Would You Rather be Taxed on the “Seed” or the “Crop”?

Taxes have such a subtle, yet profound effect on our money.  That’s why it’s important to organize retirement funds based on how those funds will be taxed (Money Mastery Principle 8).  By doing so, it becomes easier to see how taxes will affect retirement money over time.  In addition, using calculating and forecasting tools can help project how much money will be available at retirement age and what percent will be subject to some kind of taxation.

For example, without the tools to play “what if” scenarios with your money, it may be easy to get caught up in popular retirement and savings programs that may actually end up costing you serious tax dollars when it comes time to retire.  Take 401(k) programs for shutterstock_261713222instance.  The argument for these plans is that when a person begins to withdraw funds at age 65, he or she will usually “be in a much lower tax bracket” than they were during their working years, so theoretically, they should pay much less in taxes.  But if you are applying sound financial management principles to your life, you should be making much more! At least that’s what I advise my clients…don’t settle for less as you get older, demand from yourself much more!

Bart Croxford, a CPA writing for the Salt Lake Tribune, spells out what may be closer to the truth about how 401(k)s and the like will actually be taxed upon reaching retirement:

I have never seen anyone who promotes tax-qualified plans [such as IRA or 401(k) plans] run the figures through retirement.  They run the figures to age 65…But in savings, as in sports, it’s the final score that counts, not the score at half-time or even after three quarters.  The real clincher…is the fact that with tax-qualified plans one must pay taxes on the entire amount taken at retirement, including the growth, which accounts for the largest portion by far.  Whereas on tax-free plans, one pays no taxes on the growth at all.  In other words, one can be taxed either on the seed or the crop.  With tax-qualified plans, one pays on the crop and on tax-free plans [such as a Roth IRA], one pays on the seed.  One does not receive the tax deduction now, but he or she receives a far greater benefit by not having to pay taxes on the amount received at retirement.  

Of course this does not mean you should automatically dismiss 401(k) programs, and I encourage you to take advantage of matching contributions your employer may make towards a fund.  However, keep in mind that a 401(k) is only one  of many ways you can save and plan for retirement. There are other methods for saving that have great tax advantages, depend less on the stock market, do not demand management and maintenance fees, and can be used at any time without penalty. To learn more about these passive income opportunities that can help you predict a happy and secure retirement, call me today: (888) 292-1099, ext. 1.