Here’s a little tax humor for you:
“What did the Taxman say to the Qualified Plan?”
“Give me, give me, give me.”
I offer you this possible chuckle with a bit of seriousness too. It’s clear that many people contribute (or have an employer contribute on their behalf), to a qualified plan, such as a 401k, ESOP, defined contribution plan, or other pre-tax savings program. However, it’s also true that in order for these contributions to actually be taxed at a lower rate than your current rate, you’d have to have less income, for one, and the tax rate could not have increased, for another. But will both of these future conditions really be met?
Well, on the surface of it, it seems logical that they would. If I’m not working in retirement, I’ll have less cash flow and, therefore, reporting less income. However, if I’m already in the top Federal tax bracket of 39.6%, and if I’m successful enough to be able to maintain that bracket in retirement by deferring enough income that what I’ll take out of my qualified plans keeps me in the top tax bracket, how will the deferral actually save me taxes? In addition, can’t Congress, through the stroke of the proverbial pen, change the tax brackets for the worst? Maybe they’d do this to fund another war, or to help pay the near $20 trillion dollar US deficit? If that happened, so much for tax deferral as a tax savings plan.
One more certain way to save taxes on your qualified money would be to reduce your lifestyle such that the money you were pulling out of the plans actually meant you were in a lower tax bracket than during your working years. But if the majority of your savings were tax deferred, how could you then maintain your lifestyle? Lifestyle depends on access to money, and, in the case of tax deferred dollars, the more you pull out, the higher your reported income. So here’s the question: are you willing to forgo lifestyle just to save taxes?
The obvious answer to this is: no. Lifestyle is more important than taxes. But if that’s the case, how else could you save taxes by deferring them?
At Dumont Financial, a strategy we often consider for people is creating another pool of money that is tax advantaged if used correctly. If you had, for instance, both tax deferred money in a Traditional IRA and tax advantaged money in another vehicle, perhaps you would be able to access some of each, possibly keeping your taxable income (the distributions from your Traditional IRA) below the threshold of the highest tax bracket, wherever that threshold is during your future retirement. It is a flexible strategy that allows you to adjust the amounts you use in each tax bucket rather than adjusting your lifestyle just to reduce your tax burden. It’s a strategy that may keep the Taxman from ever saying to you, “Give me, give me, give me.”
These are the opinions of Brian S. Dumont and not necessarily those of Cambridge. They are for informational purposes only, and should not be construed or acted upon as individualized investment advice.
Recently, I was in Las Vegas for a convention and I happened to walk through some of the casinos. It appeared to me that some of the people playing the slot machines, poker tables, and other games of chance either looked rather depressed (perhaps they were losing?) or excited (perhaps they were winning?). But what also struck me about either situation was that all of them had at least one thing in common as related to playing the game; namely, they had to decide – at some point – to either be in the game or get out of it. If they had been losing, getting out likely meant locking in the losses. And, conversely, if they had been winning, getting out meant erasing the possibility of winning even more. Either way, a tough call.
When I was a boy, one of the rules I was taught to live by was to never hurry to a whooping. That meant that when the school bully threatened me with beating me up as I got off the bus, that perhaps, rather than try to fight him, the best thing to do was just not get off the bus! Go a little further to another stop and get off there instead. The extra walk would be worth missing the whooping!
Sometimes people wonder what the difference is between what advisors at Dumont Financial do and, say, their accountant, or even their uncle who doesn’t work in finance at all (but is a really smart guy). I explain the difference with a question:
Yes, indeed, another year has passed and perhaps, like so many of us, you realize that you still have financial goals that you’ve yet to attain. If this describes you, I’d like to offer a couple of thoughts to help. The first is to “start where you are.” One of the great things about finance is that there’s always more we can learn, set our sites on, and achieve. But this doesn’t have to be an overwhelming thought when we realize that at any given moment we can begin again. If you’re ready to “start where you are”, begin by taking a sheet of paper (or a spreadsheet) and drawing four columns.