Over the past couple weeks, I’ve received some interesting and, quite simply, fear based questions from many of my clients about how the coming year’s tax laws will affect them. For example, today’s question from a long time client was whether he should cash out his entire pension plan before December 31 in fear that the tax rates in 2013 would jump up by a significant amount. Based on media coverage, I don’t blame people for being scared and confused.
However, as FDR said, “all we have to fear is fear itself.” First of all, the
debate in Washington is about how high rates should be raised on the top tax brackets, along with what income level should constitute the highest bracket level. The President thinks rates should be raised for those making $250,000 or more, while the Speaker of the House proposed that the high rate increase should be on those earning more than $1,000,000. Therefore, if you earn less than $250,000, you should see no increase in your income taxes regardless of who wins the debate. Realistically, some form of compromise will probably result with the high income bracket being set at somewhere in between those two figures.
Now getting back to my client’s question today regarding the cashing in of his retirement account: the answer is NO. Cashing in one's entire retirement account doesn’t make sense whether rates go up or down. We have a progressive tax system in this country. This means that as our income rises into different tax brackets, only that additional income is taxed at the higher rate. Therefore, if my client were to cash in his entire pension plan funds, they would be driving themselves into a much higher bracket, even using the 2012 rates. He would be creating for himself the problem he feared all along, except he’d be voluntarily raising his own taxes.