Deferring taxes until retirement is an attractive planning strategy – consider the popularity of the 401(k) and you’ll see it.
Our compatriots have nearly $6 trillion tied up in them. Indeed, a Harris Poll indicates that the 401(k) and the tax deferral benefits it brings is the most highly valued retirement planning instrument in the land.
The problem with panaceas is clear, though: they rarely satisfy everyone. Tax deferment clearly works for many people, but for some – particularly your wealthier clients – it can backfire dramatically.
The 401(k) and its close brethren, the IRA, operate on the assumption that when you retire, you’ll find yourself in a lower tax bracket. But what about the high-net-worth retiree? In fact, the more assets you have, the less effectively the tax-deferral strategy will serve you.
Some people don’t want to face a decline in living standards – perhaps we should say, a reduction in luxury and style – when they retire, and their planning usually aims at preventing it. A tax deferment-based retirement plan would probably work against such clients.
Even if a wealthy retiree is comfortable with fewer expenditures, they must consider the impact of losing key tax deductions, like mortgage credits and child deductions. Their tax bill may start to rise, no matter the strategy they pursue. Additionally, nobody really knows what will happen to tax rates: cuts are possible, but movement in the other direction is equally plausible.
The key mistake, particularly for the wealthy, is having too much invested in tax-deferred plans. Consider the RMD – the required minimum distribution. At some point, the retiree will be forced to take a set percentage from their accounts. If the client’s IRAs or 401(k)s are swollen with cash, the RMD might push them into a costlier tax bracket. Few surprises could be nastier.
For more, please see:
Should You Defer Your Taxes Until Retirement? | Kiplingers