The Retirement Time-Bomb No One Sees Coming
Why tax deferred plans could come back to haunt you.
The main reason most people do an IRA, 401(k) or similar plan (aka Qualified Plans) is to defer paying taxes. Nobody likes paying taxes. They are the largest expense in your life, so I get why it seems smart to put them off!
But here’s what no one talks about: these plans don’t keep you from paying taxes, they just save you from paying them right NOW.
You may assume that is a good thing, but I disagree wholeheartedly. Here’s why:
In his book Come Back America, David M. Walker states that by 2030, absent significant reforms to current government programs and policies, federal taxes could DOUBLE their current levels.
I’ll say that again. Taxes. Could. Double.
That’s sounds like a pretty wild claim, so why should you listen to this guy?
As it turns out, David was the Controller General for the United States from 1998 until his resignation in 2008. That’s like being the CFO for the entire country for 10 years. When he made that statement, he knew more about the fiscal state of our country than nearly anyone on the planet.
Since then he’s been traveling the country working to help the American public understand what is at stake. Unfortunately, it appears his prediction is still on course.
This is important.
If you are investing in retirement plans that have you paying taxes later, then you could be setting yourself up for disaster if taxes rise anywhere near the level of his prediction.
Cue the picture of an atomic bomb hitting your retirement account.
Right now might actually be the best time in the past 80 years to pay taxes.
Yes, you heard me right. The fact is, historically speaking, taxes are as low as they have been for roughly 80 years.
So if you had the choice of paying taxes at one of the cheapest times ever, or paying at some future time where they could be considerably higher, what makes the most sense?
I think we can all agree that waiting to pay taxes is a gamble at best, and a train wreck at worst.
Gambling: The sure way of getting nothing from something.
~ Wilson Mizner
Now, this might be making your blood boil. You might be asking, “If this is true, then where am I supposed to grow my nest egg for retirement?”
There are a lot of answers to that question, and this is what I’ve helped thousands of clients figure out. The simplest answer is this: put your money into accounts that grow tax free. Not tax deferred, tax free!
If you build your wealth inside of accounts that grow tax free, then it doesn’t matter what the tax rates are in the future. You’ll be safe.
There are multiple options, but the two easiest to use are as follows:
- Roth Accounts — These plans are designed for you to pay taxes on the way in and then they grow tax free. You probably have an option to contribute to one through your company or financial planner, so you should consider it. However, you can only contribute a limited amount and if your income gets too high you may not be able to contribute at all, so check with your adviser to find out more.
- Life Insurance Retirement Plan (LIRP) — I believe these are the MOST misunderstood plans in the market place right now. Most people believe that life insurance is only for when you die, this is only partially true and tremendously misleading. If properly structured with a specific type of life insurance company, these plans grow tax free and have a contractually guaranteed rate of return. That means your money goes up (for sure) every year, AND you can utilize it tax free while you are ALIVE. These plans need to be set up and handled correctly, but they have incredible tax advantages and no contribution limits. Nearly anyone can use them.
Bottom line is that paying taxes later is only beneficial if your tax rates are lower when you withdraw your money than when you put it in.
Most people believe they will be in a much lower tax bracket when they retire, but if you’re building wealth effectively that shouldn’t be the case. Plus, in retirement you’ll likely lose many or all of your write-offs to offset your income.
Just like the Kentucky Derby results, nobody knows what will happen with tax rates in the future. I’m just a believer in creating financial certainty and taking the “sure thing”. In this case the “sure thing” is paying taxes while rates are at a historic low.
On the other hand, if you like gambling with your entire life’s savings, maybe paying taxes later is your thing. I just haven’t met many gamblers who ended up ahead in the long run.
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