MasterPo says: This blog is about topics and issues that are of importance to me. I am not one of the countless blogging lemmings that are tripping over each other scurrying down the hill and off the cliff of blogging oblivion trying to write the greatest blog on the latest topic de'jour. Your comments are welcome.

November 15, 2008

The Reality of Retirement: Myth #2 – Your Taxes Will Be Lower

I wish I knew who started this one!

Nothing could be further from the truth.

Several reasons why.

First, if you've done your homework you have computed some approximation of how much you will need for a comfortable retirement. "Comfortable" meaning living as you do now when working (presumably full-time). Your calculation probably shows a pretty hefty amount needed! Even without crunching numbers you've probably heard estimates of 30% to 50% of your pre-retirement income (gross of course). So if you made $80,000/yr pre-retirement you would need upwards of $40,000/yr after you retire.

I happen to think (based on logic and personal experience) these kinds of rule-of-thumb estimates are grossly off base. But that's a topic for another article.

So now you get $40,000/yr post-retirement income from your retirement funds (401k, IRA, annuity etc). That's what many full-time working people make too. So how can your retirement taxes be lower than a non-retired working person's taxes?! When you think about it, that doesn't make sense. Granted, income tax on $40,000 will probably be lower than income tax on $80,000. But not so dramatically less.

Second, most of the retirement income sources drawn upon were funded pre-tax. Your 401k, your pension (if you have one), probably your IRA (presuming non-ROTH), etc. All funded pre-tax. That means when you take money out government at all levels will want their cut that they have been waiting for all these years.

From personal experience managing my mother's retirement finances I attest the bight it BIG! Even though she had 20% withheld from each distribution she still ended up paying more tax on April 15. And if we needed to make an additional withdrawal from her retirement accounts then she got socked even harder!

Third, who knows what new income tax brackets and tax rates Congress will pass during your retirement years! In the last 20 years alone income tax rates have gone up and down, new brackets have been defined, consolidated, defined again, removed again etc. There is no tell what the tax rates and levels will be when you retire. And that's just on the Federal level. States and cities also change their taxes too.

Also keep in mind that some cities and states will follow you for taxes if you move else where post-retirement. This is especially so if you held a government job. The concept is you earned the money in that city/state so you should pay taxes to that city/state even if you live else where. The result is you could end up paying state and/or city level income tax to more than one location! That takes a bight out of things too!

The bottom line is that expecting significantly lower taxes post-retirement is a falsehood that will come back and hurt you if you haven't prepared or at least are aware of it.

Uncle Sam gets you in the end – always.

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1 comment:

Anonymous said...

Very well written! I found great 401K information here too. It's like having tax code translated into English.