Tax “deferred” retirement savings plans (IRA, 401k…) feel smooth now, but they have a nasty bite in the end. All of my tax clients who saved for retirement using tax deferred plans are now paying taxes up the wazooooo! They’re paying taxes on the income they “deferred” PLUS any interest or dividends that money gained.
For example:
- A man saved $500 each month in a traditional tax deferred 401k plan for 40 years; that’s $240,000
- If his marginal tax rate was 25% for all 40 years he would have paid $60,000 in taxes over the years.
- BUT his tax deferred $240,000 savings earned $100,000 in interest and dividends over the years, giving him a total $340,000.
Now, in retirement years when he is eligible to cash out his savings (and let’s just say his marginal tax rate is still 25%), he’ll now pay more in taxes: $340,000 x 25% = $85,000. Yes… Deferring his tax payments just cost him $15,000.
Out of all my tax clients age 60 and over, only one of them chose not to go with a traditional 401k, and instead went with a ROTH 401k ; he paid his taxes when originally earned and saved his money. Now in his retirement years he receives untaxed dividend payments each year.
My recommendation:
- Do your homework about savings plans.
- Ask your retirement adviser some hard questions about the future as well as the present.
- And, as always, beware of big banks and anything that sounds like they’re doing you a favor.