Lies 2 Many people think putting money away tax-deferred is great for retirement. Well, it is not bad but it can have lethal consequences depending on your success over the years and at what tax bracket you retire in. Remember, your deferred plan is tax at ordinary income at the rate your in when you retire. Most people want to retain the same lifestyle they had during their years of work and not have to go to soup lines at the local church to make ends meet. We now look at a qualified plan vs. non-qualified plan and look only at the numbers.
- Sam, age forty, wishes to retire at age sixty-five; Sam is in the 30% tax bracket and deposits $30,000 per year for thirty years at 7% interest, equaling $2,193,117.
- Sam receives an approximate annual tax savings of about $9,000, for a total tax savings of $225,000 during his working years.
- Sam would receive a “net” retirement income of $135,430 per year, assuming a 30% tax bracket. His money would last for just 11 years. He could take less per year and extend his dollars but the point is he is going to be hammered at ordinary income tax rates which are going up.
- Total taxes paid by Sam on his retirement income would be over $638,454.
- Total net retirement income after taxes of $1,554,660. Not the most efficient way to save for retirement.
- Jim, same age deposits $30,000 per year to the age of sixty-five, assuming an 8% return.
- Jim receives NO tax savings on his deposits.
- Jim receives a “net” retirement income of $211,712 per year to the age of 95 without taxes.
- Jim's total taxes paid on retirement income equal $0.
- His total net retirement income after taxes is more than $6,351,360. The other news is that things could get better by super charging this plan.
- Taxes saved on deposits are $225,000 on qualified plan.
- “0” on non-qualified plan.
- Taxes paid on retirement income of over $638,454 on qualified plan and
- $0 paid on non-qualified plan. That equals a tax savings of over $1,230,000.
- Total net income paid of $2,193,117 on qualified plan, and
- $6,351,360 paid on non-qualified plan. That's a difference of $6,100,000.
- Overall difference of $4,158,247.
Can you afford to lose this type of opportunity just to save a few taxes each year? The non-qualified plan would have an initial death benefit of over $2,000,000 in case Jim was to pass away early. You'll have to be the judge, but the smart approach to the money would be looking at the end game. It truly is better to be taxed on the seed than the harvest. Perhaps the best solution is to use both and spend down the least efficient dollars first; these are the qualified plan dollars subject to ordinary income tax. Then use the non-taxable funds that are created with a non-qualified strategy.