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Uncle Sam Is Eyeing Your 401K

Exactly how will the $15 trillion national debt impact your retirement income?

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.

This post is contributed by a community member. The views expressed in this blog are those of the author and do not necessarily reflect those of Patch Media Corporation. Everyone is welcome to submit a post to Patch. If you'd like to post a blog, go here to get started.

Charles Fagan May 18, 2012 at 01:27 PM
I am having morning coffee reading this post. Scary to think that my 401K money could be taxed at even a higher rate when I retire because the bureaucrats in Washington continue to spend money and will not stop the increasing debt. Someone is going to have to pay for it and I do not want my money to go toward their lunancy. Investing pre-tax dollars is helping but always looking for other methods. Thanks for the eye-opening post. Charles F.
L. Brooks May 18, 2012 at 06:10 PM
Yikes! I have been taught to defer as much as I can until retirement because I would have a smaller tax rate than I do now. Patti’s article makes sense and fits what is more likely to happen; that taxes will be going up. Heck, look at what’s happening now, all our local, state and federal governments want more “revenue” i.e. more tax money from us. Certainly gives me something to think about.
AR May 18, 2012 at 06:18 PM
yet as our debt has skyrocketed, taxes have remained flat and in some cases decreased, given the bias of every recent administration of either party, i don't see any massive tax grabs in the future. the debt-to-gdp ratio of the US is smaller relative to many other industrialized nations. were this japan or the UK, then i would say start freaking out about the debt. the US is still able to issue bonds with yields under 3%. if there was a true debt crisis, the yields would be 30%. a 401k is forced savings. the fact that these funds are difficult to extract makes the plan worthwhile. also, most companies do some kind of matching. even if your company matches only 25%, it likely far outpaces any realistic tax grab on your principal, and you will lose that.
AR May 18, 2012 at 06:21 PM
debt has skyrocketed since reagan, yet taxes have dropped. this has been sustained over decades, and indeed US debt has lower yields today than in the reagan years. basically, anyone who had put the advice of this blog post into practice over a long period of time would have been substantially wrong, and poorer
Charles Fagan May 19, 2012 at 03:16 AM
AR: 25% Really? Can you give a name of one company which will match 25% 401k contribution? I would like to apply to that company. Yes, the debt was high before, but the debt increased almost 50% over the last 3 years. At that rate, what is the amount our government has to borrow just to pay the interest on that rate. If that increase in debt continues, will we not become like some European countries? Is not the issue with the original post is that you can fund your 401K if that makes sense with your retirement plan, but you should look at what may occur and be cautious? Should we not look at where we are heading and try to stop ourselves before we become Japan, UK or Greece? The original post does not specify any specific action but just gives information on how to look at your overall retirement plan. I happen to agree that Uncle Sam will need to pay off the debt somehow, how would anyone propose they do it, in part, without raising taxes?
AR May 19, 2012 at 04:01 AM
so many tech companies exceed 25% that they are too numerous to mention - microsoft, cisco, etc etc. my former employer did 25% which is why i used that number. honestly i am surprised you would think this is rare. the time to worry about the "absolute" debt was 1982, when congress authorised paying for redeemed treasuries with created accounts. in 2012, the only issue is RELATIVE debt. and yes, the USA is RELATIVELY far better off than many of its industrialised peers, which is why we can continue to sell our debt at 3% yields. the debt does not need to be "paid off". the US government is not a person with a mortgage. the US government need only maintain a fiscal balance that allows it to continue borrowing cheaply, as we can now. indeed, "paying off the debt" would be hugely foolish - interest rates can't go much lower, and we could be using the funds to grow jobs. and the USA is not greece. we just aren't. greece does not issue the reserve currency of the industrialized world. we do. china is in no better of a position - they own so much of our debt that their fate is tied to ours. they need the USA to prosper too. with interest rates on all types of debt at historical lows, it makes no sense to try to reduce them further, which is a typical result of debt reduction. with 8% unemployment, getting people to work is more important than an abstract value.
AR May 19, 2012 at 04:10 AM
and by the way the 3% yield is on a THIRTY YEAR bond. on the benchmark ten tear note, the yield is 1.7%. why would anyone forgo growth to pursue debt reduction given those numbers??
Charles Fagan May 19, 2012 at 02:14 PM
http://money.cnn.com/galleries/2010/fortune/1001/gallery.bestcompanies_toppay.fortune/14.html - Cisco Company match Cisco just bumped their dollar for dollar match up from 4% to 4.5% This was taken from another Google search: Average 401K Match According to the Bureau of Labor Statistics, the typical or average 401K match, can vary widely. Their 2010 National Compensation Survey, found that of the 61% of employers who offer a 401K plan (a sad statistic in itself): • 49% of employers with 401K plans match 0% • 41% match a percentage of employee contributions between 0-6% of salary. • 10% match a percentage of employee contributions at 6% or more of salary. • The median is a 3% match. I agree with AR in that we may not need to pay off the debt entirely but just the debt service is increasing with the skyrocketing U.S. debt. We do need to pay for that or our children will need to pay. The original post does not suggest that everyone should forgo 'max-ing' out their 401K option; it just states that people may be surprised in seeing how much will be taken out by Uncle Sam by the taxes now and who knows in the future. All of us need to look at all options to help keep the money we work so hard to make.

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