Does Deferring Taxes to Retirement Make Sense?

Does Deferring Taxes to Retirement Make Sense?

One of the basic premises of putting money into a tax-deferred vehicle like an I.R.A. or 401(k) is that you are likely to be in a lower tax bracket after you retire.  The presumption is that your income during your retirement years will be lower and the tax rates will be the same.  But does that really make sense?

Currently, thanks to the tax cuts pushed early in the G.W. Bush years, income tax rates are pretty low by historical standards, especially the rates for capital gains.  The big question is – Will they stay that way?

Governments at all levels (federal, state, local) are currently having trouble paying their bills.  The combination of a bad economy coupled with exorbitant pay and benefits given to government workers has led to a lot of deficit spending that cannot continue. This has caused most government levels into draconian spending cuts in education, court services, and benefits for the poor and disabled.  It seems unlikely that these cuts can increase.  What’s the alternative?  Tax increases!

It seems to me that we’re likely to see major increases in tax rates in coming years.  In some states, it’s not easy to raise tax rates (like California), but I don’t think we should ever underestimate the resolve of politicians if they think they’ll take less flak for raising rates than for cutting benefits.

So, if tax rates are likely to increase in the future, does it make sense to defer taxes from the present, when rates are lower, and pay them later, when rates are higher?  Logically, it doesn’t make sense unless the difference between your current income and your income at retirement will be large enough to offset the difference in tax rates.

It used to be that retirement meant something different than it does today.  When you retired, your house was paid off, you had few debts, if any, and you expected to live a quieter and less active life.  From everything I read today, that’s no longer the case.  For many of us, we’ll simply spend a little less time working while exploring our “bucket lists”.  To the “baby boomers” who are now retiring, a major drop in income is not in their planning.  Which brings us back again to the question – should you be deferring taxes from today to the future, when income tax rates are likely to be higher?  To which I would add – Is there a valid alternative?

I believe there is.  There are products available today that will allow you to save after-tax income from today, compound it free of income taxes at a good rate of return, then spend it later without income taxes.  Think of your current income as a small box.  Imagine your savings from that small box, compounded tax free over a period of 20-25 years.  Your savings plus interest after that period of time is a large box.  The question is – would you rather let the government tax the small box now or tax the big box at higher rates later?

What is this product that will allow your savings to grow free of taxes, then be spent tax-free later?  Equity indexed universal life insurance.  This is not your daddy’s life insurance!  For more information and a no obligation consultation, give me a call at 714-585-2371.



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