The Government encourages you to save for retirement by placing your money in a “Qualified Plan Account” of which the most common accounts are 401(k), IRA, 403(b), and SEP plans. These are government approved plans that allow you to “defer” your taxes until you begin to receive income from them.
You may view these types of plans as “tax savings plans” when in fact they are actually “tax deferred savings plans.” We are taught that you will save taxes by participating in these plans, but in reality we only postpone the tax to some point in the future. The only way to win at this game is to be in a lower tax situation during distribution years compared to the bracket you were in during contribution years.
Qualified retirement plans do two things: They defer taxes and the tax calculation. During distribution years, do you know what tax bracket you will be in, what deductions you will have or what the tax rate percentage will be?
Do you REALLY believe you will be in a lower tax bracket after you retire and when you start receiving income from your qualified plan?
Questions to ask yourself if you own one of these accounts:
Is a retirement plan the best place to begin saving money?
What is your strategy or plan for withdrawing your money?
What tax bracket will you be in?
What deductions will you have?
What if you need to access this account prior to retirement?
Qualified Retirement Plans are most likely a suitable piece of your overall plan, especially if you have an employer match. However, if you are forced to borrow and pay interest because you cannot access the money in this account, you may need to reconsider the timing of your contributions to such an account. Does it make sense to contribute to these accounts while maintaining non-deductible debt at the same time?
You must have money that is accessible to you throughout your financial life or you may be forced to borrow money, which will lead to transferred dollars from your pocket to the pocket of someone else. This is not to say Qualified Retirement Plans are bad, they are not, but it is important you know and understand exactly what they do. A qualified retirement plan works very well in accumulating those dollars needed for retirement, especially if your employer matches contributions. In contrast, a qualified retirement plan may not be as efficient during the distribution years. In successful planning you must have a plan and a process that will enhance the advantages while reducing the potential wealth transfers associated with your qualified retirement plan.