Episode #38 – Should You Invest In a Retirement Plan?

Investing in a retirment plan assumes you are going to save money in taxes in the long run, but will you?

What are your choices? How do they work? How can you WIN with a retirement plan?

[00:00:21] Hi everyone, welcome to another wealthy and wise Wednesday, I hope you are doing great? Welcome to the podcast, welcome to the video whichever you like first, I am probably a little late getting this out today, sorry about that I have had this week where I pushed all these subs to come in and put in a different floor and do a little remodeling at my office and is normal subs go, we ended up getting delayed so I have been pushing, pushing and finally got in the studio here to knock out this podcast and video. I am trying to make this somewhat timely, we are about 4 weeks away from the due dates for taxes, April 15. So right now, as of right now if you are a partnership or S-corp, or a corporation, you got to have your taxes in by tomorrow or at least get an extension in there and then we have got about 4 weeks before our individual returns and LOC done and I wanted to kind of talk about some of the things to get ready to plan for and the big one, [00:01:46] seems to talk about, every CPA seems to encourage and that is some sort of a retirement plan.

[00:01:52] rather than going to many different one you could possibly have, there is essentially four that I think most people use; the 401K, IRA and of course the [00:02:06] rate that goes along with that and a 403B. For those of you who don’t know the 403B is, this is for nonprofit, it is for government, it is for school teachers, it is basically called a tax-sheltered annuity and 403B is just kind of like 401K for nonprofit. And of course the 401K where you hopefully if you put it in you get some sort of a merge from your employer and then the IRA, that is a self, kind of a voluntary investment on your own with no match, although there is [00:02:54] IRA, probably got to throw that in there because the [00:02:58] IRA is where a, it is called a self-employee pension. Sometimes if you work for a small business, they will set up a [00:03:08] to help fund your IRA.

[00:03:13] they all pretty much work the same except for the [00:03:18] and I will jump on that at the end, but the others are tax deferred which means you are going to put money in and you are going to get a tax deferral on that money. That just means you are not going to pay tax today on that money, so if I put in $10000 into a 401K or maybe my wife and I both contributed to an IRA and the equal $10000. That $10000 that we are not taxed on today, eventually we will be taxed. Tax deferral, there is another way to sat tax deferral we say tax postponing because you are just postponing the eventual tax that someone will have to pa at some point along the way. What I want to kind of point out to you today though, there is only one way to win in the retirement plan, you can make the arguments that there are two ways to win but the real way to win in retirement plan is just simply this, you have to put money in at a higher tax bracket that when you take it out.

[00:04:32] It is really that simple, if I tax deferred my money and I made 20% tax bracket and 10 years later, I decided to take that money out because I am retiring and I am still in the 20% tax bracket, well I probably didn’t win or lose. But if I put that in at a 20% tax bracket and I take it out as a 15% tax bracket then I win. I actually ended up not paying less tax on that money than I would have 10 years ago had I paid the tax then. But if I put the money in and I defer it when I am in its 20% tax bracket and now I eventually take it out at a 22 or 25% tax bracket, well I lose. There was no reason to defer that tax and take it out at a higher rate.

[00:05:32] so what I always encourage people to do is kind of look at their situation especially young people, I mean if this is your first job out your college and you are already stuffing money into a 401K, there is a good chance you are in the lowest tax bracket you are ever going to be in and it might make a lot more sense just to get rid of the tax now and then eventually put it in a place where you may never pay tax again. But, sadly you walk into the employer the first day and the HR person grabs you and they signed you up on a 401K and you are in a 15% tax bracket and so to be retiring, maybe not soon, but 40 years later retiring in a 25 or 30% tax bracket. And even though we have got a little tax relieve recently from the current administration, that can change quite quickly and the truth is we still haven’t really done anything about the deficit with 20, 30 some say even a 100 trillion dollars in unfunded liabilities were in a situation where taxes just may have to go up over the next 10, 20, 30, 40 years and if that is the case, again you may be in the lowest tax bracket you will ever be in.

[00:06:54] so you want to kind of access that. The other thing to look at is where you are at on the corporate ladder or what you plan on doing in business for your work and if you are more of an entry level right but you plan on you know obviously making a lot more money in the future, again it might make sense just to get rid of the tax now rather than defer it at the lowest tax record you may ever be in and then pay it later when you are in the higher tax bracket. Now tax deferral just basically means that someone is going to have to pay the taxes at some point. If you have an IRA for instance and you die, you wife can continue to carry that or your husband whichever way you want to look at that. The spouse can continue to carry that IRA and keep it deferred but sooner or later someone is going to have to pay the taxes. There are some strategies that can be used, multi-generational strategies where you can lower that tax rate and spread out the income over a couple different generations. But someone is going to have to pay some sort of tax sooner or later, that is what tax deferral essentially means.

[00:08:13] now the [00:08:13] rate is a little bit different because you actually pay the tax now but all the growth from that point on is not only deferred but it is tax free when you finally take that out. There are some limitation on what you can do there but the idea is you are paying the tax now and then deferring it or actually eliminating it from that point forward. We are finding a lot of people are opting to convert their IRA and even 401Ks that have what are called in-service distributions and converting those to [00:08:55] again, thinking that they might be in the lowest tax bracket that they are going to be for a while and just you know taking advantage of what is happening in the current tax situation 2018, might be a really good year to look at your tax situation and if it has come down at all, maybe converting some of your retirement plan to a [00:09:17] could be a good move.

[00:09:20] okay now, there is another theory out there that talks about tax deferral and what it does is it doesn’t even look so much on the current tax rate that we are in. In other words, it is not looking oh you are in the 20% tax bracket now, you are going to in an 18% tax bracket when you retire or you are in 25% tax bracket now, you are going to be in a 30% tax bracket when you retire. So those are things to definitely consider and I think that is an overwhelming first consideration before you start plowing a lot of money into retirement plan. But the second one is kind of interesting and what it does is that it uses this theory that today’s money, the dollar I have in my mind today is more valuable than that dollar is going to be worth in 10 or 15 or 30 years from now. So it is an inflation kind of scenario where basically says if I can keep that dollar today and let it grow for me, when I look at it, inflation adjusted after tax return. I know that is a mouthful, what they suggest is that you are gaining about 2% return each year because of the fact that, that dollar is becoming less valuable. So you are able to say if you will a more valuable dollar today and then when you pay your tax in the future, you are paying with a less valuable dollar.

[00:10:57] it is kind of the same with the mortgage. You know when you look at your mortgage and you think should I pay this off? Well one way to look at it is let’s say you wanted to add an extra 100dollars a month to your mortgage, well that $100 today is much valuable and useful today than that same $100is going to be 15 or 20 years from now. So the idea with the mortgage is yeah even though your mortgage might stay the same at $2000 a month, what happen is that you are eventually paying that mortgage with less valuable dollars. So in real terms maybe it feels like $2000 today but 20 years from now that $2000 may have a purchasing power of 15000 or maybe eleven or twelve hundred because the dollar and inflation is helping the dollar lose its value.

[00:12:05] I know it gets a little confusing and I don’t mean to do that but this theory about tax deferral is just saying that I am going to hold on to my most valuable dollars today and I am not going to pay to tax today and if I defer that and ultimately pay the tax out of less valuable dollars, the calculation you know this theory said that you are going to gain about 2% a year on those dollars. And then pay the tax later with less valuable dollars and that may be true, don’t know the answer to that but the idea is that in 35 years, if you took a 35 year lifespan, the value of tax deferral is worth about 55% more. So there you go. Take that for what it’s worth. I do like the idea of thinking about your mortgage in those terms because if you want to pay off your mortgage today, again those are the most valuable dollars whereas later, 10 or 15 or 20 years from now, you still got the same mortgage payment but you are paying them with less valuable dollars, so you are actually kind of winning that mortgage game.

[00:13:20] the bank anticipates that you are going to refinance or you are going to move or you are going to sell your house for some reason probably within the five [00:13:31] period of time. So they don’t have to worry about that because they know when you move to the new house or you refinance you are going to set up again for using your most valuable dollars in those early years for your mortgage. I just got to think of that, that is very complicated. They will make it too complicated. What I really want you to focus on is here we come, here is April, should you be putting money into an IRA, a [00:13:57] if you have been putting in a 401K and you are stuck but accessing whether or not that is a good move, whether or not you should maybe get rid of the tax now because now we will finish this discussion up, we are talking about two other locations which is the [00:14:12] IRA and high cash value life insurance. Because [00:14:18] of course is something that you have already pay tax on, so if I put $5000 into a [00:14:23] I am going to get taxed on $5000 now. But no matter how much it grows, that $5000 could grow to 10 million and I will never pay tax on the difference on that growth.

[00:14:39] that is absolutely huge because you know you can take that [00:14:43] and do some potentially wonderful things. Now the downside to the [00:14:48] because you still got fifteen, nine and half rules, there are some provision that if you use some of the money for your first home, there are some little things like that, that let you access that money a little easier and then of course what you can do with that can be a little bit constraining because you have this custodian or this administrator who has to approve what you do with a [00:15:13] now of course you can easily go and buy stocks and bonds and meet your fund in traditional investment like that, you can get into [00:15:21] and real estate, etc. There is some custodian, lot more expensive when you can potentially buy some rental properties and that kind of stuff. But those custodians like I said the administration that knows if fairly expensive.

[00:15:37] the other side is using high cash value life insurance because that too is like a [00:15:42] you are going to pay the tax before the money goes in but then if it is managed right and you avoid the, you know you stay within the IRS guidelines. Two things are to your advantage; one is really no limit to how much you can put in, the other is it is going to grow tax deferred and tax free if managed properly. And the other side of it is you have had access without any restrictions. There is no custodian, no administration and you can use it for anything you want, anytime you want for any length of time you want, so a lot of people use it so that they can build capital and then build to buy business or build to buy their next house, or their next cars, I like it for opportunity to take advantage of market that drops so that you can do the old Warren Buffet style, when prices drop, you pay to get an advantage on it and get to buy in real good pricing where you know pricing value don’t always equal. Value maybe down here and like we are seeing today in this market prices up here, what you want is when the prices is below the value, it gives you the opportunities to jump in.

[00:17:06] so using high cash file life insurance, no limitation putting pretty much as much as you want and then have access to it with no restrictions whatsoever and again handling it right will be tax free as well. So it is kind of like a rough on steroids essentially. So those are some of your choices that you have coming up here in the next few weeks and whether or not it makes sense to invest into retirement plans, if so which one? I am happy to kind of you know work that through with you if you have any question about your particular situation, we kind of access what might work best for you and your particular situation and where you think you are going to be in the next 5,10, 20 years because that is obviously an important consideration as well.

[00:17:56] again are you in the lowest tax bracket you ever going to be in or you are just kind of getting started and you are going to probably be in a higher tax bracket or are you in very high tax bracket? There is a potential that you are going to be in the lower one when you finally retire. By the way, let me just throw something out at you on that, I talked to a lot of retirees, rarely do I see someone say yeah, I am in a lower tax bracket than I was when I was working, in fact, often times it is just the opposite. They have lost all their deductions, kids are out of the house, no home exception, all that kind of stuff and now they have got all these money coming in, social security, they have got their pension, they have got money coming in from investment and they tend to stay in the same tax bracket, if not even higher tax bracket and if you take too much money from your investment account, now your social security get taxed, so it is an ongoing battle that we never get rid of and retirees are not necessarily retiring in lower tax bracket that they were when they were working.

[00:19:02] so all that kind of have to be considered so that you make the best decision based on your situation and where you think you are heading in the next 5, 10, 15 or 20 years, 30 years. And that way we can give you the most bing for your buck. So there you go, this lower retirement plan consideration review and I hope it has been helpful to you. Again, if you have any questions feel free to reach out, send it to question@wisemoneytools.com and I will answer them just as quick as I can. Anytime you want to have a strategy session and just kind of walked through some of the things that you might consider in your situation I am happy to do that as well. Be sure to subscribe to the podcast and video so that you can always staying on top of this stuff and be as knowledgeable as possible because that is going to make you a better investor. Alright till next week, have a great wealthy and wise Wednesday and then we will talk to you then. Take care.


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