When participants start contributing to their 401(k)s, future taxes are generally of little concern.
But as retirement approaches it becomes more apparent that taxes might present a significant problem, especially for those who fear that their tax rates might increase in the future.
It’s not difficult to illustrate this as long as we remember that participants are only postponing the day when taxes must be paid on the money accumulating in their traditional 401(k)s, IRAs and other such retirement plans.
When that day comes when you want to withdraw $50,000 for your retirement income, if the tax rate applied to the withdrawal is 20 percent, $10,000 will go to pay taxes.
But if that tax rate has increased to 30 percent, the tax payment would go up to $15,000.
Every dollar you pay in taxes is one less dollar available to pay your grocery, utilities, and insurance, let alone to fund travel, hobbies and the fun things we hope to do during retirement.
Consider what this means in terms of actual income.
For every $250,000 accumulated in your 401(k), IRA or other similar retirement plan, limiting withdrawals to a rate of four percent of the balance would provide a pre-tax income of $833 a month ($250,000 X 4% = $10,000 / 12 months). If 20 percent of this gross withdrawal goes to pay federal and state income taxes, you’re left with a spendable income of only $666 each month.
A quarter of a million dollars is no small amount of money, and not easy to accumulate. But only $666 of spendable income each month doesn’t really go very far.
Safe Withdrawal Rate and Taxes
Monthly Income Generated
Assuming a 4% Withdrawal Rate
and a 20% Effective Tax Rate
How much of a balance do you need in your 401(k) or IRA to provide what you would consider to be a large enough amount of after-tax spendable income?
Instead of consistently limiting withdrawals to four percent, many individuals might find that they are forced to periodically increase their withdrawals to meet some unexpected emergency.
Or in a moment of weakness, they will pull more money out so they can go on a vacation, play more golf, or go out to dinner more frequently.
Regardless of the reason, even a temporary increase in withdrawals, combined with the possibility of living a long life, can ultimately doom a person’s nest egg.
While the impact may not be apparent for another decade or two, as baby boomers age and their retirement plan balances shrink due to the withdrawals they take from their do-it-yourself retirement plans.
Ultimately it will be clear that the foundation supporting the retirement dreams of a great many people was less than solid.
But, it won’t do you any good to allow yourself to become discouraged, even if you haven’t saved as much as you would have hoped and even if most of your savings is sitting in a 401(k), IRA or similar plan.
While these plans present risks and challenges, so does everything else.
The best solution, and the best way to plan your retirement so that you have the best chance of enjoying lifelong security and independence starts with a good risk management plan.
Few things will be more important than your future retirement. And the way time flies, it will happen before you know it. We can help you plan for the inevitable.