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Are you generating an IOU to the IRS with your current retirement plan?

by Susan Wright | Contributor
Nov 18, 2019


If you’ve been putting away money for the future in a “traditional” retirement plan like an IRA or 401(k), it’s nice to know that your money can generate a return without the need to pay tax on the gain until the time you withdraw it in the future.

But money that is tax-deferred doesn’t mean that you will never have to pay taxes on it – rather, that you are simply postponing it. And, while your tax-deferred account has the ability to increase more than that of a taxable investment account, it may not necessarily mean that you’ll get to enjoy all of the benefit yourself.

In fact, the more your tax-deferred account grows over time, the happier the IRS gets – because their share of the pie is also getting larger. Plus, with required minimum distribution rules – which stipulate that you must begin taking withdrawals at age 70½ (or otherwise face a penalty) – Uncle Sam knows exactly when he will be getting his (i.e., your) money.

The good news is that there are ways that you can reduce – or even eliminate – the taxes that you’ll owe on your income in retirement. Doing so could increase the amount that you can actually spend, and in turn, enhance your future purchasing power … and ultimately, your future lifestyle.

When is $1 million not really $1 million?

If you spend any time surfing the Internet or watching TV, it’s likely that you’ve seen a myriad of commercials from financial services companies touting how you need to reach “your number” or save a certain amount of money so that you can enjoy a prosperous retirement.

But the reality is that there is no particular amount of savings that is right for everyone – in fact, the amount of assets you have saved doesn’t mean nearly as much as you think it does when it comes to living a comfortable and stress-free retirement lifestyle. Nor can it guarantee that you’ll be able to generate income for as long as you need it to (which for most people is an unknown amount of time).

Here’s an example to consider. Say that you have $1 million saved for retirement. If that money is taxable, the amount that you actually have available to spend could be considerably less.

  • $1 million – 37% tax = $630,000
  • $1 million – 70% tax = $300,000
  • $1 million - ?? future tax = ??

So, depending on where exactly you have that $1 million stashed away, it could be that Uncle Sam will be taking a fairly large chunk of icing directly off the top of the cake for himself.

For instance, if most – or all – of that money is saved in a traditional IRA or 401(k) plan (where you were able to defer your contributions and the taxes on the gains until the time of withdrawal), what you receive could be 100% taxable.

To take it a step further, no one knows what the income tax rates will be in the future. But, because we’ve been sitting in a historically low interest rate environment for more than a decade now, the likelihood of taxes going up in the future are much more likely than the rates going down.

How high could income taxes go?

Although nobody has a crystal ball, over the past century, the top federal income tax rate has been in excess of 70% nearly 50 times, and more than 90% for 13 years in a row, between 1951 and 1963.

Year Rate
Year2018 - 2019 Rate37
Year2013 - 2017 Rate39.6
Year2003 - 2012 Rate35
Year2002 Rate38.6
Year2001 Rate39.1
Year1993 - 2000 Rate39.6
Year1991 - 1992 Rate31
Year1988 - 1990 Rate28
Year1987 Rate38.5
Year1982 - 1986 Rate50
Year1981 Rate69.125
Year1971 - 1980 Rate70
Year1970 Rate71.75
Year1969 Rate77
Year1968 Rate75.25
Year1965 - 1967 Rate70
Year1964 Rate77
Year1954 - 1963 Rate91
Year1952 - 1953 Rate92
Year1951 Rate91
Year1950 Rate84.36
Year1948 - 1949 Rate82.13
Year1946 - 1947 Rate86.45
Year1944 - 1945 Rate94
Year1942 - 1943 Rate81
Year1941 Rate81
Year1940 Rate81.1
Year1936 - 1939 Rate79
Year1932 - 1935 Rate63
Year1930 - 1931 Rate25
Year1929 Rate24

Can you really generate tax-free income in retirement?

There are actually several ways that you can generate tax-free income in retirement. One is by having a Roth IRA account. In this type of IRA, the contributions go in after-tax. However, your withdrawals come out tax-free.

Unfortunately, though, Roth IRAs only allow a maximum amount of contribution each year. (In 2019, this amount is $6,000 if you are age 49 or younger, and $7,000 for those who are age 50 and over.)

There are also income limits that could prevent you from opening a Roth IRA account. For example, you could earn “too much” to qualify for a Roth, based on your annual income and your tax-filing status.

Roth IRA Income Limits (2019)

Tax Filing Status Income (2019)
Tax Filing StatusMarried and filing a joint tax return Income (2019)At least $193,000, but less than $203,000
Tax Filing StatusMarried, filing a seperate tax return and lived with spouse at any time during the year Income (2019)More than zero, but less than $10,000
Tax Filing StatusSingle, head of household, or married filing separately without living with spouse at any time during year Income (2019)At least $122,000, but less than $137,000

There is another tax-free income option, too – and it’s one that many investors are not aware of … at least in terms of generating a tax-free income stream. That is through a properly structured permanent life insurance policy.

With a life insurance retirement plan, the money within the policy’s cash value component is allow to grow tax-deferred – but that doesn’t mean that you have to pay Uncle Sam when you access these funds to supplement your retirement income (or for any other need), as long as you do so via a policy loan.

In this case, you aren’t technically borrowing against your policy. Rather, you are accessing money from the underlying insurance carrier, and simply using the life insurance policy as collateral. Because of that, the cash in your account will still continue to grow and compound.

Depending on the actual policy, the loan could be subject to interest (which is simply added to your overall policy loan balance). While you have the option of paying back the tax-free loan, an alternative strategy is to have the balance paid out of the death benefit when the time comes.

In addition to providing a tax-free source of income – regardless of how high income tax rates rise in the future – there are other benefits that are also available with the right type of permanent life insurance policy, including:

  • Income tax-free death benefit to beneficiaries.
  • No loss to the cash value, even if the stock market performs poorly .
  • Coverage for life, regardless of your future health condition (provided that the premiums are paid).
  • Ability to access the death benefit “early” for medical and / or long-term care purposes.
  • No annual maximum contribution (unlike IRAs and employer-sponsored retirement plans).
  • No required minimum distribution.

Even if you have already “maxed out” your annual Roth IRA contribution, a life insurance retirement plan can allow you to continue taking advantage of tax-deferred growth, while at the same time providing an opportunity for tax-free income down the road.

How can you take control of who benefits most from your retirement savings?

While you may still have to pay some income taxes in retirement, you actually have more control than you think when it comes to the portion that Uncle Sam will be entitled to – and that starts with having a good, solid retirement income plan in place.

Alliance America can help

Alliance America is an insurance and financial services company. Our financial planners and retirement income certified professionals can assist you in maximizing your retirement resources and help you to achieve your future goals. We have access to an array of products and services, all focused on helping you enjoy the retirement lifestyle you want and deserve. You can request a no-cost, no-obligation consultation by calling (833) 219-6884 today.

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