There is a lot of worry among financial planners about Americans' lack of retirement saving.
The advice is usually straightforward: take advantage of tax-deferred savings accounts, especially if your employer will contribute to it.
No one is suggesting you shouldn't be socking money away for retirement, but writing in Kiplinger, Michael Reese, with Centennial Wealth Advisory, makes a case against deferring taxes on retirement savings.
With a traditional IRA or employer-sponsored 401(k) account, contributions to the account are tax deductible. So are any capital gains or income the account produces.
However, at age 70 and a half, the account holder must begin withdrawing the funds and paying taxes on the money as ordinary income. If the account holder dies before the funds are withdrawn, his or her heirs must withdraw all the money and pay taxes on it.
Pay now, not later
Reese argues savers would be better off socking the money away in a regular investment account, forgoing any tax deduction and then paying taxes on any gains or income at the end of each year.
“Think about it this way,” he writes. “Let’s say you are saving $18,000 per year in your 401(k) or 403(b). You are deferring income tax on $18,000 each year you deposit the money. But when you retire, you may have built up an account worth $1 or $2 million. That is $1 or $2 million that has never been taxed! And you, or your heirs, will pay tax on every penny of it.”
Reece says you might have avoided paying some tax on the seed, but you will owe quite a bit on the harvest.
The conventional thinking about tax deferred retirement accounts stems from the idea that people will be in a higher tax bracket during their working years and in a lower bracket during retirement, so the tax bite won't be as big when they withdraw the funds.
Reece says that isn't usually the case. Retirees have not lowered their living standard after their working years, and if they've saved and invested wisely, they haven't lowered their income.
If your employer will contribute to your IRA, Reece says you should take advantage of it, but only contribute the minimum. Don't make it your primary source of retirement savings.
A Roth IRA might be an attractive option. Contributions are not tax deductible, so withdrawals aren't taxed.
The important thing is that you are putting money away for retirement. How you do it is something you should discuss with your accountant or financial adviser.