Why You Will Pay More in Taxes at Retirement with a 401(k)

Within in a few years of retiring you will turn age 70.  Then a notice from the IRS arrives that says you must start taking income this year from your deferred retirement account or be forced to pay a 50 percent penalty, plus income tax.  Deferring your taxes through an IRA or 401(k) is nice for you, but there is a limit as to how long Uncle Sam will put up with it.  At this forced distribution at age 70.5, you begin calculating when you will run out of money. If your money will be gone in seven years, but you feel healthy and think you may live to age 87, you start to get nervous.
Being forced to take out income and knowing this will deplete your money at a date certain in the near future is worrisome, to say the least.  Now you start slowing down the withdrawals.  You alter travel plans.  You eliminate eating out.  You don’t buy a new car.  You may make many sacrifices to reduce your spending so your money will last longer.  But then, unfortunately, you die.  Because you have been worried about outliving your money you have not been able to use it the way most people in retirement would like to use a good portion of their money… to have fun!  On top of that, you didn’t outlive your money (because you were so scared and so frugal) so now your beneficiaries must pay the taxes on the remaining funds or incur stiff penalties.  You got gouged two times:  First when you had to stop having fun in retirement, and second when your children had to pay a ton of tax on the money you left them to enjoy.
Deferring taxes until you are older is, in my humble opinion, not very smart. That’s because the tax system drains off a substantial portion of your savings from a tax-deferred program faster than if you just paid taxes along the way.  Had you already paid the taxes, you would not be forced to withdraw money at age 70.5.  Your tax-free income would last much longer than seven years, as in the above example.
In a real-life example for one of my clients I’ll call Thom, 74 percent of his retirement money was still in an IRA after his death because he had been afraid he would outlive it so he stopped traveling and having fun.  This IRA money went to his beneficiaries when he died, but they had to pay tax on this greater amount of income.  This forced the tax bracket to be much higher than what it was when Thom was working and putting money away in the IRA.
Don’t get caught where Thom and his kids did. Test for yourself what will happen with taxes on your retirement funds. And don’t be fooled by what everyone says about how the elderly will “hopefully” be in a lower tax bracket in their retirement years. Maybe you will, maybe you won’t and even if you are, thanks to Uncle Sam’s myriad tax laws concerning deferred programs you will gouged anyway. Look at what your beneficiaries will pay in taxes because of the infusion of extra money inherited from you.  Add up all the taxes and I believe you will find that you will pay double the amount of taxes you would have paid if  just paying-as-you-go and saving money is a tax-free environment instead.
Nobody tells you this disastrous fact.  
Think about it:  do you want to be taxed on the seed, or the crop? When you defer taxes by saving in an IRA or 401(k), you will pay taxes not only on the seed, but also everything that seed produced all along the way. When so-called retirement experts tell people to defer taxes they never run the numbers all the way through the entire retirement period, from the first day you take your first distribution to death and beyond and how it affects beneficiaries. They are only emphasizing how much money you’ll have saved by the time you retire, at say age 65. This isn’t giving you the entire story. The score at half time isn’t the final score!
Again, I’m being repetitive but deferring your taxes until you retire is following the herd mentality about this common strategy: “You will be in a lower tax bracket when you retire.”  So what if you are in a lower bracket? The money does not get taxed until distributed and when you add up all the taxes paid on your funds at this stage of the game you will find an alarming figure.  Do you think Uncle Sam is looking out for your best interest? NO!  I urge you to prepare these numbers like I have requested and determine what is best for you and your family.
Claiming you will have more money by deferring taxes is an outright lie. The total amount of taxes paid on your deferred-tax savings will be much higher than any other option.  Stop what you are doing and check out what I am saying, then email me so I can give you some tax-free retirement options that will make your heart sing! peter@moneymastery.com