**SPONSORED CONTENT BY FINANCIAL PLANNING CENTER**
Whether you are a business owner, executive, or employee, you are probably saving on a tax-deferred basis with an IRA or a qualified retirement plan such as a 401(k) plan to accumulate money for your retirement.
At first glance, these tax-deferred plans may seem like a good idea. After all, you receive an income tax break on your contributions. Your retirement accounts grow tax-deferred, and you typically don’t pay taxes on these accounts until you withdraw the money, usually during retirement.
These features help explain the popularity of these plans.
Upon closer inspection, the tax breaks are not as alluring as you may have imagined.
Let’s use a traditional IRA as an example. And we’ll make a few assumptions:
1) You have 30 years until you plan to retire. Under current tax law, you can contribute a maximum of $5,500 into your IRA (if you are under 50). If you did this (disregarding future contribution increases), your contributions over the next 30 years would add up to $165,000.
2) You are in a 28 percent tax bracket.
Let’s also project the same tax rate in retirement. Many retirees (and planners) assume you will be in a lower tax bracket in retirement. But the reality is that nobody knows what the prevailing tax rates will be when you actually retire.
How much of a tax deduction do you get each year? Twenty eight percent of $5,500 is $1,540, so you will save $1,540 in taxes in the form of a tax break, each year, for the next 30 years. Over the entire 30-year period, you will save over $46,000 in income taxes through this IRA tax deduction.
What happens now? Your contributions will grow, tax-deferred, until you take the money out. That’s where things can get interesting, because as a general rule, every dollar that comes out of your IRA or 401k is taxed as “ordinary income.”
Flash forward 30 years into the future. Your retirement accounts did exceptionally well in our example, averaging just over 10.5% per year and your balance is $1 million. Congratulations! At this time, most people should see their advisor to determine the best way to make that million-dollar retirement account last. Let’s assume you decide to withdraw 10% from your IRA each year in retirement (NOT recommended; we are merely illustrating a concept!). You would start off with $100,000, all of which is subject to tax. Your $100,000 distribution nets you $72,000: 28% of $100,000 amounts to $28,000.
Let’s review: Over your working years, you saved $46,200 in taxes. In Year One of retirement, you paid back more than 60% of your tax savings! If you are still reading, this should shock you!
How long do you expect your retirement to last? 20 years? 25? Longer? We don’t know. What we do know is if you were to liquidate that million-dollar account today, your federal income tax bill alone would exceed $395,000. If you “stretch” the IRA to benefit future generations, all of their distributions will also be taxed as ordinary income.
Participating in qualified retirement plans can help provide retirement income in a meaningful way. And taxes should never be the sole determinant when choosing an investment strategy. However, most people are not familiar with the powerful tools and strategies to help minimize the tax burden current qualified plans can impose
Nick Meriwether, Chief Financial Advisor at the Financial Planning Center, LLP is offering a complimentary “Second Opinion” on your retirement progress.
Nick Meriwether can be reached at (931) 358-3961. You can also learn more by visiting http://www.clarksvillefpc.com/.