you can save more in your deductible retirement accounts knowing that as soon as you hit the magic age of 60, you can take some money out and pay a lower tax bracket. So that’s the idea in a nutshell. It’s going to take, if you ask me, how is this going to get done because I’m not a lobbyist, and I don’t have any skin in the game. I don’t economically benefit from this idea. It’s going to take this idea being put in front of Trump. And Trump’s come up with some pretty big ideas like no tax on TIPs, no tax on Social Security, tax deduction on car loans. If he came forward and said, “You know what, I think it’s time for baby boomers to enjoy their retirement. They’ve spent the last 40 years saving, investing for retirement, and I’d like to incentivize you to go and enjoy some of this money. You’re still going to pay taxes, but you pay a lower tax.” I think a lot of people would like that idea.