Diversified Tax Structures Protect You After Retirement
- You don’t need to assume you will have to get by on less income after retirement
- Different tax structures can provide flexibility
- Most of your money will likely be in the pre-tax structure
- You should also have capital gains and tax-free structures
- What about drug coverage?
- What if you’re retiring and losing health insurance?
- When you can lower your premiums when your income goes down
Don't Settle for Less in Retirement
Have you ever received this advice?
“Professor, you should put the most that you can into deferred income tax accounts. Because you're deferring income taxes today, your money is compounding income tax deferred.”
Professors often hear this from advisers, accountants, brokers — and even the university. The person giving that advice often does so based on the belief that when the professor retires, he or she will need less money from retirement accounts annually than he or she is making in pre-retirement salary.
As a basic premise of financial planning, Filbrandt & Company never suggests goals to a client that are less than what he or she wants. It doesn't matter to us that Consumer Digest or Kiplinger says someone can live on 70 percent of their pre-retirement income. If someone is making $100,000 per year the day before he or she retires, we presume they would like $100,000 in retirement income the day after retirement until they tell us differently. We don’t presume they want less cash flow just because they retired.
The notion that you will make or need less in retirement is an assumption many financial planners use as a starting point. But as we know, life is not linear. When people are in their 50s, 60s, even 70s, they may want to travel and do more things with their money while physically able. Therefore, more money is required at that time.
After traveling the world, maybe as they get into their late 70s or early 80s, retired professors want to stay closer to home. They don't need as much money as when they traveled. Then, as they get into their 90s, they will likely need a lot of money for health care. This notion that people need less when they retire is not a real-life notion.
If all of your money is in the income-tax-deferred accounts that we described at the start of this report, it's a major trap. We are taxed based on our marginal income tax brackets, which the government can change. In the early 1970s the marginal tax bracket was 70 percent, so it made a lot of sense to defer perhaps 70 cents in income taxes for some time in the future. Today the marginal income tax is high, but it’s not 70 percent -- it's 39.6 percent.
Does it make sense to defer into the future when you might need more money for health care, and maybe the taxes will be higher? No one knows, so all of our clients want flexibility and options. We often recommend diversifying where your money is stored to take advantage of other tax structures:
- pre-tax (university retirement account), which is generally going to be the largest, up to 39.6 percent
- capital-gains tax (on returns on investments in equities), 20 percent
- tax-free (Roth IRA or investing in municipal bonds are two examples), zero percent
Capital Gains Tax Generally Less Than Income Tax Rate
Under the capital-gains structure, professors can accumulate dollars on investments. If they need the dollars down the road, the capital gains tax is the one that would be paid on a gain. That's generally less than the income tax rate.
Most of our clients have their assets distributed within the three tax structures. As they need money, they look at the current tax rates with their adviser, and then decide proactively from which “bucket” to extract their money.
Working with a fiduciary is important. Working as a fiduciary (as Filbrandt & Company does) involves being bound ethically to act in the other's best interests.
Because Filbrandt & Company is not an employee of an insurance company or brokerage firm, we don't have any pressure to satisfy an employer. Our only employer is our client, so we don't have to sell a product. We simply need a good understanding of what our client is trying to do, and help him or her get there.
And if maintaining your current income level after retirement is what you want to do – we can help you achieve it.
The information provided is not, nor is it intended to be, legal advice. You should consult your attorney for advice regarding your individual circumstances.
Circular 230 Disclosure
We are required by Treasury Regulations (Circular 230) to inform the readers of this material that, to the extent that the information contained herein concerns federal or state tax issues, such information was not written or intended to be used, an cannot be used, for (1) avoiding federal or state tax penalties or (2) promoting, marketing or recommending to another party any transaction or matter addressed herein.
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