Many of you make payroll contributions to a 401k, 403b, or 457
deferred compensation plan to save for retirement. Another reason why
you contribute to an employer-sponsored retirement plan is to put off
paying federal income taxes until retirement. While saving away is a
smart thing to do, making pre-tax contributions to a retirement plan may
give life to the most evil of all creatures - the dreaded tax zombie!
A lot of employees think contributing to a pre-tax retirement plan is a good idea because it reduces their income tax rate. Since income might be lower during retirement years, the idea is retirement plan withdrawals will be taxed at a lower rate. By avoiding taxes now and paying them later, you might think that you're getting one over on the tax man. Not so fast! During retirement your income tax rate can stay the same or even jump higher than what it was during your working years.
There are three key reasons why so many of you are finding out the hard way about the flaw in your deferred compensation tax strategy:
1) A lot of you "retire" at a relatively young age and begin possibly pulling monthly pension payments, but soon after retirement, you may begin working again, start a business or consulting firm. In the case of married couples, oftentimes the retiree's spouse is employed or running her own business. The combined income earned by the two, along with pension payments, could boost the couple into a higher tax bracket.
2) A retiree might decide to start withdrawing money from his savings plan to cover living expenses or large purchases like a child's wedding, which adds to taxable income.
3) A lot of you no longer are itemizing deductions and have fewer dependents to claim. If your mortgage has been paid off, you don't have interest payment deductions, which reduces the chance for those payments to move you into a lower tax bracket. Also, if your children are no longer dependents, the ability to benefit from the tax breaks they produced is eliminated.
The combination of retirement plan withdrawals, pension payments (maybe), income from a second career or business, and a spouse's income can lead to an all-out attack of the tax zombies. This is because the money from all of these sources may result in your post-retirement income being the same or more than your pre-retirement income. Now, couple this with fewer tax deductions, and the end result is having a tax rate that is the same or higher than your pre-retirement rate. The tax zombies will be taking a bigger bite of your hard-earned savings!
A lot of employees think contributing to a pre-tax retirement plan is a good idea because it reduces their income tax rate. Since income might be lower during retirement years, the idea is retirement plan withdrawals will be taxed at a lower rate. By avoiding taxes now and paying them later, you might think that you're getting one over on the tax man. Not so fast! During retirement your income tax rate can stay the same or even jump higher than what it was during your working years.
There are three key reasons why so many of you are finding out the hard way about the flaw in your deferred compensation tax strategy:
1) A lot of you "retire" at a relatively young age and begin possibly pulling monthly pension payments, but soon after retirement, you may begin working again, start a business or consulting firm. In the case of married couples, oftentimes the retiree's spouse is employed or running her own business. The combined income earned by the two, along with pension payments, could boost the couple into a higher tax bracket.
2) A retiree might decide to start withdrawing money from his savings plan to cover living expenses or large purchases like a child's wedding, which adds to taxable income.
3) A lot of you no longer are itemizing deductions and have fewer dependents to claim. If your mortgage has been paid off, you don't have interest payment deductions, which reduces the chance for those payments to move you into a lower tax bracket. Also, if your children are no longer dependents, the ability to benefit from the tax breaks they produced is eliminated.
The combination of retirement plan withdrawals, pension payments (maybe), income from a second career or business, and a spouse's income can lead to an all-out attack of the tax zombies. This is because the money from all of these sources may result in your post-retirement income being the same or more than your pre-retirement income. Now, couple this with fewer tax deductions, and the end result is having a tax rate that is the same or higher than your pre-retirement rate. The tax zombies will be taking a bigger bite of your hard-earned savings!
