Let’s talk about real life for a minute. Financial discussions can often devolve into philosophical numerical debates that really have no place in reality. Do you want a good theory of how to have more money in your old age, or do you want to have more money in your old age?
Let’s ask the question another way: Would you prefer to have a piece of paper that says you can potentially access money or would you prefer to actually have that money? Isn’t an asset’s value determined by what it can buy or do? Is there any value to an asset that you will never actually use to buy or do anything?
These are questions that don’t typically get asked when thinking about whether or not to put money into Qualified Plans (401k’s, IRA’s, etc.). If your reasoning for putting money into a 401k or IRA is to avoid paying taxes, at what age will you start to enjoy paying taxes? That will be the age that you start taking money out of these plans! For many people, that means not until the government makes you, which starts at age 70 ½. Again, you’ve given the government total control over how you access your money.
Let’s look at what happens in real life. There are two typical stories when it comes to what people do with the money in these plans. The first one is that the person hasn’t saved enough during their lifetime and quickly spends the money before being totally reliant on family and the government.
The other real common story is the person, we’ll call him Jeff, who saves his whole life utilizing both a 401k or IRA or both as well as other non-Qualified investments. Jeff used the IRA because he wanted to avoid paying taxes. When retirement age comes, he still doesn’t want to pay the taxes so his family lives off of everything but the money in these plans. At age 70 ½ the government (as the senior partner in your partnership over this money) demands that he begin withdrawing money so that both partners can get paid. (again, the government will decide the distribution rate between each). Jeff still hates paying taxes, so he withdrawals the minimum required distribution each year until his death.
Did you get that? Jeff spent his whole working life earning this money, and then when he retired, he then avoided ever enjoying this money! Why did he bother earning it? Couldn’t he have done better things with it?
But wait, there’s more! There’s a fairly new invention called a Stretch IRA. You might have been thinking to yourself, “well yes, Jeff didn’t get to enjoy his money, but at least his kids did.” Not so fast. The taxes on this money can be extreme. If he’s built an estate of any size, then his family must now pay both estate taxes and income taxes on this money. Both taxes are levied on the same amount of money! So some crafty advisors (or was it the financial institutions) have devised what’s called the Stretch IRA. Instead of going to the heirs or charities that Jeff would have chosen, the money goes into a new IRA which avoids taxation (and distribution) into the lives of those left behind. With these beauties, not even Jeff’s kids will get to enjoy the money! They stretch the “benefit” on for decades neatly in the hands of the financial institutions and outside of the stewardship of Jeff’s family.
This is _Part 19_ in the series titled The Trunk. To continue with this series, click on Pt 20. To use this as a growth tool, please read Pt 1, Pt 2, Pt 3, Pt 4, Pt 5, Pt 6, Pt 7, Pt 8, Pt 9, Pt 10, Pt 11, Pt 12, Pt 13, Pt 14, Pt 15, Pt 16, Pt 17 and Pt 18.
Photo credit: ambimb