Casey Snyder and Tom Sedoric, Wealth Managers

Tax deferral in one’s 401(k)s and retirement savings are often a case of “out of sight, out of mind.” Automated savings is understandably easy to do but, as always, there’s often a critical catch: will your nest egg be worth what it should be in real, spendable, after-tax dollars when you need it?

It happens to the best and even the most educated of us. We were recently referred an Ivy League-educated client who was diligent in her savings and keeping to a plan. When she talked about having a goal of X dollars for her annual retirement income, she came in for a reality adjustment when she realized that her actual income was $X minus taxes. Although she wisely planned for retirement, she neglected to consider tax efficiency—balancing pre-tax and post-tax retirement savings—as part of that plan.

The Surprising Tax Bill Due in Retirement

Baby boomers began the move to retirement in 2008. Their numbers are growing dramatically each year with an estimated 10,000 boomers reaching retirement age every day. Many are realizing their retirement plans need readjusting in part because:

  1. They didn’t save enough.
  2. They’ve come to realize that tax deferral on savings was only deferred by kicking a can down the road to an eventual tax bill.

When they realize the can can’t be kicked any further, they are forced, either for lifestyle expenses or IRS rules that require taxable distributions, to pay what is due.

The math is simple; if most of one’s savings are tied up in tax deferral plans—the traditional IRA or 401(k) vehicles—boomers will now pay income taxes on that income withdrawn. Here are a few examples:

  • A person wanting to live on $50,000 would need to draw on their nest egg to the tune of $67,000 to $68,000 from tax deferred accounts if they properly account for taxes1.
  • A family with a baseline of $170,000 in lifestyle expenses would need to draw up to $250,000 on their balance sheet with a significant contribution going to Uncle Sam1.

The shock is real, but the hard lessons experienced by one generation will be wisdom for another. When Congress passed the first Individual Retirement Account legislation in the 1970s, the goal was to prompt us to save more for retirement, shift responsibilities from corporations, and reduce dependence on Social Security. Tax deferral was an incentive to boost savings and in one sense it worked. By the end of 2019, Americans’ 401(k) accounts held an estimated $6.2 trillion in assets and represented more than 19% of the $32.3 trillion in US retirement assets, according to the Investment Company Institute.

But even this staggering number is not nearly enough.

Not unlike investing itself, diversity and tax planning must be discussed early and often. Educating the investing public about a more-diversified saving strategy has become a front and center approach in our practice and for generations of clients. It’s important to consider the unknowns of the future tax environment. Of course, it would be smart to take a tax deferral avenue if we knew that future tax rates would be lower or if the cash accumulation phase of one’s career favors it. Anyone who has studied the history of entitlements, budgets, and tax policy as we have might suggest that future tax rates will be higher, not lower, in the future. 

Planning for the True Cost of Retirement

The reality is that there is no long history of “retirement” to learn from. Until the late 19th Century, when a few outlier companies began to offer pension plans to their workers, most people worked until they were infirm or died. And they rarely lived into their 90’s as many do today. Yet, as fast as defined benefit plans (or traditional company pensions plans) emerged, they were left behind by the familiar defined contribution plan era. The retirement of the baby boom generation will be a much different experience than that of their parents.

Shifts in retirement funding will be felt even more acutely by succeeding generations. According to a 2019 survey by Business Insider and Morning Consult, half of people in Generation X have no retirement savings at all, and 13% of those with a retirement account say they are not contributing to it. Younger generations are also relying more on tax-deferred retirement plans. A Scwabb Retirement Services survey found that 58% of GenXers had only a 401(k) account for their retirement savings.

Being an educated investor that considers not only savings, but also tax obligations, makes all the difference. Today, a competent and qualified fiduciary together with a skilled tax practitioner can structure a plan that includes tax efficiency at its core. This does not mean buying the high commission “tax deferred annuity,” however. A fiduciary, in partnership with a client’s tax counsel, will help you determine the best mix of taxable, tax deferred, and tax-free assets to help achieve their client’s long-term goals. 

A plan, not a product, helps assure success over time.


1. In many states, you will also have state and local income tax on these distributions.
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