Most people have them, and while you are working, most people really like them. I am, of course, talking about your retirement plan. Specifically, this might be your 401k, 403b, 457, IRA, or other related type of plan.
You love how you get a tax deduction when you put the money in, you love how you pay no tax each year as your account grows (hopefully grows). And later in life when it comes time to pay those nasty taxes? Most people just assume that they will be in a lower tax bracket. Sounds pretty good; right?
Not so fast.
Here are three reasons that your retirement plan might be a big loser for you after you retire.
1. Your tax rate in retirement is often higher than you expect and likely to go up.
When you retire, odds are good that you will want to maintain the same standard of living that you had before retirement. I’ve never met anyone who wants to lower their standard of living now that they have more time on their hands; usually it’s just the opposite. That means you need about the same or more income, which puts you in about the same tax bracket or maybe a little higher.
But, it gets worse.
Where do you think tax rates are going in the future? One look at www.usdebtclock.org and you should come to the conclusion that there is little doubt that they will be going up. And your retirement plan is 100 percent exposed to both current tax and future taxes.
2. Your retirement plan is the only account you own that forces distributions.
We just discussed how your taxes are likely to be higher during your retirement than you expected, now we learn that once you hit age 70.5, you must begin taking money out of your retirement accounts, and pay tax, whether you want to or not. Retirement accounts are the only accounts out there that force distributions. Most of our clients don’t want to take out money from their retirement accounts, so every year this is a real pain for them to take money out of a perfectly good investment, pay taxes on it, and then perhaps just put it back into the same investment again.
3. One of the worst accounts you can leave your surviving spouse.
Do you know what happens to your surviving spouse from a tax perspective? They become a single taxpayer again. Have you looked at what that means on a tax return lately? It’s devastating. We’ve seen cases where a surviving spouse sees their tax liability increase five times or more. And retirement plans can just make it worse.
You don’t want to leave your spouse remembering you as the person who left them a huge tax bill. Your retirement plan has a big target painted on it from the IRS, and surviving spouses are often the ones who pay the biggest penalties.
When all is said and done, retirement plans are great tools to use while you are working, and the day you retire, they become one of the worst accounts you can own from a tax perspective. Do yourself a favor and talk to a retirement planning specialist who understands investments and taxes on what the best way is for you to manage this potential tax bomb.