Taxes: Certain, but postponable…
A friend of mine and fairly well known retirement plan advisor, Bert Nester put forward the following thought in a recent conversation:
Under our system, we only need to pay taxes on that portion of our income which is necessary to fund our personal living expenses.
This is a great way to look at your retirement savings. As one of life’s two certainties, taxes become even more certain with rising budget deficits. Even so, 401ks and other pre-tax savings plans allow us to delay those taxes – often for many years – and that delay has a tremendous value to us as investors.
Economists point out our pre-tax savings are like interest free-loans, so the longer the “loan” (funds held in the retirement plan account) remains outstanding, the better:
Under these plans, funds are tax-deductible when deposited into the program; Our accounts grow tax-free within the plan; and Our money is taxed only when and as we draw down the account.
Moreover, we are generally deferring taxes from the higher tax brackets during our most productive years to the lower tax brackets during our slow-down years. That’s a great trade-off! (All current political discussions aside --we may have expectations of higher taxes in the near future, but this is somewhat offset by the length of time these funds can potentially grow tax free)
How the concept applies to our earned income - Reduce unnecessary losses due to income taxes.
Fundamentally, under our tax system we only need to pay taxes on that portion of our income which is necessary to fund our personal living expenses. We can shelter our remaining income by taking advantage of a variety of pre-tax savings programs. This means all excess income should be analyzed and, if possible, put into an allowable pre-tax savings program. Otherwise, we may be paying unnecessary income taxes on
our excess income.
Remember - - Donations can be made to Uncle Sam in the form of tax payments or you can legally and ethically reduce the amount of taxes you pay with deposits going into a well-crafted pre-tax savings plan.
Know your catch-up options
The financial press seems to enjoy telling us about the past 10 years being a “lost decade” for investments. Despite those gloomy views, be encouraged: There are government-subsidized programs to help you get back on track!
Since the IRS offers so many different types of savings plans, take care in selecting the program which best suits your needs. Try to avoid features which you won’t use or don’t need -- as they will wind up costing you money. Here are a few of the available tools:
· SIMPLE-IRAs: We could easily save $12,000 to $15,000 per year with a SIMPLE-IRA program. Depending on where we are in our career, that may be sufficient.
· 401(k)s: Depending on our needs, this type of program can be configured for us to save anywhere from $20,000 to $50,000 or more per year. With such a very wide range of deposits, there is a risk of the program not being crafted for the owner’s specific situation. The key is to know your objective so the program can be engineered to produce exactly that result with the least possible cost. Otherwise, your tax savings could be lost to unnecessary expenses.
· Pension Plans: These are no longer just for old-line industrial companies. When crafted for the business owner, today’s pension plans are as different as a Ferrari is to a Model T Ford.
Example: A 50-year-old business owner living below her means could deposit $125,000 per year for 10 years into a Pension Plan and have an accumulation of $1,905,000 --thanks to tax savings in excess of $550,000.
Of course, there are rules to follow, but with the right advisors you can maximize your own retirement savings and minimize/defer payment of taxes, allowing you to keep and invest those funds longer.
John Davidson, CPA, CFP
[email protected]
Under our system, we only need to pay taxes on that portion of our income which is necessary to fund our personal living expenses.
This is a great way to look at your retirement savings. As one of life’s two certainties, taxes become even more certain with rising budget deficits. Even so, 401ks and other pre-tax savings plans allow us to delay those taxes – often for many years – and that delay has a tremendous value to us as investors.
Economists point out our pre-tax savings are like interest free-loans, so the longer the “loan” (funds held in the retirement plan account) remains outstanding, the better:
Under these plans, funds are tax-deductible when deposited into the program; Our accounts grow tax-free within the plan; and Our money is taxed only when and as we draw down the account.
Moreover, we are generally deferring taxes from the higher tax brackets during our most productive years to the lower tax brackets during our slow-down years. That’s a great trade-off! (All current political discussions aside --we may have expectations of higher taxes in the near future, but this is somewhat offset by the length of time these funds can potentially grow tax free)
How the concept applies to our earned income - Reduce unnecessary losses due to income taxes.
Fundamentally, under our tax system we only need to pay taxes on that portion of our income which is necessary to fund our personal living expenses. We can shelter our remaining income by taking advantage of a variety of pre-tax savings programs. This means all excess income should be analyzed and, if possible, put into an allowable pre-tax savings program. Otherwise, we may be paying unnecessary income taxes on
our excess income.
Remember - - Donations can be made to Uncle Sam in the form of tax payments or you can legally and ethically reduce the amount of taxes you pay with deposits going into a well-crafted pre-tax savings plan.
Know your catch-up options
The financial press seems to enjoy telling us about the past 10 years being a “lost decade” for investments. Despite those gloomy views, be encouraged: There are government-subsidized programs to help you get back on track!
Since the IRS offers so many different types of savings plans, take care in selecting the program which best suits your needs. Try to avoid features which you won’t use or don’t need -- as they will wind up costing you money. Here are a few of the available tools:
· SIMPLE-IRAs: We could easily save $12,000 to $15,000 per year with a SIMPLE-IRA program. Depending on where we are in our career, that may be sufficient.
· 401(k)s: Depending on our needs, this type of program can be configured for us to save anywhere from $20,000 to $50,000 or more per year. With such a very wide range of deposits, there is a risk of the program not being crafted for the owner’s specific situation. The key is to know your objective so the program can be engineered to produce exactly that result with the least possible cost. Otherwise, your tax savings could be lost to unnecessary expenses.
· Pension Plans: These are no longer just for old-line industrial companies. When crafted for the business owner, today’s pension plans are as different as a Ferrari is to a Model T Ford.
Example: A 50-year-old business owner living below her means could deposit $125,000 per year for 10 years into a Pension Plan and have an accumulation of $1,905,000 --thanks to tax savings in excess of $550,000.
Of course, there are rules to follow, but with the right advisors you can maximize your own retirement savings and minimize/defer payment of taxes, allowing you to keep and invest those funds longer.
John Davidson, CPA, CFP
[email protected]