By David Disraeli
Did you know you had a silent partner? Even if you don’t own a business you have a silent partner. To illustrate my point, suppose for a moment that you did own a business with a silent partner and that the silent partner owned 30% of the business and you owned 70%. Suppose further that a few years down the road your partner informs you that he now owns 50% of your business – just because he decided it was so? My guess is you would not be very pleased or cite some written agreement regarding this arrangement. By now you probably have figured out I’m talking about the IRS. The IRS decides how much of your income you get to spend and what the number will be in the future. Most believe taxes are going up.
Let’s say you went into a bank for a loan and filled out a loan application. Under IRAs/401k’s you put $100,000 since that was what the accounts were worth. You would then total the assets and liabilities and produce a “net worth” figure. The problem is the IRA figure is fraudulent. The IRS actually owns 28% to 33% of your IRA. You have the privilege of investing the government’s money until you die or retire. They love it! They get 30% of the gains without taking any risk. Here is the real rub – the IRS and Congress have the power to decide that instead of 30%, they now own 50% of all your retirement accounts. This means all those years you’ve deducted money from your current income, betting that your tax bracket would be lower when you retired and now you find it is higher. Shouldn’t you have a hedge against this? See David Disraeli’s article on tax-free retirement.
The problems don’t end there. Having money in pre-tax accounts has some serious side effects like a prescription drug. Since any money you pull out of a retirement account is taxed at your highest marginal rate, your AGI will go up dollar for dollar with your withdrawal. Therefore, all the deductions, programs, and privileges that key off adjusted gross income will be affected by your retirement plan withdrawals. For example, medical expenses and moving expenses can only be deducted if they exceed x% of your AGI. Social Security becomes taxable at certain AGI levels.
Moving on to the next generation any retirement funds you manage to leave to your heirs will complicate their taxes and raise their AGI. Many deductions are phased out that may penalize your heirs like deducting student loan interest, the ability to do a Roth, etc.
Plowing money into 401k’s may sound like a great idea while you are earning a high salary and there is a company match. This is not all bad. Since you are at the complete mercy of the IRS as to what you get to spend, i.e., your lifestyle it makes sense to consider a hedge. If you are concerned about your future tax liability on retirement accounts see below:
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