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Whether you agree with it or not, I think most people now believe that taxes are going to go up in 2013. With the Bush era tax cuts set to expire, we will likely see income taxes go up for those in the upper income tax bracket and we are likely to see a hike in the capital gains tax rate as well as the tax rate on dividends.

Any increase in taxes can have a very large impact on future plans. It is important to understand how much of an impact any tax increase might have on a person's retirement plan. Is it possible that a change in the tax code might force some to put off retirement and work longer?

To find out I ran a retirement plan in our Retirement Planner. I focused on a couple that is in the top tax bracket. I assumed that in 2013 the top income tax rate will move back to 39.6% for those making above $200,000 a year ($250,000 for couples). I also assumed that dividend tax rates move back to being taxed as ordinary income and long-term capital gains tax rates increase to 20% from 15% today. Here are my other assumptions:

Inflation (CPI)

3.00%

Current Age of Both People

45

Age Of Retirement

62

Age When Both People Have Passed Away

95

Social Security at age 67 (combined)

$40,000 per year

Average Savings Rate

$15,000 per year

Total Investment Balance Today

$600,000 (50% in Taxable, 50% in IRAs)

Annual Salary Income

$275,000

Recurring Annual Expenses in Retirement

$60,000

Return Assumption Treasuries

1.50%

Return Assumption Equities (Half of
Return Assumed to be Due to Dividends)

7.00%

Investment Mix

60% Equities, 40% Treasuries

I first ran their retirement plan using today's tax code. I found the following results:

Investment Value At Retirement

$684,000

Age When Funds Run Out

Never (97 if they live that long)

Investment Value At When Both People Pass Away

$15,500

This couple never runs out of money in retirement, assuming they both pass away at age 95, but it's very close. Their buffer at the end of their plan is less than $16,000. Now let's see what happens with the scenario tax code in 2013 that I discussed earlier:

Investment Value At Retirement

$625,000

Age When Funds Run Out

92

Investment Value At When Both People Pass Away

$0

In this scenario the couple does run out of money in retirement. In fact, they run out of money when they're 92 years old. Using today's tax code they wouldn't run out of money until they were 97 years old. Another way of looking at this is that this couple would have to postpone retirement by three years in order to get back to where they once were.

I also wanted to see the differences for a couple that doesn't make quite so much money. I ran this same scenario again and assumed the couple makes $150,000 per year rather than $275,000. This pushes them into a lower tax bracket and has a fairly large impact on the numbers:

Investment Value At Retirement

$645,000

Age When Funds Run Out

95

Investment Value At When Both People Pass Away

$0

The lower income couple is impacted less, but they are still impacted by the increased taxes on capital gains and dividends.

Clearly taxes have an impact and it is wise to prepare for a future with higher taxes. Those in higher income tax brackets might want to think about paring back on dividend paying stocks if the tax rate jumps from 15% to a potential high of 39.6%. I consistently recommend solid dividend paying stocks with a long history of increasing dividends, such as Johnson & Johnson (JNJ), Coca-Cola (KO), Wal-Mart (WMT), and Procter & Gamble (PG). For most people I recommend continuing to invest in companies such as these, even if the dividend tax rate goes up slightly for you. But for those in higher income tax brackets, if you cannot invest in dividend payers in tax-deferred funds you might be forced to scale back and move money into more tax-friendly vehicles.

Source: How Higher Tax Rates Can Affect Your Retirement Plan