Feeling The Sting Of The Tax-Deferred Retirement Account
When I first got into the financial planning business twenty-five years ago, I was taught—and believed—that a taxable account was the worst place for your money to be invested.
Why pay taxes when there are better options? After all, with a Traditional IRA and 401(k) account, you can defer the tax into the future. This was especially powerful twenty-five years ago, when everyone believed you would probably pay less tax in the future after you retired.
At that time, I also believed that the best place in the world your money could be held was in a tax-free account. But, of course, the yields sometimes aren’t attractive enough in tax-free accounts, so I developed a belief that a well-rounded retirement strategy should have some taxable, some tax-deferred, and some tax-free holdings.
No matter what, I was dedicated in my conviction that the worst of those three options was always a taxable account—which forces the saver to pay taxes NOW.
Today, I believe—rather, I’m certain—that the worst place in the world your money can be is in a tax-deferred investment.
I know that will come as a shock to many, considering that the most popular retirement savings vehicle in America is the company-sponsored 401(k) plan. But think about this: if tax rates climb significantly, most of us won’t be able to out-earn the negative tax effects without taking considerable, and unsuitable, risk. That means it’s quite possible that the balances of your IRA, 401(k), and other retirement accounts today are the highest they may ever be on a tax-adjusted basis.
You see, as taxes increase, your net asset value falls because you’re exposing these dollars (i.e., your future retirement income) to higher tax rates. That is why I believe it’s probably better to pay the tax now, today, when you know what you have to pay—especially since we are in the midst of historically low tax rates, and potentially even lower rates given the current administration’s tax reform plans.
I believe, as do many of you, that taxes will eventually rise. If that belief is correct, then paying taxes now equates to paying at a discount compared to what you will pay in the future. In truth, managing your retirement tax liability can result in significantly more retirement income and a much larger financial nest egg for your family when you’re gone—which means tax diversification through SMART retirement planning should be at the top of your retirement planning checklist.
Matt Zagula is a leading tax arbitrage expert, and author of SMART Retirement: Discover the Strategic Movement Around Retirement Taxation® with ForbesBooks. Learn more at smartretiree.com.