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Taxes and YOUR Retirement August 14, 2013

Posted by shaferfinancial in Uncategorized.
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Many folks have pointed out that taxes are the single largest expense for individuals. It is doubly important for retirement planning.  Typical financial planners tend to abide by the thought that one will retire with a lower tax rate than when they are working.  That is fundamentally wrong as any successfully retired person will tell you.

401K’s and Taxes

This is a pretty simple discussion.  Most people have been encouraged to build up wealth for retirement in 401Ks.  They are sold on taking the tax break up front, when they put money into their 401K.  Let me get this right, it is logical to take a tax break on inputs into a 401K and pay taxes on outputs when [theoretically] the outputs could be 2-4 times as much as the inputs?  So you end up paying 2 to 4 times as much taxes?

Even if the financial planners are right and you retire into a lower tax bracket this strikes me as a foolish thing to do. 

You pay 25% of your income to taxes.

You put in $300,000 to your 401K over the years. You save $75,000 in taxes.

You get $900,000 in distributions from your 401K over your retirement years.

You pay 15% rate during these years.  You end up paying $135,000 in taxes.

This is the financial advice given using their own [dubious] assumptions; you are better off paying $135,000 in taxes than $75,000.

Truth, you generally have more tax deductions during your working life [kids, mortgages, etc.] than in retirement. Truth, most people would prefer to not take a substantial income decrease in retirement.  Truth, no one knows what the tax rates will be when they retire.

So, pay more taxes even under the most positive circumstances, take on tax rate risk, penalties to access your money before the government says you can, loss of ownership of your retirement money to your company [most companies won’t let you access your retirement money until you leave the company], etc.  This is prudent advice?

The Roth IRA/401K, makes much more sense from a tax perspective.  But, it still has some of the same restrictions and penalties that make it so problematic for folks.

Some high income professionals who are self employed or work in small group practices can start solo Roth 401Ks.  These are a much better vehicle, but still has access issues as well as leaving the question of what investments do you put into them.

Decreasing Risk should be the GOAL during Retirement.

During your working years one can afford some financial risk.  In fact, it is unlikely for you to save enough money for retirement if you don’t.  But during retirement you shouldn’t.  

Here are the risks I regularly see financial planners suggest their clients take on during retirement:

Tax Rate Risk

Market Risk [large ups and downs]

Sequence of Return Risk

Rate of Return Risk [Failure to accumulate enough to retire]

Buying overvalued stocks [investing systematically]

Here are the risks that financial bloggers seem to be most concerned about.

Company failures [So they diversify into 100s if not 1000s of stocks]

Expenses 

Market Timing [they are convinced no one can time a market]

Overview

Common advised strategies of using 401K/IRA wrappers with mutual funds inside results in paying more taxes and adding in tax rate risk [the chance that tax rates go up].  Roth 401K/IRAs are better but still put severe controls on when you can access your money.  One should think hard about entering into this scheme that cedes control of ones money over to corporations and government.

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