The tax act passed last year set in motion a fantastic opportunity for American savers to greatly reduce the income taxes that are owed in the future. The amount of income taxes you’ll pay on your savings would amaze you.
The income tax rates have officially reached 50-year lows, making it unexpectantly cheap to escape a world of hurt later in your life. There are four traps that have been set for you by your involvement in tax-deferred retirement accounts. I am not suggesting that you should not have saved money into your 401k or IRA; but I know that most people who have actually saved, have put too many of their eggs in that basket.
Here are four traps that have been set that can be escaped from – if you’ll only take action.
The Tax Trap
Most savers bought-in early to the notion of saving in IRA’s and 401k accounts; all of which offer tax savings at the time of the contribution. These accounts are in the trillions of dollars and the primary retirement asset for most. At the same time, many have had the goal of having no mortgage at retirement, thus eliminating a major tax deduction – maybe even the only tax deduction outside of gifts to charity. It feels good to save taxes, but it is often the opposite of what many should do in their overall financial plan.
Our exploding national debt, rising Medicare costs, and an underfunded Social Security system all beckon for more revenue – that would be ‘tax’ to us commoners. So the trap is set because all of your income from IRA’s and 401k’s will be taxable at a time when you have fewer tax deductions to offset them and potentially higher tax rates in the future.
The Lock-and-Key Trap
The principle here is simple: the money in your retirement accounts isn’t truly yours until you’ve satisfied the government’s requirements for eligibility to use it. Generally, that means you must be 59 1⁄2 years old AND pay taxes to get access to it. So whatever the balance is in your IRA or 401k, I think you’d be well-served to get your head around the fact that all of that money is not yours. You owe plenty of taxes on it – at some point.
Why would you keep adding massive amounts of savings into accounts that restrict your ability to access them when you want them? I have several younger clients that could retire but sticker shock of taxes due to access funds early has destined them to more years on the j-o-b.
The RMD Trap
Bottom line is this: the IRS is going to get their share of your money whether you need to live off of them or not. That’s the deal you made when you put it in the IRA or 401k-type of account. There is a day of reckoning. That day is April 1 after the year in which you turn 70 1⁄2 years old and every year afterward for the rest of your life – and beyond (for your heirs). Your RMD (Required Minimum Distribution) is calculated every year based on the value of the account on Dec 31 of the prior year.
“But I don’t need that much extra income this year” – too bad. You must take it. If you do not, you will pay an additional 50% excise tax.
The Death Trap
The IRA is oftentimes the largest financial asset that retirees own. Many people hardly ever dip into their IRA, using fixed income sources and pensions first. When you do die, Uncle Sam is waiting at the door, ready to begin collecting taxes (under most circumstances) except for when it is your spouse that dies.
Plan Your Escape
If you’re concerned about what’s going on and want to reevaluate your ‘game plan’, the best move is to get an honest evaluation of where you stand in these areas. If you’re already too heavily invested in retirement plan accounts, we can’t fix the problem, but there are strategies that minimize the pain. If you’re younger and still socking away the savings, there are plenty of tools to help you not get ensnared in these traps.