Episode #95: The Importance of Tax Diversification in Your Retirement Plan

Episode #95: The Importance of Tax Diversification in Your Retirement Plan

“It is a fact that when your national debt gets to the level ours is, that it constitutes an economic threat to the society… And that kind of threat ultimately has a national security consequence for it.” - U.S. National Security Advisor, John Bolton

In this episode of Money Script Monday, Brian presents a retirement strategy where every dollar you fund is exempt from both taxes and stock market losses.


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Video transcription

Hi. Thank you for tuning in to another episode of Money Script Monday. My name is Brian Manderscheid.

Today, what I want to do is talk about the importance of tax diversification in your retirement plan.

This is a very serious issue, and believe it or not, our own Federal Reserve Chair, Jerome Powell, recently went on record stating that the U.S. federal government is on an unsustainable path.

Meaning that the national debt as a percentage of our GDP is rising and rising at a rapid rate.

There have also been a lot of political figures talking about raising taxes on the wealth, everything from the wealth tax, the 70% tax rate, and lowering the estate tax exemptions.

So, if you're a high-income earner, this topic should definitely affect you, and you should be thinking of how you can diversify your retirement plan.

Today, what I want to do is talk about the federal debt, where we stand today, your options to fund your retirement, tax-deferred vs tax-free, and finally, three tax-free retirement income options.

Federal Debt

First, let's talk about the federal debt.

federal debt

Now, that's a large number with a lot of zeros behind it. It's actually $22 trillion dollars, and that's where we stand today.

Actually, if you go to a website called usdebtclock.org, you can actually see real-time what the federal debt is, and it's rising by the second.

Believe it or not, in 2028, the national debt is expected to be $33 trillion, which is again, a large increase of where we are today.

The national deficit, which is not what we have the debt already in the books, but just the difference between what the government spends and what they take in in the form of taxes is actually $935 billion and should approach a trillion dollars by the end of the year.

So, again, not only do we have a lot of debt on the books, we're spending at near historic rates.

If we look at our national debt as a percentage of our GDP, gross domestic product, by 2034, it's expected to be 106%.

The importance of that is that's going to match the highest level that's been on record, which was during World War II, which we obviously had some very, very serious problems as a nation.

Again, this is a monumental number if we hit it.

*Now, if we look not just at the debt we already have, or the deficit, but the interest on our debt, it's expected to be higher than what we currently spend on Medicaid by 2020.

In 2023, the interest on the debt is expected to be higher to be than what we spent for national defense.

And finally, by 2025, just the interest on our national debt is expected to be higher than all non-defense discretionary programs.

Basically, everything our federal government spends not including defense.

So, again, especially if you're a high-income earner, you can see this is definitely a serious issue.

Tax Deferred vs. Tax Free

Let's next talk about how you can fund your retirement plan.

There's really two options. One is tax-deferred, and the second is tax-free.

tax deferred vs tax free

With tax-deferred, you basically take a tax deduction today, and pay taxes on the dollars you decide to contribute, and all the gains in the future have potentially higher tax rates down the road.

People often fund this type of retirement plan for the immediate gratification of getting the tax deduction up front.

However, really what the tax deduction is, is a tax postponement to again, where you'll pay the taxes on those dollars and on the growth from those dollars at some future later date, when tax rates again may be higher.

The second option is a tax-free option.

With a tax-free option, you pay taxes now while they're at near historic lows and enjoy all the gains, distributions and transfers, tax-free.

Now, you have to ask yourself, where do you think tax rates are going to go?

Up, down, or stay the same?

If you think tax rates are going to go up, it makes sense to pay taxes now, while they're again, at historic lows, funded into a tax-free retirement option so you can have tax-free income to hedge against those future higher-income tax brackets.

Now, if you believe tax rates are going to be less, which maybe you expect a substantial decrease in your lifestyle in retirement, then potentially tax-deferred option could be better for you.

Keep in mind, even if you're going to retire at, let's say, 70-80% of what you made in your working years, you still actually could be in a higher tax bracket.

Most likely you're going to lose your three major deductions: mortgage interest, your qualified contributions, and your child-tax credits.

If tax rates don't go up or down and instead stay the same, mathematically, whether you fund a tax-deferred or tax-free option, doesn't matter.

However, what I'll tell you is that tax rates never really stay the same.

They're always constantly moving up or down over the years based on what the government needs at the time and what administration is in power.

Even if you don't believe that tax rates are going to go drastically higher or lower for that matter, it still makes sense to have tax rate diversification by having money in both tax deferred and tax-free accounts to hedge against tax rate volatility.

We talked about federal debt, we talked about tax-free and tax deferred options.

Tax Free Retirement

Let's next talk about the tax-free retirement income plan.

tax free retirement

There are really three different options to choose from, the first being a Roth 401(k).

Now, the benefit of Roth 401(k)is you can contribute up to $19,000 per year, $25,000 if you're 50 and over using the catch-up provision.

The downside is not all employers offer a Roth 401(k), so there is limited access.

The next option is a Roth IRA, which you can fund $6,000 per year or $7,000, if you're 50 and over.

If you make too much income, which is $137,000 if you're single or $203,000 if you're married, you actually cannot fund a Roth IRA.

Now, there is a strategy called the backdoor Roth IRA.

However, if you have pre-existing IRA assets, due the pro-rata rule, that creates issues with doing the free Roth conversion, and that may not be an option for you.

Also, with the Roth IRA, just be aware of the five-year rule. Distributions may not be tax-free and could be potentially taxed and penalized.

Let's say your employer doesn't offer a Roth 401(k)or you want to contribute more than those limits, or you make too much money for a Roth IRA or again, you want to contribute more, the next best option is an indexed universal life policy.

Now, with an IUL policy, it's a life insurance contract, so you definitely want to have a want and need for insurance.

The benefit being that there's actually no contribution that the government imposes, so if you want to fund $20,000, $30,000, $40,000, $50,000 or more, you have the flexibility to do so.

Additionally, the way the IUL policy works is you actually get the upside gains of the stock market up to a limiting factor, like a cap rate, the trade off being there's a zero percent floor protected from the stock market declines.

Think of the IUL policy as a bunker, where every dollar you fund into the policy is exempt from both tax rates in the future and stock market losses.

We talked about the importance of tax diversification.

To emphasize that point, there was a U.S. National Security Advisor named John Bolton, who actually said that the national debt is an economic threat to society, which carries national security consequences.

Again, our own federal government is saying this is a serious problem and so should you as well.

If you're a high-income earner especially, you definitely want to take advantage and consider doing some tax diversification in your retirement plan.

If you think about it, you're already most likely diversifying against stock market risk by putting a portion of your money in stocks and a portion of your money in bonds.

Why not take the added step to tax diversify your retirement plan by putting a portion of your money in tax-free, and a portion of your money in tax-differed?

With that, thank you very much. We'll see you next time.

The information here is presented by licensed professionals and not specific to any individual's personal circumstances. To the extent that this material concerns tax matters, it is not intended or written to be used, and cannot be used, by a taxpayer for the purpose of avoiding penalties that may be imposed by law. Each taxpayer should seek independent advice from a tax professional based on his or her individual circumstance. These videos are provided for general information and educational purposes based upon publicly available information from sources believed to be reliable. The information presented may change at any time and without notice.

*Source: https://finance.yahoo.com/news/us-debt-payments-soon-exceed-160557722.html

About Brian Manderscheid

Brian Manderscheid is the Vice President of Case Design at LifePro. He works with financial professionals designing advanced case illustrations that are built for longevity and are always in the best interest of the client.


This information is meant for educational purposes only.

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