Consider how many taxes you pay are completely voluntary. One could argue sales taxes are not voluntary since in order to purchase goods and services most include some form of sales tax. But what about income taxes…especially income taxes in retirement?
Here is the problem in a nutshell…
All our lives we are led to believe saving for retirement in a tax-deferred savings plan, such as an IRA or 401(k), is the best way to save for retirement. The message is powerful and it comes at us from everywhere! The government wants you to save in a 401(k) or IRA, the banks want your IRA money, the mutual fund and investment banking companies want your money in a 401(k) or an IRA, even your tax professional encourages you to save in some form of tax-deductible or tax-deferred retirement strategy.
Most of us are happy paying less in taxes each year as we save and the deductions feel great. But what happens when we reach retirement? If we have done everything we’ve been taught to do like pay off our house, raise our children past our ability to claim them as dependents, and saved a bunch of money in our tax-deferred or tax-deductible retirement plans, we have set ourselves up for a massive payback of all those tax savings within the first three to five years of retirement, depending upon your tax bracket.
It is clear this is a great plan for the government, but not so great for you. In fact, if you need $60,000 of spendable income in retirement and are in a 20% tax bracket, you need to withdraw $75,000 from your retirement savings. How long can you withdraw that amount of money, especially in a volatile investment portfolio, and still have assets remaining at the end of your retirement? Couple the larger required withdrawal with a bad sequence of returns from the market and trouble could be brewing.
Take a look at the illustration below. Notice in the first illustration, there is no difference in the bottom line. It doesn’t matter what sequence of returns you receive (they are in reverse order on the right). Your investment results over time will not change.
The Double Dilemma – Tax and Investment Trouble
Now take a look at what happens when you need to take income from a taxable IRA or 401(k) in a 25% tax bracket! If you need $25,000 to live on you must take $33,000 from your account. The column on the right shows why a bad sequence of returns along with a taxable IRA can send you BACK TO WORK only EIGHT YEARS AFTER YOU RETIRE!
Our opinion is to focus on the things you can control. We can’t control market performance, but we can plan for how we save for retirement so we don’t give back 30 years of tax savings in just 3 to 5 years.
Is there a solution? The best solution is first to educate yourself to understand how you save for retirement can impact your retirement future. We have many Vital Tax Solutions that can help you plan for this.
Contact us today to learn more!