56 • MARTIN H. RUBY
Paul is deferring $75,000 in taxes over his working years. This is the big savings all of us are being promised with 401(k)s. After all, look at how much of his taxes he is able to avoid while work- ing: $75,000! Here’s the catch, and it’s a big catch. When Paul goes to spend his money in retirement, he owes $375,000 in taxes. Remember, he deferred taxes on contributions only, but he’s being taxed on his contributions and account growth. That makes poor Paul pay $300,000 extra dollars in taxes! Of course, Paul could take his $75,000 of tax deferral during his working years, invest it in a fully taxable account until age sixty-five. Then he could use the growth (after taxes) of this fund to offset the extra taxes he incurs during his retirement years. The- oretically possible, but complex and not very realistic. After all, do you know anyone who actually does this? Of the thousands of sav- ers I’ve met with, fewer than five are taking this approach. More likely, people take their tax deferral (in the form of a tax refund) and simply spend it. So they are faced with this big tax bill in their retirement years with no way to cover it other than their retire- ment income. It’s a pretty shocking analysis for most of our clients. But it’s just the math associated with growing assets tax-deferred. When the principal AND growth have to be taxed in the future, it can really add up. Now You’re in the Know Very few people have done what you just took the time to do: quantify their tax risk in traditional tax-deferred retirement plans. More smart, financially sophisticated savers make this mistake than any other. And now you’ll know better.
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