Retirement: Which is Your Best Choice?
Retirement planning provides several options and is not a size fits all. This is why which is the best retirement plan is written to help you figure out which is best for you.
When it comes to retirement planning our clients have a number of different choices. Typically, they must decide between a tax deferred retirement plan or a Roth retirement plan. A tax deferred plan offers a tax deduction for contributions and then the money grows tax deferred. A Roth has no tax deduction on contributions but money grows tax free. Cash value life insurance can also be thrown into the mix as a potential retirement planning vehicle. There is no tax deduction for money contributed to a life policy but, if withdrawals are structured as loans, money can be taken out tax free. With all of these options it is helpful to compare them and see the advantages and disadvantages of each.
Tax Deferred Retirement Plan; Tax advisers often counsel clients to take full advantage of tax deferred retirement plans (traditional IRA, SEP, SIMPLE, 401k, etc). The advantages of these types of plans are:
- 1. Client receives a tax deduction for contributions
- 2. Gains grow tax deferred
- 3. It is possible that money will be taken out when the client is in a lower tax bracket
- 4. Funds have some protection from lawsuits and bankruptcy
- 1. Client is a 35 year old male in good health
- 2. He earns a net return of 7.5%/yr
- 4. He is in a flat 25% tax bracket now and in retirement
- 5. He earns $100,000/yr and will get Social Security in retirement based on that income
- 6. His retirement goal is to generate the future value of $24,000/year after tax, that amount will increase every year with inflation.
- 7. Inflation is 3%
- 8. He will live until age 90
- 1. At age 65 he will have accumulated $444,617.
- 2. He will be able to generate the income he wants after tax and will die with $860,887.
- 1. At age 65 he will have $523,934
- 2. When he dies he will have $1,366,476
- 1. He will have the same portfolio value of $444,617.
- 2. He will be able to meet his retirement income goal and will die with $1,522,508.
- 1. He would have an initial death benefit of $100,000 that his beneficiaries will get tax free if he dies. The death benefit would increase over time. This is very important should the client die prematurely, the traditional and Roth IRAs would only provide the value of all contributions while the life insurance strategy would provide much more.
- 2. At retirement he will have accumulated cash value of $332,004, his death benefit would have grown to $405,045.
- 3. He could take out tax free withdrawals and loans from his policy in the amount of $28,623/yr until age 90.
- 4. He could gift the insurance to a trust to have the death benefit payable outside of his estate.
Below is a numerical example of an IRA at work with a sample client.
Assumptions:
>LI>3. He is going to contribute $4,000/yr to a tax deferred retirement plan every year until age 65 when he will retire
Here are his results in retirement:
The client has saved $30,000 in taxes over 30 years. An argument could be made that he could have saved those tax savings, but in reality we very rarely see clients do this. If we assume that he saves his tax savings every year into a taxable account and earns the same 7.5% the outcome will be as follows:
Most people assume that they will be in a lower tax bracket in retirement, however this is not necessarily the case. We have no way of knowing what tax rates will be in the future, but with the problems that Social Security, Medicare, and Medicaid are having it is naive to assume that they will be lower.
He now has a pool of money where every dollar that comes out is taxable. Depending on his income, distributions could also affect the taxability of his Social Security. He is also forced to start taking money out at 70 ½ whether he wants it or not.
Roth IRA & 401k; The Roth IRA and the new Roth 401k have given clients another retirement planning option. Roth contributions are not tax deductible but grow tax free. There are also no required minimum distributions and distributions do not affect the taxability of Social Security benefits.
If we use the same example as above our client will have the following results at retirement:
This clearly leaves the client in a better situation than the tax deferred strategy, even if we assume he invests his tax savings.
Of course every client situation is different and the facts and circumstances will dictate which type of retirement strategy is best.
Life Insurance Strategy; The Life Insurance Strategy directs the contributions into a life insurance policy instead of a tax deferred or Roth retirement plan.
For this example we used the same return assumptions. For this particular insurance product we needed to use numbers that were much more conservative than most insurance companies would illustrate. We also used an equity indexed life insurance product that can slightly lower potential returns but that has a guaranteed minimum return (vs. a variable life insurance contract that has no limit on the upside and no limit on the downside).
The results are as follows:
The life insurance strategy has no limit on contributions, provides a death benefit that makes the plan fully funded at death, has no income limitations, and it can be removed from the estate.
High income clients might have estate tax issues and may not be able to contribute to a Roth or Traditional IRA. The insurance strategy has no limits on contributions, regardless of income, and it can be removed from the estate. This makes the life insurance strategy something to think about.
Article Source: EzineArticles.com
