Tax reporting is a statutorily compelled obligation. Saving for retirement occurs every week as we withhold money from our paychecks today to place money in our retirement accounts for a better tomorrow. The first is compulsory, and the second is a decision. Sound tax planning is an intentional choice to marry those two actions.
The three primary factors are how much to save, how to invest that savings, and the distribution strategy you should deploy. Yes, it is a strategy, meaning there should be a purpose behind each of those decisions.
The earlier you begin saving, the lower the percentage of deferred income is needed in order to maintain your standard of living upon retirement. Start early. Albert Einstein allegedly claimed on his death bed that he did not know the seven wonders of the world, but the eighth wonder was indeed compound interest.
Keep in mind a successful retirement has nothing to do with replacing your income. Your life after work is about maintaining your standard of living. Saving thus serves two masters: the first, money that you keep you are not accustomed to spending, making it easier to replace your standard of living. The second, the more you save today, the more you will have to replace your standard of living tomorrow.
When defined contribution plans and Individual Retirement Accounts (IRA’s) were created, the only option was to defer taxable income until a later date. The argument was that you would retire in a lower tax bracket than when you worked. Countless families that we represent will gladly explain the pitfalls of that belief.
Many plans now offer the choice inside of your defined contribution plan to utilize the Roth option. If your plan does not have that option, you may still qualify to contribute to a Roth IRA. The Roth option requires that you pay taxes on the income today, but you never have to recognize it again. That includes the growth of those assets.
Arguably, these plans should have never been referred to as defined contribution plans. Always begin with the end in mind. You defer income today so you have a better future tomorrow. They should be referred to as defined distribution plans. And you get to be the one determining the distribution.
If you believe your tax rate will be lower in the future, you should defer taxation today. More than half of my retirement savings have already been taxed.
When you begin distributions depends upon your wishes and objectives and on the amount you have accumulated. A common strategy is to have fixed expenses covered by an automatic payment – Social Security or a pension – with the social (fun or discretionary) expenditures coming from the savings. Based on 32 years of observation of other families, when the social funds are depleted, the desire to use them is also reduced. Your retirement is unique, but that does not mean it should be arbitrary. Plan it and execute it.
Joseph A. Clark is a Certified Financial Planner and Managing Partner of The Financial Enhancement Group, and an SEC Registered Investment Advisor. Contact Joe at yourlifeafterwork.com or 800-928-4001. Securities offered through World Equity Group, Inc. Member FINRA/SIPC. Advisory services can be provided by the Financial Enhancement Group (FEG) or World Equity Group. FEG and World Equity Group are separately owned and operated. World Equity Group, Inc. does not provide tax advice. For tax advice consult with a qualified tax professional.