Commentary by Joseph Clark
In the present moment, an individual’s decision to elect deferring taxes via a 401k or traditional IRA plan seems appropriate. Tax-deferred savings reduce taxable income in the current year. However, predicting and understanding the impact of that tax deferral during retirement becomes more complex.
Deposits into tax-deferred accounts occur during an individual’s working years. Typically, savers are married and filing a joint tax return. In contrast, the largest required minimum distributions occur when individuals are older, and often widowed. Consequently, money can be deferred at lower marginal tax rates and withdrawn at higher rates.
Pundits disagree, arguing that both spouses previously had higher incomes, may still be working and tax deferral makes sense. Such perspective may have been true in an era when the largest source of an investor’s retirement income was a pension and the benefit was reduced or remained the same upon the death of a spouse. However, that is not the case today with a defined contribution plan or IRA. As we age, the required minimum distribution increases.
For more than 25 years I have witnessed families save diligently, planning to use their tax-deferred resources to fund an enjoyable life after work. The account often becomes a safety net rather than an opportunity for enhanced retirement. Fear and frustration set in whenever the account value drops, regardless of the reason.
The drive to protect the account balance keeps most individuals from touching their tax-deferred plans until they reach the required minimum distribution age. At age 70.5, people begin taking small distributions that increase annually as the percentage of the account withdrawn grows.
Sadly, one spouse will pass away and the surviving spouse generally inherits the entire account. The amount of the withdrawal required on a percentage basis will continue to change each year just as it would have if the spouse were still alive. But the tax bracket may change dramatically. In the present moment, tax deferral will usually feel better. However, when considering the journey of life, the decision to defer or not demands thoughtful discussion. Taxes do matter!
Joseph Clark is a certified financial planner and managing partner of The Financial Enhancement Group, LLC an SEC registered investment advisor. Securities offered through World Equity Group, Inc., member FINRA/SIPC. Tax advice provided CPAs affiliated with Financial Enhancement Group, LLC. Mr. Clark can be reached at email@example.com, or (765) 640-1524.