Advisors expect record federal debt to result in higher taxes

As the federal debt reaches record levels, financial advisors anticipate rising tax rates that will affect financial planning.

The Treasury Department announced late last month that the federal debt hit $34 trillion, the highest amount on record and up $1 trillion from three months earlier, according to the Committee for a Responsible Federal Budget.

Red ink has been gushing in Washington for decades, and the consequences of the massive fiscal imbalance aren’t going to hit immediately. But advisors say higher tax rates are pretty much inevitable.

“As an advisor, the national debt is a very concerning issue, especially with younger clients that have a longer time horizon, because the bill is eventually going to come due,” Kyle Hill, founder of Hill-Top Financial Planning wrote in an email. “When looking at planning for the future we're trying to anticipate future tax rates compared to current tax rates. I tell clients to plan on higher taxes in the future to pay for all the spending we've done and continue to do.”

It’s not just the need to finance the debt that is putting upward pressure on tax rates but also the looming expiration of lower rates in 2026, when a 2017 tax law expires. Current rates might be as low as it goes for taxes, said Robert Stromberg, president of Mountain River Financial.

Stromberg encourages his clients to consider Roth individual retirement accounts – either as conversions from traditional IRAs or as the vehicle for their company retirement plan. Roth contributions are made after paying taxes while withdrawals in retirement are tax-free, meaning clients will tax the tax hit now with relatively low rates and avoid taxes later at higher rates.

“It stands to reason we are going to see rates rise,” Stromberg said. “It makes a strong case for Roth and other tax-free avenues. In the long run, [the current tax rate] might be an extremely attractive rate to lock in.”

There are only two solutions to the burgeoning debt, said Pam Horack, owner of Pathfinder Planning. The government will face the same choices that confront people wrestling with their own debt – either spend less or earn more.

“The government is going to have to raise taxes, particularly on higher-earning people, in order to help bring the budget into balance,” she said.

Where to draw the line on who pays more in taxes is always a fraught political issue. Horack said most of her clients are households that make $300,000 or less.

“I feel like they’re taxed at an appropriate level,” she said.

Reducing spending also causes fierce political fights. The debate over federal spending will reignite soon, as Congress tries again to avoid a government shutdown on Jan. 19.

“I think that the national debt is a serious issue that Congress needs to address by significantly reducing spending," Herschel Clanton, founder of Chancellor Wealth Management, wrote in an email.

Hill agrees that reducing spending should be the focus when it comes to debt reduction. During debates over the budget, tax cuts are often blamed for ballooning deficits and debt. Hill pushes back against that assertion.

“It's not the tax cuts that are the problem, it's the spending,” he said. “If we can't get spending under control, we'll never have enough coming in.”