The national debt is now inching towards $16 trillion. In fact, it has continued to increase an average of $3.96 billion per day (that’s right, per day!) since Sept. 28, 2007! Concerned? Visit http://www.usdebtclock.org/ to track our nation’s debt.
What really has me worried is how this debt will impact retirement income for millions of Americans. Consider that qualified plans (401Ks, IRAs and 403Bs) defer the tax and defer the tax calculation—to an unknown rate. And where do you think taxes will be in the next 5, 10 or 20 years, when waves of baby boomers go into retirement?
By contributing pre-tax dollars to your 401K, you are exposing your retirement nest egg to the future risk of increased taxes. Essentially, you are at the mercy of the government.
My $10,000 Check Story
That would be the same as asking me for a $10,000 loan and I hand you a $10,000 check. The first thing you should ask me is, “When do I have
to pay you back?” and “what interest rate are you going to charge me?” If my
reply was, “I don’t need the money now. But I’ll let you know when I do. And,
I’ll let you know at that point what interest I’m charging you.” You would be
crazy to cash that check, wouldn’t you?
Yet that’s exactly what we’re doing with each contribution we make to our retirement plans. Let’s say at point of retirement, you have $550,000 in your 401K and you’re in a 28 percent tax bracket. For the sake of simplicity, let’s assume taxes stay the same until you reach retirement. In a 28 percent tax bracket, of that $550,000, $154,000 would belong to Uncle Sam, leaving you with the remainder, $396,000. But if taxes go up then the portion that goes to the government is going to be higher.
I’m not saying contributing to your 401K is a bad thing. Sometimes it’s a good financial move. It really depends on what your overall tax plan is, and what your exit strategy is in retirement when you will be required to take distributions at 70 ½ years of age (RMDs).
I’m constantly surprised at how many people don’t realize that their pension income, 401K, IRA and 403b distributions will be taxed in retirement so they have no idea what percentage of their retirement assets they will actually get to keep. No one has a crystal ball when it comes to future tax rates. Yet most people have placed their retirement savings in tax-deferred accounts, what Ed Slott, CPA and author of Retirement Savings Time-Bomb, calls future tax-bombs. For some, up to 80 percent of their retirement income (if not 100 percent) will come from tax-deferred accounts.
Next to mortgage interest and taxes, how people fund their qualified plans are the biggest areas of adverse wealth transfers that seriously impact the ability to create enough wealth to provide an income that will last throughout retirement.
The two questions you need to ask yourself before making a contribution to your qualified plan and retirement accounts are, “What tax bracket will I be in when I retire?” and “What deductions will I have when I retire?” Okay, there are other answers you need to know about your retirement income, too, but the answers to those two questions would be a good place to start.