Many of us bought into the idea that when we retired our “tax bracket” would be lower. Unfortunately, this is more and more unlikely. As you are reading this, the politicians in Washington are running the Federal Deficit ever higher, currently approaching $30 TRILLION dollars. Even though interest rates are low right now, the only way to pay for the deficit in the future is to RAISE taxes (especially after interest rates are allowed to normalize). So what does this mean for your retirement and what, if anything, can you do about it?
Imagine a set of triplets who we’ll call, Moe, Larry and Curly. At college graduation they made a pact, they agreed that by age 65, they would each accumulate $1 million for retirement. Moe during his working years, diligently stashed money in his company’s Traditional 401K plan, Larry went a different way and put money in a “non-qualified” diversified portfolio of mutual funds, stocks and ETFs, and Curly stashed his money in something we’ll call his “Maximum Tax-Free Retirement” account. They are now 65 and retired and have each sitting on $1 million. They decide that they will pull 6% or $60,000 from their accounts each year to live on. Let’s see what happens next. Moe, since his 401K used pre-tax” dollars withdraws his $60,000, but he must pay both State and Federal taxes, which we'll assume have a combined rate of just 40% (in the early 1980s this rate was over 80%!). Larry, is using an account that he can withdraw from at more favorable “long Term Capital Gains“ rates which we’ll assume is 25% between State and Federal. Curly invested after tax dollars in his “Maximum Tax-Free Retirement Income” strategy, which like Moe’s 401K grew tax deferred. But at withdrawal, he can withdraw his $60,000 TAX FREE. So let’s see how they did.
Moe Larry Curly
Withdrawal $60,000 $60,000 $60,000
Tax Consequence -$24,000 -$15,000 -$0.000
Net Income $36,000 $45,000 $60,000
I think that we would agree that Curly's "Maximum Tax-Free Retirement" strategy produces the most after tax dollars because he is the only one of the brothers with tax free retirement income!
Does this mean that you should stop putting money in your 401K, IRA, 403B, SEP or SIMPLE Plan? No. But, no one should ever put all their eggs in one basket. However, if your company is only matching up to the first 5 or 6% of your salary deferral of your contribution, maybe it makes sense to defer just enough of your salary to get the "maximum" match and then put anything above that 5 or 6% match into something like Curly’s “Maximum Tax-Free Retirement Income” strategy, as a tax diversification strategy.
If you have questions about 401k plans, we recommend you visit ODIRA.
But what else does Curly’s account do and why do I call it the “Maximum Tax-Free Retirement Income” strategy? It:
Why do I call this the “Maximum Tax-Free Retirement Income Strategy” instead of something else? Because to me it doesn’t matter what it is called, just look at the three brothers. At retirement time, who do you want to be, Moe, Larry or Curly? Me, I want to have what Curly has: Safety of Principal, Potential for Double Digit Gains, Locked In Yearly Tax Deferred Growth, Tax Free Withdrawals,. Additionally this account has no mandated Required Minimum Distributions (RMDs) to deal with in retirement and no 10% early withdrawal penalties if you need to pull out some of your account prior to age 59 ½. If you want even more information, click here to request a free copy of one of our information packed books.
Like with any retirement strategy, the earlier you start the better. If you are in your 20s, I believe you should try to put in at least $100/month. But here's the best thing, unlike with an IRA or 401K, there is no maximum contribution! $6,000-$12,000 in a year is a typical amount to contribute, however, there are people who put in a million dollars a year or more. If you are highly compensated or have a 401K or other retirement plan at work, you are still able to contribute to the "Maximum Tax-Free Retirement Income" strategy, unlike with a Roth IRA or Traditional IRA.