A Taxing Choice: How to Save for Retirement
By Joseph Carter Gray, CLU® | Pacific Insurance Group, Inc
It’s been said the only certainties in life are death and taxes, to which Will Rogers famously quipped that, “death doesn’t get worse every time Congress meets.” Life is full of surprises but your retirement should not be one of them. Do you think that taxes will be higher or lower in the future? Tax diversification can help counter the ever-changing tax environment and provide flexibility in retirement. Tax diversification refers to placing your money in accounts with differing tax treatments. The purpose of this article is to encourage you to balance out your overall retirement plan by utilizing tax-free accounts. There are three general tax categories of accounts: taxable, tax deferred, and tax-free.
You can either defer for a year, even years, or pay the tax now and never again. The key difference between taxable and tax-free resides in when taxes are paid.
1. Taxable accounts – Growth in these accounts typically result in taxes in a given year, as all income is subject to taxes annually, whether it is received or reinvested. One key benefit of the taxable account is withdrawals, which can occur at any time without a tax penalty.
2. Tax deferred – These are typically referred to as retirement accounts, such as Individual Retirement Accounts, usually IRA’s and 401(k) plans. They are specifically designed for retirement spending and have certain age restrictions and penalties for early withdrawals (most commonly before age 59 ½). In exchange for these restrictions, retirement accounts are allowed to grow tax deferred, meaning an individual gets a tax a deduction now but must pay the tax later.
3. Tax free – There are 3 places you can put your money and receive tax-free retirement income. A Roth retirement account, municipal bonds and maximum funded life insurance. Placing money in 401(k)’s and IRA’s provides you with a tax deduction now. Contributing to tax-free accounts provides you with tax-free income in retirement. Each delivers benefits that could prove to be more valuable depending on future tax rates. The BIG question is: where do you think taxes will be in the future? Let’s take a look at the facts:
• Can we really get rid of Social Security when it is the only source of income for nearly 1/3 of seniors?
• The national debt is how many double digit TRILLONS of dollars? Who is going to lend us more money? How are we going to pay it back?
• With the baby boomers hitting retirement age, how is the US Government going to pay for the exploding costs of Medicare and Medicaid?
Almost all of my clients believe taxes will be much higher in the future. If the majority of your retirement account is in traditional IRAs/401(k) accounts and you are able to forgo the current tax deduction, consider shifting your contributions to Roth accounts, municipal bonds and maximum funded life insurance. One of the best books I have ever read is Tax-Free Retirement by Patrick Kelly. He does an amazing job comparing tax-free retirement options.
When working with clients, I have noticed the best savers for retirement are often the worst spenders in retirement. This can cause a huge tax problem when the majority of their retirement savings are in a traditional 401(k)/IRA retirement account, because they delay paying the tax until they die and then, the tax has to be paid on the entire balance that year pushing them into the highest tax bracket. Don’t get me wrong, I am a huge fan of people putting money into any retirement account that has an employer match, as long as they realize they have not paid the tax yet and plan accordingly. Conversely, in a tax-free account, it generally gets better for your legacy the longer you live because of the way it passes on the tax advantages. I believe in using multiple strategies through a balanced holistic approach, which usually incorporates all three categories of accounts.
About the Author: Carter Gray is affiliated with Pacific Insurance Group, which is a General Agent for multiple insurance companies and provides a variety of insurance and annuity products. “Specializing in advanced case design, we help people get their money working for them in smart and safe ways, getting more bang for their buck.” Contact Carter today to schedule your free financial health evaluation (email@example.com or 425-246-1676).
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