RE: Is Financial Planning All One Big Lie? Part 2
Great insights, @nealmcspadden. Let me speak about the idea that taxes will be lower in retirement. If you rely on your retirement savings, such as a 401(k) or IRA, there's a large chance that your taxes will be more in retirement than they were when you were working. Here's why:
As you mentioned, those 401(k) and IRA contributions that you made in your working years are not tax exempt, they are tax deferred. When you withdraw your contributions, they are treated as ordinary income (just like wages). You have to pay Uncle Sam. In doing so, your social security income will likely be taxed more (up to 85%) because your taxable income will increase.
You might think you can still let your retirement funds could stay in your account forever, but that won't work either. Once you reach age 70 1/2 , the IRS requires that you start withdrawing from your retirement accounts. They have a table, somewhat based on your life expectancy, that tells you what percent you need to withdraw. It's called the RMD (short for Required Minimum Distribution). The RMD percent increases every year after age 70 1/2. You might think that you can just ignore withdrawing the money. If you do that, the IRS hits you with a whopping penalty, which is 50% of what the RMD. So say you have $500K in your retirement account and you turned 70 1/2. You have two choices (a) withdraw $20,000, which is approximately your RMD if you are married, and pay the tax on it, or (b) pay a $10,000 penalty instead and fork it over to the IRS with no benefit for you.
PS. The RMD is fully taxable.
- A real huge mistake that many people just starting out in retirement do is to cash out their retirement money immediately. That puts you in probably the highest tax bracket you've ever been in, and makes Uncle Sam's take much higher than it needed to be. You could easily be splitting your hard earned retirement savings 50/50 with Uncle Sam, as well as possibly your state tax authority.
Bottom line...tax planning is every bit as important, and possibly more so, than financial planning. You may or may not be OK without a financial planner. You DEFINITELY need a good tax person on your side to avoid these, and many other, pitfalls.
Ira - upvoted and resteemed.
100% agree on all points.
If you want to get super picky you can defer your 401k rmd if you are still working for that company. That’s pretty rare though
@nealmcspadden Actually that's exactly my situation. I work at H&R Block in the state tax QA testing group. Our group tests the digital tax product for each state. Like most people at Block, I work seasonally., as an employee. I work enough hours so that I qualify for their 401(k). What's nice is not only that I'm 100% vested immediately (because they do that if you're over 50), but I'm not subject to the RMD either (I'm over 70), as long as I'm continuing working here. I also qualify for the company match. Even if I decide to "retire" I only would have to withdraw gradually based on my RMD at that time, which is OK.
This gives me tremendous flexibility. I can continue to work (another perk of the 401(k) is that you can put all your salary into it if you want to), or I can just put a part of it in and build up my account - makes a nice supplementary travel fund because I have some say into how many months I work each year. As a bonus, my family can live on my current earnings and I don't have to withdraw from my "retirement" accounts. Also, if I can work as long as the job stays interesting, I won't have to deal with all the classical retirement questions, such as finding a boring job that doesn't pay anything.
The job is certainly interesting, testing all the state tax regulations, so I pick up some tax knowledge as I go along. This year it promises to be extremely "interesting" because of the new tax law.
Actually, I think retirement is something of a scam. It's basically for people who don't like their job. Did you ever notice that people who enjoy their work keep doing it after their "normal" retirement age? I know a number of tenured professors who just keep working, perhaps at a reduced schedule, because they love what they do. And think of all those Senators, Congresspeople, and both Presidential candidates, who in my opinion should retire but persist in working far beyond their useful life. If you enjoy your job, why not continue doing it, and draw a paycheck for doing it as a bonus, so to speak?
Of course, if everyone had my attitude, that would make current financial planning assumptions obsolete.