Most of my clients contributed a majority of their savings during their accumulation years to company retirement plans using pre-tax dollars. They now have large 401(k) and IRA account balances. They also have large tax liabilities and onerous required minimum distributions.
I think if you asked each of them if they would go back and make a different decision about using pre-tax dollars into a company retirement plan versus after-tax dollars into a Roth or Roth-like option, they probably would. They would if they understood where taxes are likely to head in the future.
During the working years putting pre-tax dollars into company retirement plans gave them a tax deduction. That was a good thing. Every dollar mattered. What’s interesting, though, about the accumulation years is that it’s the time in life when 1) we already have the most tax deductions and 2) were generally paying a lower historical tax rate. Although paying taxes on the seed (the contribution dollars) during the accumulation years may have seemed a little bit more difficult, I don’t think it would have been terribly onerous. In fact, it would have been a good thing for the following reason… It would have helped them to establish a lower lifestyle to live on.
Here’s what I mean… In the situation of making payments into company retirement plans with pre-tax dollars, I pay less in taxes. If I pay lower taxes, I get more take-home pay. If I get more take-home pay, I spend more take-home pay on my lifestyle. In essence a higher take-home pay establishes a higher lifestyle in the long term.. (I do NOT buy the philosophy that people take their reduced taxes due to saving in their company retirement plan to save more …they use the tax savings to spend more)
On the other hand, If I take after-tax dollars and save them for retirement, I have less take-home pay to live on. Having less take-home pay to live on establishes a lower lifestyle long term.
This is the reality of a paycheck… We live on the net. If that changes up or down, we increase or decrease our lifestyle.
But here’s the real pay off of using after tax dollars to save instead of pre-tax… If I get to retirement and don’t have to pay taxes on my withdrawals, I have a double win.
The first win is that I already developed a lower lifestyle expense by saving after-tax dollars. This carries me into retirement having lower living expenses.
The second win is that I now get all my retirement money tax-free and it doesn’t show up on my tax return as income. This means that all my Social Security benefits are tax free as well.
Maybe it is too late for you to change the pre-tax, after-tax savings decision. But you still can tell someone starting out toward retirement.
If you have any questions please feel free to contact me.
