The Tax Deferral Myth
January 28, 2020
When did saving money ‘pre-tax’ become a good idea? Think back; Do you remember the first time you got a job that had a 401(k) type retirement plan? I say type because the 401(k) is not the only option, there are other plans such as 403(b), TSA, SIMPLE IRA, SEP IRA, Deferred Comp and others.
Retirement Planning Advice
So do you recall the conversation that you had with perhaps a parent or someone at work after getting your first teaching position? Did it go something like this; “Now that you are making real money, pay yourself first. You have this great benefit that allows you to save money without paying taxes for years! Use it as much as you can!”
That was likely good advice at that time. If you were 20-30 years old you probably found yourself in a high tax bracket. No kids, no house/mortgage, no property taxes, probably not married or filing jointly. In other words, you had a good reason to be deferring the tax burden on your money to the future. Besides, you had probably heard what everyone else was hearing at that time about taxes: “They will be lower when you retire so defer paying them now.”
Has Your Current Retirement Plan Evolved with You?
The challenge for you became the growth of the younger you to the more mature you. Perhaps you married, had kids, purchased a house, a business, or any combination of these. In other words, pretty soon you had what is known as tax deductions. So within a few years of you starting your first tax-deferred retirement plan, you were no longer in a position where it made sense to defer the taxes on your income.
Why would you not want to defer taxes while you are working? At the time in which you gained tax deductions, you were getting your taxes on-sale or at-a-discount and who doesn’t like getting something on sale?
Taxes Will Likely be Higher When You Retire
If you follow trends, you have already come to the realization that taxes are probably not going to be lower when you retire. The facts are pointing to them likely being quite a bit higher. There are ample amounts of information to be found about the future of income tax-increases. But of course no one knows your situation better than you. The problem, though, is that when you begin to pile-up the tax deductions, life gets busy, as so many people put it. Before we know it we no longer find ourselves with the time or energy to worry about whether or not we should be deferring taxes on our income…it is just a miracle that we have any extra income to save in the first place!
It’s Not Too Late to Make a Change
I read an article recently on CNBC-online by Kathleen Elkins where she took a quote from the Wall Street Journal that reminded us: “[Many early backers of the 401(k)] say it wasn’t designed to be a primary retirement tool and acknowledge they used forecasts that were too optimistic to sell the plan in its early days,” The Wall Street Journal reports. “Others say the proliferation of 401(k) plans has exposed workers to big drops in the stock market and high fees from Wall Street money managers.”
It seems that American’s have become dependent on a system that is a poor substitute for a plan that MUST DELIVER when it is time to retire. I recently asked a group of employees at a large factory in Southeast Ohio why they put so much emphasis into their 401(k) plan. The answer was surprising; they are comfortable with it because pretty much all 2,200 employees were using it for their retirement.
Are You Comfortable with Uncle Sam as your Partner?
Let’s put some logic to that idea. A retirement plan in which a) the employee takes all of the risk b) the employee must figure out how much of their paycheck should be redirected from each paycheck to get the right amount of income at a future unknown date, and lastly c) the employees’ partner in all of this, Uncle Sam, will let them know on the date of retirement how much money they will be taking in the form of taxes from each withdrawal during retirement. I don’t know if that is a one-size-fits-all plan or if something with that many potential pitfalls should be a part of a more complete approach. But what other options are there? That is a discussion for another day. Contact us to learn more.
By Jeff Mohlman