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An IRA or 401(k) May Actually Harm Your Retirement

by Samuel N. Asare


Nine out of ten Americans would likely say that tax-qualified plans like 401(k)s, 403(b)s, and IRAs are best for retirement income planning. But have they taken the time to research the real-life experiences of retirees who have applied these vehicles to their actual retirements?

Consider this: if you were offered a loan contract stipulating that the interest rate on the loan would not be determined until the loan was due in, say, twenty or thirty years, and that interest rate could be whatever we decided – you’d have no input or recourse whatsoever – would you sign that contract? Of course not!

Then you need to seriously rethink your tax-qualified retirement plan because, in essence, they do exactly that. You delay paying the taxes due today – at today’s rates – until you begin to withdraw or are forced to do so by the IRS, and then pay taxes at whatever rates are in effect at that time.

The Seeding Years

George and Nancy live in a beautiful Virginia community with their two children, Nora and Bill. Their gross annual income is roughly $120,000. On an annual basis, they make tax-deductible contributions of $15,000 to their 401(k) plans, and pay $13,000 in deductible mortgage interest payments.

Their “taxable” income is, therefore, approximately $77,400 ($120,000 minus the $15,000 401(k) contributions, minus $13,000 mortgage interest deductions, minus $14,600 dependent/personal exemptions for their family of four, based on 2010 thresholds).

Based on this scenario their approximate income tax liability – based on 2010 thresholds – would therefore be $11,713.

The Harvesting Years

One day George and Nancy will be retiring. Based on their goals and dreams, they’d have paid off their Virginia house and, of course, Nora and Bill would be working adults with respectable careers, raising their own beautiful families. Given these conditions, both their CPA and so-called financial advisor would suggest they could expect to live comfortably on about 80 percent of their pre-retirement income, or $96,000 per year.

Their “taxable” income in retirement would therefore be approximately $75,100 ($96,000 minus $7,300 in personal exemptions, minus 13,600 in standard deductions – based on 2010 levels. Assuming that tax rates remain unchanged at 2010 levels (which is altogether unlikely, given the current fiscal climate) their approximate tax bill would be $11,138. Yes, they’d be retired, living on 20 percent less income, and yet would be in the exact same marginal tax bracket!

Of course there are those who offer the shallow argument that you saved money upfront – by deferring the taxes due and allowing them to compound. What these short-sighted individuals fail to realize is that this only holds true if people move into a lower tax bracket in retirement.

However, paying lower taxes in retirement is actually a rarity. A reduced total income does not automatically mean a reduced “taxable” income, which is the only thing that really matters when it comes to paying taxes. In the case of George and Nancy – just like millions others – their “taxable” income decreased by only 3 percent, even though their total income was a whopping 20 percent LESS. Additionally, notice that in this example, we assumed the same tax rates. What is the likelihood of that really happening in the future?

Most people fail to consider that since income from qualified plans counts toward the computation of their “provisional income,” they potentially expose up to 85 percent of their Social Security checks to taxation. In effect, their 401(k)s and IRAs make them pay additional taxes they would not otherwise pay.

We have also encountered numerous frustrated seniors who are being forced to take the IRS mandated “minimum distributions,” even though they do not require that much income to live, not to mention the taxes due on these mandatory minimums.

Nonqualified Options May Suit Many

Many Americans are completely unaware of the nonqualified alternatives within the confines of the Internal Revenue Code that could be funded with after-tax dollars and accessed completely income tax free even before age 59½. In addition, withdrawals will not count towards provisional income calculations, thereby allowing the owner to possibly skip taxation of his/her Social Security checks. Lastly, remaining funds may be transferred to named heirs at the owner`s death, income-tax free.

We believe that you should implement whichever option you prefer within the tax code, but wouldn’t it be a good idea to first find out what those alternatives are? For your no-obligation consultation please call (877) 656-9111 or visit today!

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This website is for informational purposes only. All opinions expressed are solely those of Laser Financial Group, LC., and our editorial staff. The information is not to be construed as any form of professional advice, nor as solicitation for the purchase or sale of any security, whatsoever. No particular outcome is guaranteed. No strategy can guarantee a profit, protect against loses, or ensure peace of mind. Recommendations are based solely on third party insurance products for which we receive compensation. Laser Financial Group, LC, does not provide investment advisory services. This does not constitute an offer to provide services in any jurisdiction in which such offer or solicitation would be unlawful under the laws of such jurisdiction. Any United States tax reference on this website is not intended to be used, and cannot be used for the purpose of avoiding penalties under the Internal Revenue Code, or promoting or recommending to another party anything addressed herein.

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