As you might recall from our recent email about Deferring Taxes by way of 401k or other retirement plan contribution creates a bill that the IRS is eventually going to collect on. Even if it comes from your beneficiaries. If you do NOT attempt to grow your pre-tax bucket through investing, the reasons for paying your tax bill now (Roth Conversions or Roth contributions) would boil down to whether or not you believed that your tax rate would be the same or lower in retirement. However, almost all of us attempt to grow our pre-retirement accounts which directly benefits the IRS. Let us show you some numbers.
 

In the hypothetical situation above, you can clearly see the impact of growing the pre-tax bucket and how it directly benefits the IRS. It also benefits the state you live in when you take the withdrawals if you pay a state income tax. The impact to the 7% annual return given a 22% tax rate on withdrawals is an actual return rate of less than 5.5% after taxes.

You work hard to save for the future and manage your investments (as do we!) and it might be a little eye-opening to see how much the IRS benefits from that work. We spend a lot of time building portfolios with the right balances and investments, rebalancing them every quarter* and being patient during market turmoil – and the IRS is waiting to collect their portion of that work. The only solution you have is to focus on filling up the other tax buckets and not being afraid to PAY THE IRS NOW versus later. It takes some work and emotional awareness, but that’s what we are here for!

Next up: Required Minimum Distributions (RMD’s) – how they impact you AND your heirs

Disclosures

This information is not intended to be a substitute for specific individualized tax advice. We suggest that you discuss your specific tax issues with a qualified tax advisor.

*Rebalancing a portfolio may cause investors to incur tax liabilities and/or transaction costs and does not assure a profit or protect against a loss.

This is a hypothetical example and is not representative of any specific situation. Your results will vary. The hypothetical rates of return used do not reflect the deduction of fees and charges inherent to investing.

Contributions to a traditional IRA may be tax deductible in the contribution year, with current income tax due at withdrawal.  Withdrawals prior to age 59 ½ may result in a 10% IRS penalty tax in addition to current income tax.

A Roth IRA offers tax deferral on any earnings in the account. Qualified withdrawals of earnings from the account are tax-free. Withdrawals of earnings prior to age 59 ½ or prior to the account being opened for 5 years, whichever is later, may result in a 10% IRS penalty tax. Limitations and restrictions may apply.