The Retirement Tax Trap
We’ve seen a lot of press this year on the 401(k) “experiment” and whether it’s worked for America’s savers. More articles are talking about the high cost of 401(k) fees, and the astonishing fact that fees alone can cost a couple the equivalent of 1 to 2 years’ salary.
But one shortcoming of 401(k) accounts that’s been overlooked by the media is taxes.
We’ve all heard the pitch. 401(k)s (and IRAs) allow you to accumulate money for retirement tax deferred. While that’s a great benefit today (a portion of your income is not taxed), it’s a bum deal for the future. Because when you retire, you owe taxes not only on your 401(k)/IRA contributions, but on all the gains you’ve amassed over the years.
There are a few problems with this approach:
First, many individuals start a 401(k) early in their careers, when they are in a low tax bracket. At this stage, tax deferral isn’t a good deal, as their tax liability is low. As their careers develop, many workers move into higher and higher tax brackets. In fact, for many of us, some of our highest tax bracket years are those years leading up to retirement and in the early stages of retirement. Put together, this means many people pay a higher tax rate on their 401(k) when they withdraw money than they would have paid when they contributed.
But even if you have the same tax rate when you retire that you have today, you’re still growing taxable benefits. Let’s say over the next 25 years, your $250,000 of contributions grows into a $1 million IRA. When you go to retire, you owe taxes on all $1 million – your $250,000 of contributions and your $750,000 of growth within the account.
Once you combine federal and state taxes, many higher-earners are losing 40 percent or more of their 401(k) income to taxes. That $100,000 in income they were expecting is now whittled down to $60,000 or less.
Viewed through this lens, a 401(k)/IRA isn’t so much a savings plan as a huge future tax liability. “Tax deferred” looks less and less attractive to many savers.
We believe a better approach is to pay taxes on your contributions now, and then access your gains tax free in the future. This is the exact thinking that has led to the boom in the Roth IRA and Roth 401(k) market in recent years. But while this approach addresses the tax issue, it does nothing to address all the other drawbacks to 401(k)s and IRAs.
We take a very different approach to growing your retirement nest egg. We believe flexibility, growth and security can all be balanced in a tax-free instrument. When combined, these factors create an exceptional retirement savings plan.
Few people we know like paying taxes. But 401(k)s and IRAs have set up a system where Americans are paying more taxes than necessary on their retirement income. And that’s an issue today’s savers are just starting to comprehend.
If you want to learn about a vehicle that will allow you to create a tax free income with flexibility, growth, and security then get on my calendar for a 30 minute phone call to see if you are a good fit for this strategy!
Call 301.577.6340 now to schedule your appointment!