I hope everyone survived dealing with their taxes over the last few months. It can be very stressful to try to maximize your taxes and put money away for your retirement while protecting your cash flow from being drained at both ends. This month we will look at tax deferred retirement strategies. We will look at the advantages and the disadvantages of these types of strategies. It is always a balancing act to decide which is the appropriate strategy to put money away for retirement. You need to decide if you want to save tax money now and pay taxes later -- this strategy may give you instant gratification on your taxes, but you wind up having funds tied up in government controlled accounts where the government determines when you need to start pulling funds out and what the tax payment will be. The type of plans that we will discuss in this article are tax deferred plans. These plans include 401K plans, SEP plans, Simple IRA plans and 403B plans. In these types of plans, an employee or self- employed person will chose to defer some of their income and put it away tax deferred in one of these strategies. The benefit is that you will not pay state and federal income taxes on the amount that you contribute to these plans. In most cases you may also receive a matching contribution from your employer. The benefit is that you can painlessly put money away for your retirement; you get an immediate tax deferral and a possible company match. The negative to these types of plans is that the plans have government rules that can and do change on a regular basis. The other negative is that you are required to start withdrawing funds from these accounts when you turn age 70 and a half. If you do not start taking the government mandated RMD’s or Required Minimum Distributions you will incur a tax penalty of 50% of what you should have taken out. That is a painful penalty. If you are under 59 and a half, you may be subject to a 10% penalty plus you also pay tax on the funds that you withdraw on from retirement accounts. There are some exceptions such as being disabled, where you do not have to pay the 10% penalty. Most people think that they are saving taxes on their contribution, you are actually compounding taxes. Here is
an example, say that you invested $5,000 in a tax deferred plan for 1 year and you let it compound for 30 years and then you withdrew the funds. If you were in a 30% tax bracket you deferred $1,500 of taxes. 30 years down the road your funds will hopefully be worth more money. If they compounded at 6% per year for the next 30 years your account would be worth $28,717.50 and if you are still in a 30% bracket your taxes when you withdrew funds from your account would be $8,615.25. In the end you need to decide in this illustration was it worth saving $1,500 in taxes to have to pay $8,615.25 in taxes later on. What you need to ask yourself is, would it have been better to put the $5,000 away in a tax free environment, pay the $1,500 of taxes up front and not pay the compound tax later. If the income tax rate increases the strategy could wind up costing substantially more. The advice that we often give people is to contribute up to the employer match and look at other strategies for contribution amounts over that. Everyone has different circumstances and there is not any one size fits all answer. It is worth analyzing your situation with an advisor who is knowledgeable about your overall situation and who can give you advice about your current situation and who can run retirement alternatives to see which strategy is appropriate for you. For additional information, please feel free to email me at marcs@equityplanning.com, And, don’t miss our article next month on Tax Free investment strategies. The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendations for any individual. Securities offered through LPL Financial, Member FINRA/SIPC. Investment advice offered through US Financial Advisors, a registered investment advisor. US Financial Advisors and Equity Planning are separate entities from LPL Financial.
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