If you have money in a tax-deferred retirement account such as a 401(k), IRA or 403(b), you’re sitting on a tax time bomb. Here’s why…
Conventional wisdom says, “Maximize your contributions to tax-deferred plans. Your money compounds without being reduced by taxes and you’ll end up with more money during retirement.” But like much conventional wisdom about personal finance, it’s baloney.
The Society of Actuaries says if tax rates remain the same, “It doesn’t make any difference whether [the taxes] are taken away from you at the beginning (tax-exempt) or at the end (tax-deferred). It’s the same fraction of your money that is left to you.” But most people look at their savings and think it’s all theirs. You’ll owe Uncle Sam the taxes he let you defer all those years. On every penny you’ve put in and every penny of growth you will owe taxes.
“It’s a very big deal when people realize they only have two-thirds or three-quarters of what they thought they had.” according to Boston College’s Center for Retirement director, Alicia Munnell,
If the tax rates are actually lower during your retirement, you might come out ahead by deferring your taxes. But where do you think tax rates are headed long term? You must consider what tax rates might be during a retirement that could last 30+ years. People think taxes go up due to the aging demographics of our country and unsustainable national debt.
Today there are 62 million Americans using Social Security and Medicare. By 2045, however, more than twice as many (140 million) Baby Boomers and Gen X-ers will be over 65 and drawing from Social Security and Medicare. Where do you think the money for all of this will come from?
If tax rates go up, the more successful your nest egg, the higher the taxes will be. Many expect to retire in a lower tax bracket but many are actually in a higher tax bracket. That’s happening for two reasons:
#1: Required Minimum Distributions (RMDs)
Whether they want to or not, Retirees have to start taking those pesky RMD’s from tax-deferred accounts after reaching age 70½. The RMD’s may be pushing them into a higher tax bracket.
#2: The “Social Security Tax Torpedo”
Many are surprised to discover their income from various sources causes 50 to 85 cents of every dollar they receive from Social Security to be taxed.
RMDs can trigger a “tax torpedo” that taxes up to 85% of your Social Security benefits. Financial planners and accountants are seeing retirees’ tax rates double or more because of this!
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