What's next for boomers
In the years ahead, five key trends will dominate your financial life. So far you've been lucky, baby boomer. Now it's time to be smart.
3. Taxes will go up
The past 25 years: Once it joined the work force in the early '80s, the generation that protested the Vietnam War found it had a new beef with Uncle Sam: He was taking an obscene share of their paychecks.
You might not remember it - perhaps you blocked it out - but the top federal income tax bracket in 1980 was a mind-numbing 70%, or double today's rate. Even if you were in the middle class, earning $100,000 in today's dollars, you fell in the 49% bracket.
Of course, you know what happened next. Ronald Reagan rode tax cuts to electoral victory in the 1980s, and soon afterward the idea of hiking taxes became verboten in Washington (just ask George H.W. Bush). This led to a precipitous decline in rates over the past two decades. Today, if you earn $100,000, you're in the 28% bracket. And the maximum rate on long-term capital gains also dropped, from 28% in 1980 to 15% today.
What's next: The tax cuts of the past decades were supposed to lift economic growth (which they did) and, partly through hotter GDP growth, hike tax receipts faster than federal spending (which they did not). Not even close. The resulting tsunami of federal debt is one reason to expect your taxes to rise over the next quarter-century.
Another reason: your generation's retirement. The oldest boomers have already become eligible for Social Security, and they'll become entitled to Medicare in three years. If today's tax rates remain in place, 76% of all federal income tax revenue in 2050 will be soaked up by those two programs - before a penny is spent on defense, national parks, health care for the poor or haircuts for congressmen. Something has to give; it will probably include today's historically low tax rates.
Do it now
Pay Uncle Sam up front. While it's hard to put a happy spin on higher taxes, you can hedge against them - but you need to change some old ways of thinking. In the past, a standard financial planning adage was to delay paying taxes as long as you could - say, by investing in IRA s and 401(k)s. But if taxes are due to climb, that thinking is obsolete.
With that prospect, Roth IRA s and new Roth 401(k)s become the accounts to use in the coming era. In traditional IRA s and 401(k)s, you postpone income taxes on your contributions until you withdraw the money at retirement. With the Roth versions, you pay taxes on the money you put in - now, at today's low tax rates - but pay no taxes on that money (or earnings on that money) in the future when rates will likely be higher.
Rising tax rates should also intensify the appeal of municipal bonds, which are issued by cities, counties and states and which pay you interest income that's largely exempt from federal income taxes. Because of temporary factors in the bond market, it happens that munis are unusually attractive right now. If tax rates do rise in the future, then municipal bonds - or the more practical alternative, muni bond funds - bought at yields that reflect today's low tax rates will be more valuable still.