What about My IRA and 401k to Maximize My Retirement Income?
There are many lackluster characteristics found in qualified plans, which are tax-deferred vehicles such as IRAs, 401(k)s, 457s, 403(b)s, and TSAs. What many Americans (and the financial professionals from whom Americans receive advice from) do not realize is that qualified plans only focus on two of the four phases of retirement planning—the contribution and accumulation phases.
These plans typically give us a tax break on the front end or during the contribution phase when the dollar amounts are small. These plans defer taxes into future years and into future tax environments. These plans typically become fully taxable when we begin to withdraw from them, and when the dollar amounts are much larger. Thus we end up paying more in taxes.
Ask yourself this question: If you were a farmer, would you rather receive a tax break when you purchase seed in the springtime and then pay taxes during the harvest? Or, would you rather just pay taxes on the seed and enjoy a bountiful, tax-free harvest? Of course we want tax-free harvests!
Qualified plans are often utilized under the preface that during our retirement years we are likely to be in lower income tax brackets, so tax-deferral may make sense for some people. Well…not exactly. The majority of Americans are finding themselves in as high or even higher tax brackets during retirement. Even if we have lower income during our retirement years, we do not have the tax deductions we had during our earning years.
So what happens during the other two phases of retirement planning—the distribution and transfer phases?
When we begin to take distributions from these plans during retirement, the government is taking more and more for income taxes and we are effectively getting less and less to spend. And what tax deductions do we have left? If the home is paid off, the mortgage interest deduction is gone. Our children likely have families of their own, so no deductions are found there either. And we are likely no longer contributing to tax-deductible qualified plans, so no luck using that deduction. This is why most Americans find themselves in as high or even higher tax bracket! For more insight, visit our Resource Library to read The Deferral Trap which appeared in Forbes Magazine in 2004.
What About Future Tax Rates?
As baby boomers retire, placing increasing pressure on entitlement programs such as Social Security, Medicare, and Medicaid, the War on Terror and its continued funding, tax rates are almost certain to increase. Thus deferring taxes into future years increases the risk that your retirement nest egg will be taxed at higher rates than today, ultimately leaving you with less after-tax income.
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Tradition - Equity Management
Our parents and grandparents taught
us to get an education, find a good
job, buy a house, and then pay off that
house as soon as possible. Sounds great
doesn’t it? Well, things aren’t
the same today as they were for our
parents and grandparents. Today we change
jobs more frequently, move to a new
home every 5-7 years, and refinance
our mortgage every 4.2 years.
Yet, given these statistics most Americans
still choose a 30-year fixed mortgage
to finance their homes. Many even postpone
saving for retirement until the mortgage
is paid for. These are two big mistakes
that Americans make in managing their
money—mistakes that are literally
costing American households millions
of dollars each and every year.
Are You Saying That My Home Is
Not A Good Investment?
Absolutely not. Your home can
be a great investment. However,
homes were meant to house families
and create memories, not store
cash. Given the nature of how
we view our home and home equity,
we are not optimizing this asset.
The three key elements of any
prudent investment are Liquidity,
Safety and Rate of Return.
Home
equity has the following characteristics:
Home Equity is not LIQUID.
In fact, equity in our homes
feels like cash until you
need it. However, when you
need it is the time you
may not be able to qualify
to get it. It is better
to have access to it and
not need it, than need it
and not be able to access
it.
Home
Equity is not SAFE.
With every principle payment
you make you increase your
risk while losing safety.
As you pay down your mortgage,
you increasingly have more
equity to lose while the
mortgage lender is in an
increasingly safer position.
For example, a $300,000
home with $250,000 of equity
can still be foreclosed
on as a result of a $50,000
mortgage that hasn't been
paid.
Home
Equity does not earn a RATE of RETURN.
Our
homes will appreciate, based
on the supply and demand
found in the market place,
regardless of whether the
home is owned free and clear
or fully leveraged by using
a mortgage.
We
are reducing our tax deductions,
killing our partner, Uncle
Sam. With each
principal payment, you are
reducing the mortgage interest
tax deductions the government
affords us. 82% of Americans
that itemized their deductions
in 2003 claimed mortgage
interest as their largest
deduction.
Home Equity FAILS all three key elements
of any wise and prudent investment:
Liquidity, Safety and Rate of Return.
Does this sound like a wise
way to invest? Are you optimizing one
of your most valuable assets?
A common misconception about the path
to financial independence is that the
best way to pay off your home is to
pay extra principal payments towards
your mortgage. Actually, not paying
principal payments is the wisest and
the quickest way to accomplish financial
independence. A homeowner can accumulate
the amount of cash needed to pay off
a home much sooner by using a conservative,
tax-advantaged, mortgage-acceleration
plan.
It is important to remember that the
most important elements of home equity
management are maintaining liquidity
and safety of principal. Then, if you
can separate equity to grow in a safe
and liquid side fund earning a competitive
rate of return, while having it accessible
in the event of an emergency or opportunity,
you are on the path to maximizing your
tax deductions and optimizing your assets.
